GIDec2014lowres

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Central securities depositories

Custody networks

GCC capital markets

Safety in numbersWhy beneficial owners are

seeking greater transparency

December 2014/ January 2015

GLOBAL INVESTOR/ISF DECEM

BER 2014/jANuARy 2015 uS LEN

DING GCC M

ARKETS HEDGE FuND DIVESTM

ENT 2015 OuTLOOK M

SCI uPGRADES CuSTODy NETW

ORKS COLLATERAL MAN

AGEMEN

T RISING RATES N

ORDIC ROuNDTABLE N

uMBER 274

Calendar Performance (%)

Year-to-Date 2013 2012 2011 Since

inception

Arabian Markets Growth Equity Fund 28.66 37.95 11.91 -2.16 9.26

S&P Pan Arab Composite Large Mid Cap Index 21.55 21.62 3.10 -13.62 0.66

Relative Performance 7.11 16.33 8.81 11.46 8.60



inception

Rasmala GCC Fixed Income Fund 6.50 1.14 14.56 6.47 10.03

Citigroup MENA Broad Bond Index GCC 6.03 0.03 12.63 7.49 7.11

Relative Performance 0.46 1.11 1.93 -1.02 2.92

Source: Rasmala’s internal performance measurement, as at 30 September 2014.

Performance is net of fees based on A-Share Class in USD. The inception date of

the fund was 30 July 2006. Five star Morningstar award, as at 30 September 2014.


Performance is net of fees based on Distribution Share Class in USD.

The inception date of the fund was 31 March 2009.

Morningstar Rating

Your guide to the MENA regionRasmala, Arabic for “Capitalization”, is a MENA based institutional boutique asset management firm operating in the region since 1999. From Morocco to Oman, Rasmala specializes in the professional money management of funds and portfolios across the MENA markets in a variety of asset classes including equities, fixed income, money market and other alternative investment strategies. Our team of 19 professionals, based across the region, bring a unique investment philosophy and track-record that caters to the need of our clients’ investment objectives.

This advertisement is prepared by Rasmala Investment Bank Limited (“RIBL”). RIBL is regulated by the Dubai Financial Services Authority (“DFSA”). Financial products or services related to this advert. will only be made available to customers who RIBL is satisfied meet the regulatory criteria to be a “Professional Client”, as defined under the Rules and Regulations of the Dubai International Financial Centre (“DIFC”). This advertisement does not, and is not intended to, constitute an invitation or an offer of securities in or from the DIFC and accordingly should not be construed as such. This advertisement has not been reviewed by, approved by or filed with the DFSA. Nothing in this advertisement is intended or purports, nor should be deemed or construed, to be an offer or solicitation with respect to securities or financial instruments. This advertisement does not constitute a commitment to conclude a transaction, nor are any terms legally binding on any person.

Investment is our HeritageTel: +971 4 424 2700, +971 4 424 2757 | Email: [email protected] | Web: www.rasmala.com Dubai International Financial Centre, The Gate Village, Building 10, Level 1, P.O. Box 31145, Dubai, UAE.

Past performance is not a guarantee of future returns.

GLOBAL INVESTOR/ISF dEcEmBER 2014/jANuARy 2015 1 WWW.GLOBALINVESTORMAGAZINE.COM

| EDITOR’S LETTER

Editor Alastair O’Dell Tel +44 (0)20 7779 [email protected]

Reporter Hannah Smithies Tel +44 (0)20 7779 8990 [email protected]

Reporter Paulina PielichataTel +44 (0)20 7779 [email protected]

Contributors Ceri Jones, Dave Simons and Paul Golden

Design and production Keith Baldock

Publisher Will Browne Tel +44 (0)20 7779 [email protected]

Business development manager Zara Mahmud Tel +44 (0)20 7779 [email protected]

Business development executive Tim Willmott Tel +44 (0)20 7779 [email protected]

Marketing manager Gillian Harris

Reprints Christine [email protected]

Publishing director Stuart Allen

Divisional director Danny Williams

Global Investor/ISFNestor House, Playhouse YardLondon EC4V 5EX, UKwww.globalinvestormagazine.com

Next publication February 2015

Global Investor Incorporating ISF (USPS No 001-182) is a full service business website and e-news facility with supplementary printed magazines, published by Euromoney Institutional Investor PLC.

Annual subscription rate US$1400 £825 (UK only) ¤965 ISSN 0951-3604

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Directors Sir Patrick Sergeant, The Viscount Rothermere, Christopher Fordham (Managing Director), Neil Osborn, Dan Cohen, John Botts, Colin Jones, Diane Alfano, Jane Wilkinson, Martin Morgan, David Pritchard, Bashar AL-Rehany, Andrew Ballingal, Tristan HillgarthPrinted by Buxton Press

© Euromoney Institutional Investor PLC, London 2014

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Dear reader,

We have once again reached the time of year to take stock and to turn our attention to the future. It has been a stellar year for stock markets. In the US the S&P500 is now 25% above its pre-crisis level, fuelled by employment numbers smashing already punchy analysts’ forecasts. In Europe’s powerhouse economy, Germany, the DAX exceeds its previous peak by 20%. One may feel confident that all is well in the world and settle down for the festive season.

However, look elsewhere and the outlook is worrying. Bond yields hit record lows across Europe at the end of November and even 10-year US treasury yields have fallen from 3% to 2.3% during the year despite the approach of tighter monetary policy – so there is demonstrably a high degree of risk aversion in the markets. The equity bulls and fixed income bears cannot both be right.

It is not hard to identify problems. Outside the US it is hard to find much growth or even job creation. Europe teeters on the brink of recession once again and the solution to the eurozone’s problems remains as far out of reach as ever – desperately needed quantitative easing, if it ever happens, has been pushed back well into 2015. Russia’s energy-dependent economy appears to be on the brink of catastrophe. While the precipitous fall in the oil price has provided a fillip for some, it has created just as many losers. It is also an ominous sign that demand may be weakening – the last time the price fell this fast and far was 2008.

The Middle East is the region perhaps most exposed to lower energy prices. But when we held our Middle East Summit at the end of October, people were remarkably sanguine. Perhaps this was because there is so much else happening in the region ( from page 12), from the approaching internationalisation of Saudi Arabia to the great strides being made by regulators to strengthen markets.

Congratulations to all of the winners of our Middle East Awards (see page 18). It was a real pleasure to present them after our best-ever attended event in Dubai.

Kind regards, Alastair O’Dell Editor +44 20 7779 8004 [email protected]

Happy New Year?



inception

Arabian Markets Growth Equity Fund 28.66 37.95 11.91 -2.16 9.26

S&P Pan Arab Composite Large Mid Cap Index 21.55 21.62 3.10 -13.62 0.66

Relative Performance 7.11 16.33 8.81 11.46 8.60



inception

Rasmala GCC Fixed Income Fund 6.50 1.14 14.56 6.47 10.03

Citigroup MENA Broad Bond Index GCC 6.03 0.03 12.63 7.49 7.11

Relative Performance 0.46 1.11 1.93 -1.02 2.92


Performance is net of fees based on A-Share Class in USD. The inception date of

the fund was 30 July 2006. Five star Morningstar award, as at 30 September 2014.


Performance is net of fees based on Distribution Share Class in USD.

The inception date of the fund was 31 March 2009.

Morningstar Rating

Your guide to the MENA regionRasmala, Arabic for “Capitalization”, is a MENA based institutional boutique asset management firm operating in the region since 1999. From Morocco to Oman, Rasmala specializes in the professional money management of funds and portfolios across the MENA markets in a variety of asset classes including equities, fixed income, money market and other alternative investment strategies. Our team of 19 professionals, based across the region, bring a unique investment philosophy and track-record that caters to the need of our clients’ investment objectives.

This advertisement is prepared by Rasmala Investment Bank Limited (“RIBL”). RIBL is regulated by the Dubai Financial Services Authority (“DFSA”). Financial products or services related to this advert. will only be made available to customers who RIBL is satisfied meet the regulatory criteria to be a “Professional Client”, as defined under the Rules and Regulations of the Dubai International Financial Centre (“DIFC”). This advertisement does not, and is not intended to, constitute an invitation or an offer of securities in or from the DIFC and accordingly should not be construed as such. This advertisement has not been reviewed by, approved by or filed with the DFSA. Nothing in this advertisement is intended or purports, nor should be deemed or construed, to be an offer or solicitation with respect to securities or financial instruments. This advertisement does not constitute a commitment to conclude a transaction, nor are any terms legally binding on any person.

Investment is our HeritageTel: +971 4 424 2700, +971 4 424 2757 | Email: [email protected] | Web: www.rasmala.com Dubai International Financial Centre, The Gate Village, Building 10, Level 1, P.O. Box 31145, Dubai, UAE.

Past performance is not a guarantee of future returns.

2 dEcEmBER 2014/jANuARy 2015 GLOBAL INVESTOR/ISF WWW.GLOBALINVESTORMAGAZINE.COM

cOnTEnTS DEcEmbER 2014/JanuaRy 2015 |

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35

30

GLOBAL INVESTOR/ISF dEcEmBER/jANuARy 2015 9 WWW.GLOBALINVESTORmAGAZINE.cOm

| MIDDLE EAST ASSET ALLOCATION

The GCC is booming once again. The Dubai Financial Market General Index was up 46.7% as Global Investor/ISF went to press, even allowing for a near

20% correction since September due to the sharply falling oil price. But beyond such headline figures, there is strong evi-dence of growing sophistication in the GCC markets and the more balanced path of economic growth should protect against the excesses that led to the 2009 Dubai World-led crisis.

Nigel Sillitoe, CEO of Insight Discovery, says: “More and more companies are look-ing to establish a presence in the region – I am staggered by the amount of announce-ments of who is arriving in the Middle East, almost weekly. It is becoming a Who’s Who. There is a trend – whether based in Qatar, Bahrain or Dubai – to cover Africa, which is obviously the next opportunity for asset managers.”

GCC markets are expected to develop rapidly, with bolstered regulation, increas-ing international attention due to MSCI upgrades and Saudi Arabia set to join the international fold. But it is Dubai that is really setting the pace in the region.

Nick Tolchard, head of Invesco Mid-dle East, who has been in Dubai leading Invesco’s asset gathering operation since it acquired its licence in 2005, says: “The Dubai International Financial Centre (DIFC) has been a great place to be based. You remember a few years ago there was a debate, was it Dubai, Qatar, Abu Dhabi or even Riyadh? You sense that the DIFC is so firmly established now, everybody’s here. The new regulatory regime the Dubai Financial Services Authority is bringing in for the domiciling of funds is attracting interest. It has been one of the fastest-grow-ing parts of Invesco from a distribution perspective over the last nine years. We take the view that you need one base in the region – we now cover Africa from Dubai.”

Insight Discovery’s fifth annual Mid-dle Eastern Investment Panorama, based

on interviews with 236 financial advisers, mostly independent (IFAs), in the region, investigated the changes in exposure they expected to make over the next 12 months (see chart above). Global developed market equity strategies were the most positively viewed, in line with previous years, but structured notes were a surprisingly close second. Larger allocations are planned to be made to both structured notes and developed market equities over the next 12 months by 48.6% of respondents.

While increasing global equity alloca-tions suggest increasing risk, structured products have come into favour due to the protection that they offer from fall-ing markets, says Sillitoe. “There has been quite a big shift towards structured notes, which have not been that popular in the past. Most markets have been rallying pretty strongly so I think they want to take some risk off the table.”

Emerging markets remain popular, in

third position with 47.7% expecting to increase allocations, but have fallen down the rankings. It has traditionally been a strong asset class as non-resident Indians (NRIs) have a particularly strong home market bias and, as a result, are used to investing in volatile markets.

Just 25% of respondents planned to increase exposure to hedge funds of funds and 15% to single-strategy hedge funds. While hedge funds have long been popular with family offices they have been far less popular with financial advisers and banks. Says Sillitoe: “Banks and financial advis-ers remain wary due to bad experiences in the past. There is a tendency for FAs and banks to be more cautious.”

While still near the bottom, hedge funds are slightly more popular than in previous years. There has been a concerted effort among UK and US managers to start marketing in the region and there are more hedge fund managers setting up in

All roads lead to DubaiAsset allocation and capital flow data suggest that the GCC financial markets are developing rapidly. Alastair O’Dell investigates

Will your company’s or clients’ exposure to various strategies over the next 12 months increase, decrease or stay the same?

Sample size: 236

48.6%

48.6%

47.7%

42.2%

41.4%

32.9%

30.6%

29.6%

28.4%

25.8%

25.0%

24.8%

23.9%

22.8%

21.4%

15.0%

11.5%

39.6%

32.0%

33.6%

39.8%

44.2%

53.6%

38.2%

49.7%

47.2%

47.4%

44.1%

45.4%

49.5%

52.9%

36.9%

44.3%

49.8%

11.7%

19.4%

18.6%

18.0%

14.4%

13.6%

31.3%

20.8%

24.4%

26.8%

30.9%

29.8%

26.6%

24.3%

41.7%

40.7%

38.8%

Equity strategies – global developed

Structured products

Equity strategies – global emerging

Equity strategies – GCC stock

Equity strategies – GCC funds

Equity strategies – sharia-compliant

Alternative strategies – private equity

Fixed interest – GCC funds

Alternative strategies – real estate

Fixed interest – global developed

Alternative strategies – hedge fund of funds

Fixed interest – global emerging

Alternative strategies – other

Fixed interest – sukuks

Alternative strategies – gold

Alternative strategies – hedge funds

Cash

Increasing exposure Maintaining exposure Decreasing exposure

Middle eastern investMent PanoraMa survey of ifas


| analysis

Asset managers took the most severe reputational beat-ing from the financial crisis despite having little to do with causing the chaos. A

recent PwC survey of 2,000 adults in the UK found that only 12% of people trusted fund managers, putting them well behind retail banks (32%) and even investment banks (15%).

It is striking that asset managers are trusted by just a third as many people as trust retail banks, damaged by bail-outs, the payment protection insurance misselling scandal and association with the mortgage-led crisis, and investment banks, which have been pilloried as “casino” banks in the popular press. Why have asset managers fared so badly?

The report found that mistrust focused on asset managers due to a heady mix of emotive customer concerns and poor communication. The most cited concerns among individuals were particularly rel-evant for fund management – getting a poor return on savings (37%), overcharg-ing (31%) and risky investments (30%). It is striking that even the people that guide investors to products – financial advisers – were twice as likely to be trusted, by 28 percentage points.

This all seems a bit harsh. Asset manag-ers played little role in the financial crisis and none of them was bailed out with pub-lic money. Investors suffered no losses as a result of fund managers going out of busi-ness – and few did – as assets were simply transferred to another entity.

Additionally, with the exception of hedge funds or products at the exotic end of the spectrum, asset managers do not take on risk-enhancing leverage. Many measures have also been introduced in the intervening years to enhance investor pro-tection – such as the Retail Distribution Review – and reduce systemic risk.

Galling though it may be, you have to hand it to the retail banks. Veritable pari-ahs just a few years ago, retail banks are regaining trust at a faster rate than any other type of financial institution in the UK. One in 10 people trusts retail banks more than a year ago – the ratio is just one in 20 for asset managers.

Perhaps part of the reason for the reha-bilitation of retail banks is the effort put into managing their reputation. The sur-vey respondents said their anxieties were driven more by press coverage (25%) than personal experience (19%). Beyond the

top three concerns were four others, from selling data to a third party to the ethics of the business, representing 29% and 23% of customers respectively (see graphic above). While it is difficult to do anything about poor returns on savings when a related concern involves making risky investments, ethi-cal issues may be easier and cheaper to rectify.

Asset managers have not engaged with the public the way retails banks have, with lavish adver-tising stressing their community-minded, local values.

Cooperative Bank is shouting about the £1bn of loans it has withheld to people who failed to live up to its ethical policy and will make a £25 donation to charity on behalf of anyone who switches his or her current account to the bank. Barclays has launched LifeSkills, a platform to help young people learn about searching for jobs and money management. Nationwide had a big branding push based on having

no, presumably greedy, shareholders. Nat-West in England and RBS in Scotland have listed changes they have made to improve customer service in television adverts and online under the banner “goodbye” to unfair banking.

Whether all these campaigns ulti-mately prove to be successful or not, all these financial institutions see value in appearing benevolent. While improving cus-

tomer service through digital offerings, greater transparency and cost reductions are good, a stellar reputation could be a key differentiator in luring customers through the door.

Asset managers that can revolutionise the way they engage with customers and are able to articulate values and culture could have a major advantage. This is likely to become more important as defined con-tribution pension arrangements become more prevalent and market disruption from new entrants becomes more likely.

Incumbent asset managers must shake off their air of aloofness and tackle this very real issue. The experience of retail banks shows that reputations can be recu-perated and the benefits are substantial. g

Bad companyAsset managment’s reputation unfairly took a beating during the crisis. Ironically, they might have something to learn from retail banks, writes Hannah Smithies

Veritable pariahs just a few years ago, retail banks are regaining trust at a faster rate than any other type of financial institution

A stellar reputation could be a key differentiator to encourage

customers through the door

Consumers’ most significant concerns

37% 31% 30% 29% 25% 23% 16%23%

Which, if any, of the following would you say you are most concerned about regarding the way banks and thefinancial sector handle your money?

Getting a poorreturn on my

savings

Overchargingwith unfair fees

The institutionmaking riskyinvestments

with my money

My personaldetails beingsold to third

party

Security ofmy account

details

Security ofmy personalinformation

Thebusiness’s

ethics

Theinstitution

goingbankrupt

Source: PwC: Stand out for the right reasons

Consumers’ most signifiCant ConCerns


| NORDIC LENDING ROUNDTABLE

Chair: It has been a strong year for mar-kets and for M&A activity. We have also seen a slew of regulations. How have these affected the health of the securi-ties lending market?

Murphy: It has been a challenging year but stock lending is as important as ever as a liquidity tool within the financial mar-kets. Revenues have been challenged this year across some products in securities finance, but it is still an industry that offers an important return on assets in a difficult economic environment. Uncertain condi-tions also drive new demand from hedge funds, and encourages new supply into the market. I have not seen any beneficial owners choosing to leave this year.

Karczewski: This year and last year have been similar in respect to general flow, but the demand profile for securities is chang-ing a little. We are seeing stable demand on the equities side but an increase in demand for exchange traded funds and fixed income upgrade trades. With the regulation coming through the system there is going to be a squeeze on liquid-ity and an increase in downgrade-upgrade trades.

We have just issued a report for which our business advisory team canvassed 150 sovereign wealth funds, asset managers and hedge funds globally. Findings sug-gest the multibillion-dollar hedge funds see an opportunity to start financing their assets directly. Hedge funds do not have the same constraints as some of the more classic investors, as under Ucits rehy-pothecation is not allowed.

Rudilokken: I agree. This year our secu-rities lending business has improved. In Norway, when we came out of the finan-cial crisis in 2008-09, volumes were thin because suddenly everyone had pulled

out. Then, we saw the lenders came back to the market before the borrowers. After a couple of years international borrowers came back and during the last two years or so we have seen the local borrowers com-ing back into the market as well.

There are some demands from new requirements, especially requirements around equities which will need to be calculated in a different way. It will be interesting to see how the market devel-ops. Will it be the same players doing the same thing or will they differentiate them-selves more greatly in future?

Saebo: We are mostly lending assets in Norway and here we have seen increased demand versus last year. Especially, the Norwegian oil service sector is facing a tough time so there has been increased demand in that sector. And, this is in addition to high grade bonds for collateral upgrade-downgrade purposes.

Rudilokken: We are also working in the Norwegian market and see this increased flow, which looks to be specific to that country.

Murphy: We have seen strong flows but it has mainly been stock specific, with a slight increase in potential merger or arbi-trage in the final quarter and in small to mid-cap companies.

Karczewski: Did you see any change in pricing around oil stocks during the recent Scottish referendum? The UK was quite nervous generally with a lot of price fluctuation.

Saebo: We saw a little spike but the trend has been there for a while.

Chair: Have regulations and increased capital requirements already changed the securities lending business? And, what will be their future impact?

Karczewski: As a large US organisation, we are having to deal with Dodd-Frank and many other regulations. The impact on capital charges and balance sheets will be significant. We have to adjust the pricing accordingly, which the more sophisticated clients understand. The question is where do you pass on those charges? The issue is that we are currently not on a level playing field – capital is accounted for differently depending on the regulator of the bank or prime broker and whether it is Emea or US-based. Will the market start to pay less to borrow as a result? Or, simply use dif-ferent ways to source stock? A great deal is changing and new models are being adopted – this is the future for any large player.

Rudilokken: We see the same. We get

PARTICIPANTSCeri Jones, chair Dan Murphy, head of equity finance, SEBDag Rudilokken, head of trading, securities finance, DnB Jane Karczewski, managing director, prime finance and delta one, Citi Jorgen Saebo, head of treasury, FolketrygdfondetUlrik Modigh, head of asset management operation, Nordea

Northern exposureSecurities lending is expanding in the Nordics, albeit modestly and limited to certain sectors, but the issue of how the costs associated with new regulations will be spread between participants hangs over the market

18 december/January 2015 GLObaL InVeSTOr/ISF WWW.GLObaLInVeSTOrmaGaZIne.cOm

middle east awards |

Market movers The Global Investor/ISF Middle East Awards 2014 recognised the region’s top performers in financial services at its fifth annual gala ceremony in Dubai on October 29

Regional AwardsCEO of the Year: Shayne Nelson, Emirates NBDRegional Asset Manager of the Year:

QNB Asset ManagementRegional Broker of the Year: Mubasher

Financial ServicesEquities Manager of the Year: NBK CapitalFixed Income Manager of the Year:

Emirates NBD Asset Management Sharia Fund Manager of the Year:

Rasmala Investment BankSukuk Manager of the Year: BLMEGlobal Custodian of the Year: CitiSub-custodian of the Year: HSBCExchange of the Year: NASDAQ DubaiGCC Financial Centre of the Year: Dubai

International Financial Centre MENA Financial Centre of the Year:

Casablanca Finance CityWealth Manager of the Year: Barclays Cash manager of the Year: Arab BankTransition Manager of the Year: CitiFund administrator of the Year: Deutsche BankConsultancy Firm of the Year: Insight DiscoveryBest Newcomer of the Year:

Lazard Asset ManagementBest Newcomer Fund of the Year:

NBAD Asset Management

CEO of the Year

– Shayne Nelson

Equities manager – NBK Capital

22 december/January 2015 GLObaL InVeSTOr/ISF WWW.GLObaLInVeSTOrmaGaZIne.cOm

TARGET2-SECURITIES |

Target2-Securities (T2S) will soon be introduced progres-sively across much of the EU, but rather than simplifying settlement arrangements it is

so far leading to a proliferation of business models.

The aim of T2S is to end fragmenta-tion in eurozone securities settlement by providing a single platform to settle transactions in central bank funds across borders. The service will be offered at a flat price for all participating central securities depositories (CSDs) with no difference between domestic and cross-border transactions.

The initiative is introducing competi-tion between European CSDs that have previously largely enjoyed the status of natural monopolies. A European securi-ties settlement engine will enhance their ability to expand within the EU and, although it will not be completed until March 2017, CSDs are already positioning themselves for their opening moves.

As a core part of a CSD’s offering will be irrevocably outsourced to a third party, each will need to increase the scope of its services to counterbalance lower mar-gins from settlement. There will be some services CSDs will need to hang on to in each country, such as corporate actions and issuance, as these tend to operate in accordance with local laws, but the prize will go to those that develop cross-border settlement services, as well as increasing the value they add in asset servicing, con-sultancy and collateral operations.

“There will be a great incentive to oper-ate throughout Europe and to be able to move collateral from one country to another,” says Henry Raschen, head of regulatory and industry affairs for Europe at HSBC. “Countries with large volumes of

collateral to move will be attractive, and it will be interesting to see how collateral in smaller national markets is serviced by the larger CSDs compared to the country’s own CSD.

“Three main options seem to have evolved for participants – first, to build your own CSD. This is advantageous if you have the volume of assets, range of services and cli-ent base to achieve economies of scale. Second, some will consolidate set-tlement activity through their net-work of eurozone offices to be able to use one route into T2S using the CSDs with greatest functionality and lowest cost. Third, and possibly combined with the second option, some will become so-called directly connected participants (DCP).”

HSBC will become a DCP in the German market, its biggest securities settlement operation in the eurozone by trades set-tled, when settlement migrates to T2S in September 2016.

Mixed modelsSome larger banks are selecting a mixture of the DCP and ICP (indirectly connected participant) models depending on the market and provider in that market.

Owen Jelf, global managing director of Accenture’s Capital Markets practice, says: “Many banks are still deciding or have not yet taken any action – they want to see T2S implemented first and evaluate their options after the big volume players are on board.

“The complexity shift of providers can

be difficult and costly as interfaces and processes are typically embedded within a bank’s organisation. However, there are sizeable benefits, especially in liquid-ity pooling considering the markets’ risk and regulatory environment, which is why some of the bigger banks have already made the investment in defining a renewed network strategy including con-

nectivity to T2S.”JPMorgan plans

to insource settle-ment in six major European markets where the firm has critical mass, in wave two of T2S. “It is an opportu-nity to consolidate settlement on a

single platform,” says Diana Dijmarescu, managing director global markets infra-structures, at JPMorgan. “We think it will improve efficiency and allow us to manage our liquidity and collateral efficiently.

“We are already seeing a large a number of CSDs able to offer multimarket solu-tions but it depends on the type of client they are targeting – in most cases a domes-tic audience that is using existing gateways to local CSDs to access other markets.”

T2S’s first-wave user acceptance test-ing is now underway, and reports indicate progress is good, although history sug-gests that CSD system upgrades can be challenging.

Monte Titoli, an Italian CSD in the first wave, is focused on building market share. It has scrapped T2S adaptation charges for clients, and will bear ¤30m ($37m) in costs, which its general manager, Mauro Dognini, says covers its overall invest-ment from 2006-16 and includes its new asset servicing capabilities and collateral

“There will be a great incentive to operate

throughout Europe and to be able to move collateral from

one country to another” HEnry rascHEn, HsBc

CSD ascendencyTarget2-Securities will mean that CSDs will need to expand their offering in areas such as collateral management to remain competitive, finds Ceri Jones

1 EDITOR’S LETTER3 nEWS

The top stories from www.globalinvestormagazine.com6 anaLySIS

Hannah Smithies considers the wider implications of Calpers’ divestment of hedge funds

7 anaLySIS Hannah Smithies questions why the reputation of asset management has not recovered as quickly as that of retail banking

aSSET manaGEmEnT8 aSSET manaGER VOX POP

Leading asset managers give their recommendations for 2015 to Global Investor/ISF

9 Gcc aSSET aLLOcaTIOnAlastair O’Dell analyses asset allocation and capital flow data from the leading Middle Eastern economies

12 mIDDLE EaST maRKETSAfter a successful 2014, Alastair O’Dell talks to asset managers about the prospects for the region’s markets

14 Gcc FInancIaL cEnTRES Alastair O’Dell considers the state of the competition to become the leading regional financial centre

16 mScI uPGRaDESAlastair O’Dell investigates the effects of MSCI upgrading Qatar and the UAE to emerging market status

18 mIDDLE EaST aWaRDS 2014Global Investor/ISF recognised outstanding achievements in the region at a gala ceremony in Dubai

aSSET SERVIcInG20 cuSTODy nETWORKS

Regulatory developments are creating a multi-tiered custody market where sub-custody will become more regionally focused. Paul Golden investigates

22 TaRGET2-SEcuRITIEST2S will mean that CSDs need to expand their offering into areas such as collateral management to remain competitive, finds Ceri Jones

24 nET STabLE FunDInG RaTIOSThe Basel Committee has listened to the industry but has not delivered everything it wants. Alastair O’Dell considers the implications

SEcuRITIES FInancE26 cOVER STORy

Institutional investors are demanding increasing levels of data and transparency to remain comfortable with their lending programmes, finds Dave Simons

30 cOLLaTERaL manaGEmEnT US beneficial owners are increasingly managing collateral internally and considering non-cash alternatives, finds Ceri Jones

35 InTEREST RaTES US beneficial owners that are concerned about the impact of higher interest rates could learn much from previous rate cycles, writes Paul Golden

37 nORDIc LEnDInG ROunDTabLE Securities lending is expanding in the Nordics but the issue of how the costs associated with new regulation will be spread among participants hangs over the market

42 FacE TO FacE Massachusetts Prim has returned to securities lending after seven years. Deputy chief investment officer David Gurtz talks to Paulina Pielichata about why it restarted

44 PEOPLE mOVESMajor appointments in asset management, asset servicing and securities finance

45 bEST OF THE WEbContent available exclusively at www.globalinvestormagazine.com


| nEWS: aSSET manaGEmEnT

APPETITE FOR RISK GROWS AMONG INVESTORSGlobal investors’ appetite for risk has been restored amid greater optimism over the outlook for profits and the economy, according to a sur-vey carried out by Bank of America Merrill Lynch during November.

A net 47% of the global panel expected the economy to strengthen in the year ahead, a significant rise from the 33% recorded in October.

A similar level of positiv-ity was expressed relating to profits with a net 42% expect-ing global corporate profits to improve in the coming year, up from 27% last month.

Investors said deflation was the biggest risk to the market’s upward trajectory.

Nearly a third, 29%, of the global panel thought eurozone deflation was the biggest tail risk, followed by geopoliti-cal crisis (21%). Furthermore, when asked what they consid-ered to be the greatest risk in 2015, 71% cited deflation over inflation.

Investors have signalled that their optimism has been trans-lated into action over recent weeks. In October, a net 16% of the panel said they were tak-ing lower-than-normal levels of risk. This month, 2% are taking above-normal risk.

Asset allocators have shifted from cash and increased their allocations to equities. A net 13% of respondents to the global survey were overweight cash in November, down from a net 27% in October.

The proportion of asset allo-cators overweight equities has risen by 12% to a net 46%.

Japan is the region most in favour, while investors are sending mixed signals about appetite towards Europe.

A net 45% of global asset allo-cators were overweight Japan, a rise from a net 32% in October and 23% in September. n

uK INFRASTRuCTuRE INVESTMENT DRIVES GROWTHEvery £1 of infrastructure spending would increase UK GDP by £1.90 over three years, according to Standard & Poor’s (S&P). Increased infrastruc-ture investment would drive economic growth and bolster the UK’s competitiveness.

S&P expects real GDP to grow by between 2% and 3%

per year over the next several years. It projects spending on infrastructure would have a strong effect on job creation, with each extra 1% of GDP spent adding over 200,000 jobs in that year.

“The benefits of infrastruc-ture investment do not stop at the short-term boost to output

and employment,” said Jean-Michel Six, chief economist for Emea at S&P. “Over the longer term, improving infrastructure can enhance the private sec-tor’s productivity, for instance, by reducing transport and communication costs. And the resulting economic gains can be significant.” n

MAjOR CHANGE AHEAD FOR WEALTH MANAGERSThe vast majority (90%) of European wealth management senior executives expect consoli-dation, according to a joint report by JPMorgan Asset Management and Oliver Wyman, with 85% expecting that larger players will acquire smaller players.

Survey respondents also expected half of all European wealth to change hands. The report said the next generation of clients was emerging as wealth was created in new industries and a peak transition of wealth to a younger generation occurred over the next 20 to 30 years.

The survey revealed a number of challenges looming for the wealth management indus-try. Stefan Jaecklin, partner and head of the wealth and asset management practice at Oliver

Wyman, said: “The traditional wealth manager proposition is coming under strain. A clear understanding of the forces at play, a focused strategy and efficient execution will separate the future winners from the losers.”

Digital innovation would provide opportu-nities to engage and service clients better, but would also enable innovative players to disrupt the market. The regulatory focus on client pro-tection and the stability of the financial system was creating numerous challenges for wealth managers, but was also opening up opportuni-ties for differentiation.

The survey included responses from 23 wealth managers across Europe, as well as an online sur-vey of an additional 136 industry professionals. n

HEDGE FuNDS FAIL TO GRASP AIFMD IMPLICATIONSHedge funds in Europe are set to suffer a sharp increase in fines as well as rejection by investors as the majority fail to understand the funda-mental changes in governance, reporting and operational requirements under the Alternative Investment Fund Managers (AIFM) directive, according to ViClarity.

US and European regulators fined the banking sector a record $43bn in 2013, and this pressure

is set to continue as the authorities drive to mini-mise risk in this sector. Hedge funds are firmly in their sights, the compliance software provider believes.

Ogie Sheehy, founder and CEO of ViClarity, said: “Many hedge fund managers seem to think the directive just requires a change in reporting practices, but in fact a much more fundamental overhaul of business operations is required.” n

TRIENNIAL VALuATION DRIVES ‘SHORT-TERMISM’Regulators’ insistence on FRS17 valuations, the triennial cycle of valuation and modern portfo-lio theory is driving pension schemes to think in short-term nominal-return terms, according to 44% of institutional investors who took part in a Hermes Investment Management survey.

The growth in passive management was also cited as a cause for concern, with 61% of institu-tional respondents believing large shareholders were likely to “become unaware” of the compa-nies they invest in, forgoing voting rights and thereby losing influence.

Saker Nusseibeh, chief executive of Hermes said: “The short-term factors driving the man-agement of pension schemes require detailed

attention. Schemes need to have the freedom to act and focus on longer-term considerations to best serve their end-beneficiaries, savers.

“As asset managers, we have a responsibility to manage savers’ money as best we can, and that is often not achieved when short-term constraints are applied.

“I am stunned that less than one-third of inves-tors believe pension funds should look at the overall quality of life experienced by their ben-eficiaries, rather than maximising retirement incomes for their members.

“A staggering 49% of investors disagreed with this, 17 percentage points more than those who agreed.” n


nEWS: aSSET SERVIcInG |

SEC ADOPTS MARKET TECH INFRASTRuCTuRE RuLESThe US Securities and Exchange Commission (SEC) has adopted new rules designed to strengthen the technology infrastructure of US securities markets.

The rules, comprising Regu-lation Systems Compliance and Integrity, impose requirements on large trading platforms and market participants intended to reduce the occurrence of systems issues and improve resilience when systems prob-lems occur.

SEC chairman Mary Jo White said: “The rules mark an historic shift in the com-mission’s regulation of the US securities markets that will better protect investors by requiring comprehensive new controls for the technological systems that form the core of our current markets.

“The rules provide greater accountability for those responsible for our criti-cal market systems, helping ensure such systems operate effectively and any issues are promptly corrected.”

Given the current heavy reliance on technology and automated systems in the securities markets, the impact of technology failures can be significant. Recent technol-ogy issues in the markets have illustrated the risks of systems issues.

Under the regulation, self-regulating organisations, certain alternative trading systems, plan processors and certain exempt clearing agen-cies will be required to have comprehensive policies and procedures in place for their technological systems. n

SSE AND HKEx LAuNCH STOCK CONNECT PROGRAMMEThe Shanghai Stock Exchange (SSE) and the Hong Kong Stock Exchange (HKEx) have launched a joint venture that allows non-residents to invest in shares listed on the SSE and denominated in renminbi, known as China A-shares.

The Shanghai-Hong Kong Stock Connect Programme will enable Chinese firms to broaden their investor base and give investors access to the asset class.

Investors are now able to invest without having to apply for qualified foreign institu-tional investor or renminbi qualified foreign institutional investor status.

HKEx CEO Charles Li said: “The launch of Shanghai-Hong Kong Stock Connect is a very significant breakthrough in the opening of China’s capital

markets for both domestic and international investors, as well as a landmark in the interna-tionalisation of renminbi.”

While investors will have a lot more choice and diver-sity, the Chinese authorities have introduced restrictions designed to limit the influence of foreign capital.

Michael Mulvihill, equity product specialist at emerging markets investment manager Ashmore, said: “Despite the restrictions, foreign investors should rightfully see this as an opportunity to gain exposure to the dynamic reform and development activity within mainland China.

“The success of the pro-gramme will depend on the level of foreign demand and there are good reasons to believe demand will be strong.” n

MONTE TITOLI SCRAPS TARGET2-SECuRITIES ADAPTATION CHARGESMonte Titoli will not pass on the costs of its preparations for Target2-Securities (T2S) to its clients, according to new gen-eral manager Mauro Dognini, speaking at a BNP Paribas Securities Services semi-nar. He revealed that the central securities depository (CSD) had incurred adaptation costs for T2S of ¤30m ($37.8m).

“The decision to spend all this money and be an early mover is actually aimed at moving market share and increasing rev-enues,” said Dognini.

“T2S will bring a lot of changes. It will not happen tomorrow, but we will move out of the monopoly situation we are in today. It will increase competition among CSDs and might also increase competition between custodians.”

The step will differentiate the CSD from Clearstream and Euroclear, the two larg-est European CSD groups, which intend to charge their users a maximum of ¤30m and ¤25m respectively, as adaptation costs to T2S.

Monte Titoli will retain the same pricing for settlements throughout wave one and it may increase only slightly in the second wave. Custody fees will not go up.

The firm has taken a decisive pricing ini-tiative, according to Alan Cameron, head of relationship management, international banks and brokers. He said there were many good things about this, but it would rely on taking market share to be sustain-able. “Looking at what has been indicated, you have to wonder if they can sustain it.” n

SCM PRIVATE OuTSOuRCES TO SGSS Societe Generale Securities Services (SGSS) has been man-dated in the UK by investment company SCM Private to provide a wealth and investment management administra-tive outsourcing solution for its three new direct-to-consumer online wealth management solutions.

SGSS was selected for its capacity to provide a complete front to back-office wealth management solution. The solution pro-vides custody safekeeping at a segregated client account level.

SCM Private founder Gina Miller said: “[SGSS] under-stands the wealth management industry’s need and demand for a tailored turn-key solution that adapts both to regulatory and cost-cutting pressures, as well as the changing profile of end-investors.”

SGSS’s fully integrated wealth and investment management outsourcing solution, launched in the UK in September, is aimed at mid-tier wealth and investment fund managers.

CALLAN ASSOCIATES uTILISES PFAROEUS consultant Callan Associates has adopted RiskFirst’s real-time analytics and reporting platform, PFaroe.

The system will be used by Callan’s capital markets research group to help sponsors with their strategic planning, asset allo-cation and asset-liability studies, aiding the implementation of effective investment strategies and derisking solutions.

Jay Kloepfer, director of capital market and alternatives research at Callan, said: “More and more of our clients are imple-menting derisking flight plans and, in this respect, analytics are vital in enabling them to better monitor their funded status and decide when to execute changes in strategy.

“We view PFaroe as a major step forward in the analytics we can offer, allowing us to perform more frequent and deeper sim-ulation modelling, so that we have a real handle on clients’ risk positions. This puts us in a far stronger position to implement solutions and then monitor their success.”


| News: securities fiNaNce

FSB SEEKS STANDARDS TO PuRSuE SECuRITIES FINANCE DATAThe Financial Stability Board (FSB) is developing interna-tional standards to facilitate the collection of data on secu-rities financing markets. It wants all authorities to collect data, allowing the detection of risks to global financial sta-bility and the development of policy responses.

Mark Carney, chairman of the FSB, said: “The proposed standards are an important step to ensure authorities fully understand trends and risks in one of the core funding mar-kets for a wide range of market participants. The global data collection and aggregation based on the FSB standards and processes will help trans-form securities financing markets into more transparent and resilient sources of financ-ing that would better serve the needs of the economy.”

The FSB said enhanced data collection on securities financing markets is needed for authorities to obtain more timely and comprehensive visibility into trends and devel-opments in these markets.

It will complete its work on developing standards and processes by the end of 2015, based on public consultation findings and further discussion with market participants. By then, the FSB will also develop an implementation timeline for global data collection and aggregation.

Daniel Tarullo, chairman of the FSB standing committee on supervisory and regulatory cooperation, said: “The imple-mentation of the proposed standards and processes will allow authorities to establish a monitoring framework to support their efforts to effec-tively address financial stability risks stemming from securities financing.” n

LIquIDITy ALLIANCE ExTENDS T2S ACCESSWhen Target2-Securities (T2S) goes live in waves from 2015 to 2017, international members of the Liquidity Alliance will gain access to a pan-European liquidity and collateral pool.

Iberclear in Spain and Clear-stream’s central securities depository (CSD) in Germany, Clearstream Banking AG, will act as the gateway into T2S for the entire Liquidity Alliance.

Jesús Benito, CEO of Iber-clear, said: “This new facility

will allow all members to tap the huge collateral resources T2S will make available. In this way, we will be able to maximise the full potential of T2S, enhancing its capabilities and extending its reach at a time when the effi-cient access and use of collateral has become a priority.”

T2S will make cross-border settlement and respective col-lateral flows in Europe more attractive and boost collateral liquidity beyond and within Europe.

Monica Singer, CEO of Strate, a South African CSD said: “While we had already been fol-lowing [T2S] with interest from a distance, we did not think we could benefit directly. Our Liquidity Alliance membership now opens up a great opportu-nity to access T2S.”

When Clearstream con-nects to T2S in wave three on September 12 2016, it will also make eurobonds available on T2S. Iberclear will connect to T2S in wave four. n

ESMA’S DATA uNDERREPRESENTS SHORTING ACTIVITyUndisclosed short interest could represent as much as $28bn, double the amount

currently disclosed under the European Securities and Markets Authority’s (Esma’s)

regulation 236/2012, accord-ing to Markit.

There are 442 publicly dis-closed short positions under the Esma rule, which cover 250 companies with an aggregate value of $14.1bn.

Relte Stephen Schutte, an analyst at Markit, said: “While noble in intent, Esma’s disclo-sure requirements do leave market observers with some unanswered questions around the extent of shorting activity that takes place below the dis-closure threshold.

“Esma’s data does seem to underrepresent shorting activity overall, as the current aggregate value of the demand to borrow across the companies with publicly disclosed short positions represents $43.6bn, more than three times the aggregate value of disclosed positions.

“We estimate that the undis-closed data across Europe for the 453 companies represent another $28bn, almost double that currently disclosed.”

Regulation 236/2012 requires public disclosure of short positions in European listed equities where positions are greater than 0.5% of total shares outstanding for individ-ual companies. Trading firms are obliged to report these fig-ures to their national regulator in an overall effort to increase transparency and stability in capital markets. n

INTEDELTA AND FINADIuM TEAM uP UK-based risk and collateral consultancy InteDelta and US-based securities finance research and consultancy firm Finadium are partnering to provide a joint service to their clients. The partnership will combine InteDelta’s global risk consulting expertise with Finadium’s research offering as part of InteDelta’s global alliance programme.

The deal enables InteDelta to bundle Finadium research into its advisory assignments, complementing its existing retainer services and providing the firm with an increased capability to support on-site consulting in the US market. InteDelta’s core service offering in risk and collateral man-agement covers market intelligence, organisational change, business re-engineering, risk modelling, technology architec-ture design and systems implementation.

Finadium will be able to support its existing client base with longer-term on-site consulting and expand the reach of its research into the Asian market. Finadium’s activities in securi-ties finance cover collateral management, liquidity, securities lending, repo, prime brokerage, custody and related products. Finadium research reports include primary surveys, regula-tory analyses and product reviews.

ITALIAN SEC ExTENDS SHORTING BANItalian regulator Consob has extended the restriction on short selling until the end of trading on January 27 2015. The ban was first imposed on October 28.

The emergency measure renews the ban on the creation of new net short positions, and the increase of existing net short positions, on shares issued by Banca Monte dei Paschi di Siena and Banca Carige.

The ban concerns shares of the two banks and all related instruments included in the calculation of the net short position in accordance with Regulation 236/2012 and Commission Regulation 918/2012, with the exception of indices-related instruments.


anaLySIS |

Ripples of dissatisfaction have been spreading through the pensions world since early September, when the Cali-fornia Public Employees’

Retirement System (Calpers) announced it is to pull its entire $4bn hedge fund allocation. More than a few of its peers are now reassessing their own investment strategy.

The second-largest pension fund in the US put its decision down to “complex-ity”, “cost” and a “lack of ability to scale at Calpers’ size”. Across the pond, London Pension Fund Authority pulled out of Brevan Howard in June, citing “disap-pointing” results, its failure to disclose exposures and “unjustifiable” fees. The Dutch pension fund PMT exited in Sep-tember, largely due to costs.

So far there has been no exodus, but there are indications of a marked slow-down in fresh allocations. While Hedge Fund Research (HFR) notes that total assets in Q3 2014 of $2.82trn was the ninth consecutive quarterly record total, the pace of inflows is slowing. Just $15.9bn of new capital was allocated in Q3, a signif-icant decline from the $30.5bn of inflows during Q2, and well below the $23bn of Q3 2013.

Figures from Eurekahedge are even more downbeat, suggesting that hedge funds are experiencing a fourth consecu-tive month of net outflows, with investors redeeming $20bn since August, trimming year-to-date net asset inflows to $55bn.

The extent to which other pension funds are thinking along the similar lines – the Teacher Retirement System of Texas and the UK’s Railways Pension Scheme are all reviewing their allocations – will become clear in the coming quarters as the signifi-cantly-lagging data emerges.

Unfortunately, the early signs are not good. An EY survey showed that in North America and Europe, investors decreasing allocations outweighed those increasing by approximately 25%. Only 13% of insti-tutional investors planned to increase their allocation to hedge funds in the next three years.

High fees, low returnsIs it reasonable to think that we might be reaching a turning point? Discontent over high fees and poor returns has cer-tainly been brewing for some time. Only 19% of US investors said hedge funds were worth the fees, despite the fact that there is widespread evidence of fee erosion over the past few years, bringing down the “two and 20” fee structure closer to 1.5 and 18. A Pyramis survey conducted over the summer showed that 31% of institutional

investors in the US said hedge funds were the least likely asset class to meet perfor-mance expectations.

A Preqin survey showed that 59% of institutional hedge fund investors were looking mainly for reduced volatil-ity and just 7% were more motivated by high returns. If hedge funds satisfied the demand for low volatility and diversi-fied returns, they would justify their fees despite meagre returns – the problem is that they have not fulfilled even this for some time.

Research by Vanguard, a manager of low-cost funds and exchange traded funds, showed that most hedge fund categories failed to provide significant diversification beyond that of a 60:40 portfolio of stocks and bonds over the course of the financial crisis. Likewise, a study by IPAG business school found there were “significant cor-relations” between hedge funds and the stock market.

Matters have not been helped by the fact that hedge funds have severely underperformed the S&P500 since the beginning of the year. It is an unfair com-parison – hedge funds typically aim to deliver absolute returns, not necessarily high ones – but it provokes uncomfort-able questions in the light of Vanguard’s research.

The cost of selecting and monitoring hedge fund allocations compounds the problem. Calpers noted that they were simply “too complex”, taking more time to administer than was justified given that hedge funds cannot be scaled to a mean-ingful size for the mammoth fund.

Bright sideHowever, this turnaround should not worry the bulk of good hedge fund man-agers. Many institutional investors,

particularly in Europe and Asia, are stick-ing with hedge funds or even increasing their allocations. Asian private sector pension funds have increased their invest-ment in hedge funds from 13% in 2013 to 15.7% in 2014, according to Preqin.

This could be explained by different pri-orities for pension schemes across these regions. Those in the US most commonly – 28% of respondents – cite their fund-ing status as their top priority, so would naturally be drawn away to rapidly-rising equity markets.

Conversely, European investors were most concerned about the low-return environment (26%) and volatility (26%) and Asian investors most about volatil-ity (23%), risk management (21%) and the low-return environment (18%). Such

institutional inves-tors are more likely to be attracted by hedge funds that confidently offer stable 4% to 7% returns with a low risk profile, increasingly so when rising inter-

est rates may start squeezing bond values. Demand should be strong, at least until Europe and Asia follow the US into a period of sustained growth.

Whether Calpers’ decision turns out to be a catalyst or not, it seems that hedge funds will find investment from some quarters tailing off. This may benefit pen-sion funds, putting them in a stronger position to negotiate on costs and demand more tailored products. It may also have a positive impact on the hedge fund industry.

IPAG’s study suggested that the growing weight of hedge funds’ assets was one of the reasons they had become increasingly correlated with the stock market. With less money to manage, hedge funds could become more nimble and regain their ability to exploit market inefficiencies. g

Abandoning alphaHannah Smithies considers the impact of Calpers’ divestment of hedge funds

If hedge funds satisfied the demand for low volatility

and diversified returns, they would justify their fees despite

meagre returns


| anaLySIS

Asset managers took the most severe reputational beat-ing from the financial crisis despite having little to do with causing the chaos. A

recent PwC survey of 2,000 adults in the UK found that only 12% of people trusted fund managers, putting them well behind retail banks (32%) and even investment banks (15%).

It is striking that asset managers are trusted by just a third as many people as trust retail banks, damaged by bail-outs, the payment protection insurance misselling scandal and association with the mortgage-led crisis, and investment banks, which have been pilloried as “casino” banks in the popular press. Why have asset managers fared so badly?

The report found that mistrust focused on asset managers due to a heady mix of emotive customer concerns and poor communication. The most cited concerns among individuals were particularly rel-evant for fund management – getting a poor return on savings (37%), overcharg-ing (31%) and risky investments (30%). It is striking that even the people that guide investors to products – financial advisers – were twice as likely to be trusted, by 28 percentage points.

This all seems a bit harsh. Asset manag-ers played little role in the financial crisis and none of them was bailed out with pub-lic money. Investors suffered no losses as a result of fund managers going out of busi-ness – and few did – as assets were simply transferred to another entity.

Additionally, with the exception of hedge funds or products at the exotic end of the spectrum, asset managers do not take on risk-enhancing leverage. Many measures have also been introduced in the intervening years to enhance investor pro-tection – such as the Retail Distribution Review – and reduce systemic risk.

Galling though it may be, you have to hand it to the retail banks. Veritable pari-ahs just a few years ago, retail banks are regaining trust at a faster rate than any other type of financial institution in the UK. One in 10 people trusts retail banks more than a year ago – the ratio is just one in 20 for asset managers.

Perhaps part of the reason for the reha-bilitation of retail banks is the effort put into managing their reputation. The sur-vey respondents said their anxieties were driven more by press coverage (25%) than personal experience (19%). Beyond the

top three concerns were four others, from selling data to a third party to the ethics of the business, representing 29% and 23% of customers respectively (see graphic above). While it is difficult to do anything about poor returns on savings when a related concern involves making risky investments, ethi-cal issues may be easier and cheaper to rectify.

Asset managers have not engaged with the public the way retails banks have, with lavish adver-tising stressing their community-minded, local values.

Cooperative Bank is shouting about the £1bn of loans it has withheld to people who failed to live up to its ethical policy and will make a £25 donation to charity on behalf of anyone who switches his or her current account to the bank. Barclays has launched LifeSkills, a platform to help young people learn about searching for jobs and money management. Nationwide had a big branding push based on having

no, presumably greedy, shareholders. Nat-West in England and RBS in Scotland have listed changes they have made to improve customer service in television adverts and online under the banner “goodbye” to unfair banking.

Whether all these campaigns ulti-mately prove to be successful or not, all these financial institutions see value in appearing benevolent. While improving cus-

tomer service through digital offerings, greater transparency and cost reductions are good, a stellar reputation could be a key differentiator in luring customers through the door.

Asset managers that can revolutionise the way they engage with customers and are able to articulate values and culture could have a major advantage. This is likely to become more important as defined con-tribution pension arrangements become more prevalent and market disruption from new entrants becomes more likely.

Incumbent asset managers must shake off their air of aloofness and tackle this very real issue. The experience of retail banks shows that reputations can be recu-perated and the benefits are substantial. g

Bad companyAsset managment’s reputation unfairly took a beating during the crisis. Ironically, they might have something to learn from retail banks, writes Hannah Smithies

Veritable pariahs just a few years ago, retail banks are regaining trust at a faster rate than any other type of financial institution

A stellar reputation could be a key differentiator to encourage

customers through the door

Consumers’ most significant concerns

37% 31% 30% 29% 25% 23% 16%23%

Which, if any, of the following would you say you are most concerned about regarding the way banks and thefinancial sector handle your money?

Getting a poorreturn on my

savings

Overchargingwith unfair fees

The institutionmaking riskyinvestments

with my money

My personaldetails beingsold to third

party

Security ofmy account

details

Security ofmy personalinformation

Thebusiness’s

ethics

Theinstitution

goingbankrupt

Source: PwC: Stand out for the right reasons

Consumers’ most signifiCant ConCerns


aSSET manaGER VOX POP |

2015 outlookLeading asset managers talk to Global Investor/ISF about where they see opportunities in the new year

In the immediate aftermath of the US credit crisis, share prices rose faster than profits. This was followed by a repair phase when Federal Reserve stimulus was at its peak and cost savings, share buybacks and rising dividends were the main drivers of modest annualised total returns of 8% to 9% for US equities. We view the second half of 2014 as the period of transition from policy action to the repair phase in Europe. We expect this phase to continue through 2015, with single-digit total returns driven by a combination of earnings and dividend growth. But with less ability to cut costs, including labour, share buybacks less prevalent and dividends already high in proportion to profits, earnings growth will be the main driver of returns.

Arne Hassel, head of investments, Coutts

We see 2015 as being characterised by a continuing divergence in global growth that will create attractive pockets of investment opportunity for stock pickers. Given lower energy prices, we believe US consumption has the potential to accelerate, to the benefit of durables and luxury goods-related companies. In Japan and Europe, continuing currency weakness is likely to support those companies with a global footprint. It is worth mentioning that we do not expect the consumption recovery story to be derailed by potential interest rates hikes in 2015. India is the only bright spot in emerging markets in our view – it has an exciting investment story, with exceptional demographics and a vibrant private sector.

Alex Tedder, head of global equities, Schroders

US interest rates may remain lower for longer, perhaps even until 2020. Ris-ing inflation, which would be a prompt for the Federal Reserve to raise inter-est rates, is not expected to come into play, with little sign of wage or com-modity inflation to drive it higher. We will keep an eye on this as well as look-ing for any rhetoric reversal from the European Central Bank. In the mean-time, income orientated asset classes in the form of high-quality US equities, global natural resources and infra-structure could offer opportunities.

james Lydotes, Boston Company Asset Management

Cyclical assets will give the best investment opportunities in 2015 on the back of the increasing momentum of the global economic recovery. While the recovery will be led by the US and emerging Asia, it will be gradual and not likely to be in a straight line. Numerous risks remain, particularly the growth and deflation threats for the eurozone and Japan, alongside the fading economic momentum in the UK economy. Accord-ingly, those commodities and currencies poised to benefit from US and Chinese growth are likely to be the main benefi-ciaries in 2015. Our favoured assets are cyclical commodities such as industrial metals and energy, and the US dollar.

Nitesh Shah, Research Analyst at ETF Securities

With an increasingly uncertain outlook for global markets and a persistently low UK base rate constraining gilt yields, the clear message from the fund managers attending our con-ference this year was that to outperform long-term liabilities, institutional investors will need to look beyond domestic assets for positive returns in 2015. Almost half the fund managers (47%) expected that investment-grade and high-yield credit will deliver the weakest returns during 2015, so unsurprisingly allocations here are projected to decrease over the course of the year. With tight credit spreads and low gilt yields, these asset classes have clearly lost favour among institutional investors.”

Lennox Hartman, global head of fixed income strategies, Aon Hewitt

The FX market has traded on well-established themes for a couple of years with respective central bank policy and their bias of future direction being the main influence for foreign exchange. Gone is the focus on fiscal outlook, debt levels and, for the G10, even current account balance. Instead, in the context of global disinflation develop-ments, the countries closer to generating inflation in line with their target will continue to see strong exchange rates while the central banks in easing mode through lower pol-icy rates or quantitative easing should continue to expect weaker currencies.

The dollar will continue to outperform all other G10 cur-rencies in 2015 as we expect strong growth and Federal Reserve tightening in the second half of 2015. On the back of additional central bank measures we expect the yen, euro and Swiss franc to continue to depreciate. After we pushed back the first rate hike from the Bank of England until Feb-ruary 2016, the pound is likely to weaken further against the dollar. Norwegian and Swedish currencies will trade within a range against the euro after some near-term weakness.

The outlook for commodity currencies, such as Aus-tralian and New Zealand dollars, is uncertain. Usually we would expect them to come under pressure as the dollar appreciates. On the other hand they can offer some yield pick-up, which instead could benefit them. Although the Canadian dollar will underperform the US dollar, it should be among the strongest currencies as Canada should ben-efit from the US recovery.

Carl Hammer, currency strategist, SEB


| mIDDLE EaST aSSET aLLOcaTIOn

The GCC is booming once again. The Dubai Financial Market General Index was up 46.7% as Global Investor/ISF went to press, even allowing for a near

20% correction since September due to the sharply falling oil price. But beyond such headline figures, there is strong evi-dence of growing sophistication in the GCC markets and the more balanced path of economic growth should protect against the excesses that led to the 2009 Dubai World-led crisis.

Nigel Sillitoe, CEO of Insight Discovery, says: “More and more companies are look-ing to establish a presence in the region – I am staggered by the amount of announce-ments of who is arriving in the Middle East, almost weekly. It is becoming a Who’s Who. There is a trend – whether based in Qatar, Bahrain or Dubai – to cover Africa, which is obviously the next opportunity for asset managers.”

GCC markets are expected to develop rapidly, with bolstered regulation, increas-ing international attention due to MSCI upgrades and Saudi Arabia set to join the international fold. But it is Dubai that is really setting the pace in the region.

Nick Tolchard, head of Invesco Mid-dle East, who has been in Dubai leading Invesco’s asset gathering operation since it acquired its licence in 2005, says: “The Dubai International Financial Centre (DIFC) has been a great place to be based. You remember a few years ago there was a debate, was it Dubai, Qatar, Abu Dhabi or even Riyadh? You sense that the DIFC is so firmly established now, everybody’s here. The new regulatory regime the Dubai Financial Services Authority is bringing in for the domiciling of funds is attracting interest. It has been one of the fastest-grow-ing parts of Invesco from a distribution perspective over the last nine years. We take the view that you need one base in the region – we now cover Africa from Dubai.”

Insight Discovery’s fifth annual Mid-dle Eastern Investment Panorama, based

on interviews with 236 financial advisers, mostly independent (IFAs), in the region, investigated the changes in exposure they expected to make over the next 12 months (see chart above).

Global developed market equity strat-egies were the most positively viewed, in line with previous years, but structured notes were a surprisingly close second. Larger allocations are planned to be made to both structured notes and developed market equities over the next 12 months by 48.6% of respondents.

While increasing global equity alloca-tions suggest increasing risk, structured products have come into favour due to the protection that they offer from fall-ing markets, says Sillitoe. “There has been quite a big shift towards structured notes, which have not been that popular in the past. Most markets have been rallying pretty strongly so I think they want to take some risk off the table.”

Emerging markets remain popular, in third position with 47.7% expecting to increase allocations, but have fallen down the rankings. It has traditionally been a strong asset class as non-resident Indians (NRIs) have a particularly strong home market bias and, as a result, are used to investing in volatile markets.

Just 25% of respondents planned to increase exposure to hedge funds of funds and 15% to single-strategy hedge funds. While hedge funds have long been popular with family offices they have been far less popular with financial advisers and banks. Says Sillitoe: “Banks and financial advis-ers remain wary due to bad experiences in the past. There is a tendency for FAs and banks to be more cautious.”

While still near the bottom, hedge funds are slightly more popular than in previous years. There has been a concerted effort among UK and US managers to start marketing in the region and there are

All roads lead to DubaiAsset allocation and capital flow data suggest that the GCC financial markets are developing rapidly. Alastair O’Dell investigates

Will your company’s or clients’ exposure to various strategies over the next 12 months increase, decrease or stay the same?

Sample size: 236

48.6%

48.6%

47.7%

42.2%

41.4%

32.9%

30.6%

29.6%

28.4%

25.8%

25.0%

24.8%

23.9%

22.8%

21.4%

15.0%

11.5%

39.6%

32.0%

33.6%

39.8%

44.2%

53.6%

38.2%

49.7%

47.2%

47.4%

44.1%

45.4%

49.5%

52.9%

36.9%

44.3%

49.8%

11.7%

19.4%

18.6%

18.0%

14.4%

13.6%

31.3%

20.8%

24.4%

26.8%

30.9%

29.8%

26.6%

24.3%

41.7%

40.7%

38.8%

Equity strategies – global developed

Structured products

Equity strategies – global emerging

Equity strategies – GCC stock

Equity strategies – GCC funds

Equity strategies – sharia-compliant

Alternative strategies – private equity

Fixed interest – GCC funds

Alternative strategies – real estate

Fixed interest – global developed

Alternative strategies – hedge fund of funds

Fixed interest – global emerging

Alternative strategies – other

Fixed interest – sukuks

Alternative strategies – gold

Alternative strategies – hedge funds

Cash

Increasing exposure Maintaining exposure Decreasing exposure

Middle eastern investMent PanoraMa survey of ifas


mIDDLE EaST aSSET aLLOcaTIOn |

more hedge fund managers setting up in the DIFC.

The Invesco Middle East Asset Man-agement Study 2014 surveyed people representing a mix of sovereign investors, family offices, private banks, retail banks and IFAs across the GCC – skewed to the UAE – and describing themselves as either GCC local, Arab or western expatriate, or NRI. The fifth annual report found a higher degree of willingness to accept risk and money exiting structured products.

While in 2013 higher yields continued to draw retail investment into fixed income – over the past four years allocations to global fixed income increased from 9% to 14% and local fixed income from 2% to 8% – this is expected to reverse. Tolchard says: “According to the respondents, a lot of the fixed income will rotate into equities, as well as hedge funds and infrastructure.” This is was mirrored in Invesco’s global sovereign wealth fund (SWF) survey earlier in 2014, which found that a third expected to shift fixed income allocations towards equities.

Almost a third, 31%, of those in the retail market expected global equity allo-cations to increase into next year, and 21% expected to increase local equities. “For IFAs, equities are much more favoured than alternatives. But if you talk to SWFs, it is the other way round – they will be put-ting more and more into alternatives.”

This may be because retail inves-tors are more concerned with liquidity considerations and are wary due to the underperformance of products sold to them in the past. Says Tolchard: “Among

western expats, allocations to alternatives have fallen from 27% in 2014 to 10%. It is interesting to see the retail and institutional markets moving in opposite directions.”

Infrastructure has really picked up momentum over the past 12 months due to inflation concerns and long-term objec-tives but this is confined to brownfield or existing projects. Tolchard says: “That is why institutions are buying into UK air-ports rather than digging with the first shovel on HST2 [a proposed UK railway].”

There has been a trend towards invest-ing in local equities. The Invesco report found that western expats’ allocations

have gone from 2% to 10% over the past three years. Investors are increasingly keen to invest in the region and, anecdo-tally, IFAs seem to be offering more local options in their ranges.

The aspect that really differentiates the Middle East is the local home market bias and preference for physical assets. Says Tolchard: “There is a lot more money going into home market equities than there is elsewhere in world. Globally you see money going into global equity, but not here. There is a greater focus on local investing and that is a reflection of the confidence in the region.”

Capital flowsThe biggest vote of confidence in the UAE can be found in the reasons investors chose to allocate. When the Arab Spring started in 2012, money started to flow in from the Mena region. In 2013 the flows persisted and drifted into more targeted real estate and investment portfolios. Respond-ents to that year’s Invesco survey ranked political stability as the key driver, above investment opportunity. In 2014 this reversed. “It is being driven by the invest-ment landscape rather than just the safe haven aspect,” says Tolchard. Crucially for the UAE’s long-term success, capital is no longer being pushed out seeking a home. It is being freely attracted.

Indeed, the UAE is the only GCC country experiencing net positive private capital flows from other GCC countries with a net 31% of respondents reporting an increase, with even Saudi Arabia slightly net-neg-ative at –2% (see chart 2). Tolchard says: “Before, money from the Gulf was going directly out of the region. Now, some

Financial adviser regulationIt is fair to say that financial advisers in the UAE have historically had a poor reputa-tion. “Years ago it was shockingly bad but it is gradually getting better,” says Sillitoe. The rapid improvement is due to a combination of advisory firms making a deter-mined effort to become more professional and regulators getting tougher, together ensuring that advisers have minimum professional qualifications.

Financial advisers realise that they cannot continue with historic practices. Some advisory firms have never had a visit from any regulator in the last ten years – now they are getting a lot tougher and carrying out onsite visits. It is now very diffi-cult to operate illegally or without the appropriate licence. Personal finance media appeared over the last five years so investors are becoming more savvy and probing.

The biggest international influence on regulation in the region is almost cer-tainly the UK. The regulator of Qatar’s financial advisers, the QFC Authority, has introduced commission disclosure in line with the UK’s Retail Distribution Review (RDR). “Over time, a version of RDR is bound to be introduced… it is a sign that things are changing,” he adds.

In addition, the QFC Authority insists advisers have the same level of qualifica-tion as mandated in the UK by the FCA, so-called level 4 (roughly equivalent to the first year of university). “A lot of regulators look to the UK for best practices. You have to remember that a large percentage of the financial advisers working over here are British.”

“More and more of them are using fund rating companies… It is a sign this part of the world is becoming more professional” NIGEL SILLITOE, INSIGHT DISCOVERy

“There is a greater focus on local investing and that is a

reflection of the confidence in the region”

NICK TOLCHARD, INVESCO


money is flowing via the UAE. There is a sense that the UAE is developing itself as a regional hub. If Saudi money starts to flow through the UAE then, given the pools of capital, that is potentially a lot.”

Another structural change is the passing down of wealth to the next gen-eration. There are signs that it is inclined to diversify away from family businesses, potentially listing companies and using the proceeds to invest in listed securities and funds. It could provide the missing piece for the developing capital markets.

Tolchard says: “What is interesting for the asset management industry and markets here is that it would improve the corporate environment, with more com-panies listed, with initial public offerings potentially in the future. That will have a knock-on effect on the breadth of the stock market and encourage the growth of a pensions industry.”

In addition, the existing single fam-ily offices may develop into multi-family offices (MFOs), similar to the situation in Europe. The DIFC sees family offices as a key pillar of the industry in Dubai. As MFOs tend more towards mutual funds, it could provide a fillip for the asset man-agement industry.

Rise of DubaiThere is a growing feeling that Dubai is obtaining an unassailable lead in the race to become the financial centre for the region. “The DIFC has done a good job attracting international asset manage-ment companies,” says Sillitoe. “Qatar is carving out a niche for itself as well. All are competing, even if they say they are com-plementing each other.” He estimates that office space in Bahrain costs half as much

as in Dubai, and Qatar is also cheaper.There is also evidence of bolstered risk

management. Says Sillitoe: “More and more of them are using fund rating com-panies, such as Bloomberg, and using rated funds. It is a sign this part of the world is becoming more professional.”

This view is supported by Reza Yazdi, head of sales at Morningstar Dubai. He says: “This emphasis on heightened due diligence… helps investors make better decisions by bringing more transparency into the market. It will also help end-investors get reasonable price structures. We think that this approach will better professionalise this market for the benefit of the end-investors.”

GCC markets still have their nuances, however. NRIs retain a significant bias for home market securities and are partial to using leverage in their portfolios – it seems that for some, emerging market equities are not volatile enough – using a model where the bank sells both the investment

vehicle and loan. About 42% of NRIs use leverage, compared with 20% of GCC locals and 1% of western expats, and the average debt level is 60%, so a non-lev-eraged return of 7% becomes 12%. This is expected to increase in 2015 – Invesco found 53% of those surveyed planned to increase leverage in 2015.

Target returns are also very high. Invesco found that NRIs’ return expectations were a whopping 10.6% per annum, while those of GCC locals were only slightly behind at 9.6%. By contrast, SWFs and western expats typically expect approximately 7%. NRIs tend to benchmark against Indian interest rates and the base rate has been 8% throughout 2014. “The average NRI puts 39% into India, so if they cannot beat rates, it does not stack up for them,” he adds. GCC locals tend to benchmark against real estate, and as IFA-sourced funds typically represent a small amount of total wealth, says Tolchard, “they see it as a pot of risk assets”. g

Relationship-driven marketsThe Middle East has a famously relationship-driven business environment. The Insight Discovery report confirmed that it was essential for partner asset manage-ment firms to have a physical presence in the region.

“Typically the well-branded, best known operations such as Frankin Templeton, Fidelity, Invesco and Schroders perform particularly well, as you might expect. They have been here longer and have put a lot of effort building their brand with banks and financial advisers.”

There are a handful of few such as Aberdeen, Ashmore (which opened in Saudi Arabia in October) and Pimco that are serious players without having a local pres-ence. “Every other firm of note is here in the region, whether institutional money manager or retail,” adds Sillitoe. “You need to have a local presence if you wish to do well in this part of the world.”

invesco Middle east asset ManageMent study

11

6

23

27

7

3

4

5

52

13

51

2

5

1

42

31

1

73

1

6

4

1

33

1 1

6

5

1

72

Strong in�ow

Net respondent view

Slight in�owSlight out�owStrong out�ow

Net respondent view of the direction of private capital �ow for each GCC market for 2013 and 2014

UAE Saudi Arabia Qatar Kuwait Oman Bahrain2013 2014 2013 2014 2013 2014 2013 2014 2013 2014 2013 201423 38 16 12 7 7 5 12 11 9 13 11

+12 +31 +2 –2 –3 –5 –4 –9 –9 –4 –10 –8


mIDDLE EaST maRKETS |

Equity markets in the GCC had a spectacular year due to solid financial results as well as several other supporting fac-tors, from the UAE and Qatar

MSCI upgrades to Saudi Arabia announc-ing it is soon to allow foreign investors to own shares directly. The question becomes whether such optimism and progress can be sustained.

The International Monetary Fund esti-mates that GCC growth rates will range between 4.5% and 6% during 2015. Sal-eem Khokhar, head of equities at NBAD Asset Management, says: “Growth of the GCC region needs to be considered in an international context. These are some of the strongest rates that you will see across the world.”

Galal Khadr, head of treasury and private banking group at UNB, sees many reasons to believe in further mar-ket advances. “Today we have far better regulation than we had previously. The Dubai markets are the best performing in the region and many others are doing very well. The amount of initial public offerings (IPOs) in the pipeline will bring diver-sification as well as help liquidity.”

A concentration on oil and related products has tradition-ally been a hindrance to investors, but the Dubai Financial Services Authority and Nasdaq Dubai confirm there is now a healthy pipeline, and the opening of Saudi Arabia, accounting for half of all GCC market capitalisation, offers huge benefits. And, as Khokhar says: “The gov-ernments are looking to diversify away from oil revenue, so there is a lot of spend-ing on infrastructure and projects. There is also the financial centre.”

Manoj Aidasani, head of investor ser-vices GCC at Deutsche Bank Securities Services, says: “Saudi Arabia is the most diverse in terms of options – there is pharma, retail, banking, everything you want to diversify.”

He says to achieve meaningful diversifi-cation portfolios must look beyond equity products to sukuk, but says such markets could be improved by enhancements to market infrastructure. “This region has a big sharia-compliant market. There are money market funds with a huge amount of assets. But all these are traded OTC – that is an area that could move to a system with a trade settlement mechanism, even if execution remained OTC.”

Khadr points to a series of announced mega-projects from the Mohammed

bin Rashid City in Dubai to solar power production in Abu Dhabi. He estimates $100bn will be spent in the next five years and $300bn by 2030. “These projects will help. Population growth will be witnessed and so will consumption and investment. Emerging market investors will start com-ing in. Also, it looks like it will be another

good year for local banks. Interest rates will not rise for the foresee-able future.”

As the UAE is a net exporter of capital it should remain insulated from the effect of rising global interest rates. If it were reliant on foreign

direct investment it may be subjected to cancellations when finance becomes more expensive.

Khokhar says the sharply declining oil price should not have a dramatic effect on the region, noting that the cost of produc-tion in the GCC is very low at between $10 to $20 per barrel and a sustained low price would ultimately lead more expensive producers – such as US shale produc-ers – to cut supply. He is confident that economic growth can be sustained. “There are plenty of positive factors to look forward to including favour-able demographics, consumers are increasing by the day. I think that there is enough to drive growth for a decade or so.”

However, as David Marshall, senior executive officer at Emirates NBD Asset Management, notes: “Statistically there is no correlation between economic growth and asset prices. We are more positive on a stock selection basis than on the macro view.

“If you look at where valuations are at

the moment they are trading at about 12.5 times next year’s expected earnings. That is pretty much in the low to mid-range so valuations do not look particularly stretched.” Financials make up approxi-mately 40% of the UAE markets and “operating profits are probably going to drive strong financials – we think there is some serious upside there”.

Governance concernsGovernance has certainly been a core con-cern of GCC investors during 2014, with the Arabtec-led shock leading to the fur-ther tightening of rules – a process that started back in 2008 with the emergence of a series of corporate scandals.

Khadr says the regulatory effort is already bolstering governance. “Regula-tion is becoming much more effective. A lot of the companies now have two inde-pendent board members, which was not the case before. And we have seen a lot of regulation regarding IPOs… There are a lot of committees within the central bank looking into the financial sector.”

Governance is also becoming more for-mally integrated into the stock selection processes of asset managers, says Marshall. “It is one of the things that has changed a lot – our invest-ment process has changed over the years and corporate

governance has become a key part of our checks.”

Khokhar adds: “Governance is very important given that we have been upgraded to emerging markets status and Saudi Arabia is preparing to open up. It is very important that the governance issue is addressed and the environment becomes more transparent in line with international standards. We have come a long way but there is still work to be done.” g

“The amount of IPOs in the pipeline will bring diversification as well

as help liquidity” GALAL KHADR, uNB

“It is very important that the governance issue is addressed and the environment becomes

more transparent” SALEEM KHOKHAR,

NBAD ASSET MANAGEMENT

Next stepsThe drivers of GCC stock markets will be very different in 2015, finds Alastair O’Dell


mScI uPGRaDES |

The effects of the MSCI upgrades of Qatar and the UAE have been the subject of speculation in financial cir-cles for many years. The two

GCC markets were the first that MSCI had upgraded from frontier to emerging status, so the range of potential outcomes was plentiful. It is a refreshing change to be in a position now to assess whether the effects have been as anticipated.

Robert Ansari, executive director at MSCI, plays down its importance. “MSCI really is following what the markets are already doing, not necessarily leading it. Classification by MSCI comes as a by-product of what the markets have done before – so you could argue that some of the effect in terms of money flow had already happened.”

However, in the run-up to the upgrade it is estimated that there was approxi-mately $4bn of additional volume in the Qatar and UAE markets at the time of the upgrade.

Shafi Wahid, head of institutional trad-ing and broker network at Mubasher Financial Services, says: “It was a steep learning curve as we were going into uncharted territory. We had a fourfold increase in daily settlements compared to what we were used to. Custodians were stretched, brokers were stretched and exchanges were stretched. And we had to be up and running the next working day. But despite all of the difficulties, we pulled through.”

He says the exchanges were “very

switched on” and alert to the problems brokers may face.

MSCI operates a three-stage process. The first is a consultation with market par-ticipants, exploring their concerns. It then shares its findings with the regulators and exchanges, which then decide if they want to make the requested changes. The final stage is for the investors’ experience and to assess whether the changes have been implemented sufficiently. “That can take some time. Clients need to see it working and benefit from the changes made,” says Ansari.

The upgrades have been positive for all concerned – in some areas there has been a significant impact and in oth-ers less so. Ajay Kumar, assistant general manager at Qatar National Bank, says: “From an asset manager’s point of view, the obvious benefit was the increase in liquidity – twofold in Qatar and fourfold in Dubai. That helps quite a lot. The other thing was the uplift in valu-ations. So there was measurable benefit.”

However, there were also anticipated benefits that did not materialise. “The impact cost of trading is still very high. It is important for a large asset manager, such as QNB, that has an impact on the market – we were hoping that would reduce.”

Fewer buy-and-hold investors in the market would reduce impact costs and

reduce bid-ask spreads. This is still expected to happen, just over a longer timeframe that many hoped.

“It still leaves a lot to be desired. We have to remember that there have been markets in the region that have gone back to being frontier – the process has to be continued,” adds Kumar. He notes, for example, that there was a “major hiccup” when the last rebalancing took place.

There has been a shift in the source of volatility since the upgrades. Frontier markets are largely sheltered from global events, whereas emerging markets are caught in market movements. “Volatil-ity moved from 10.5 to close to 20 in

Qatar, and from roughly 20 to 30 in the UAE,” says Kumar. “And there has been a shift in correlations. The factors that affected these mar-kets have changed. Before, you could

just do research in the local market and be reasonably comfortable. Now there are influences from beyond the market.”

Commentators have often questioned why MSCI identified the two markets so far in advance of their eventual ascendance, creating a constant will-they-won’t-they guesswork for several years. Ansari says: “With the benefit of hindsight, what MSCI will probably do going forward is ensure that those markets considered to be reclassified are closer to being ready.” g

It is now possible to assess whether the MSCI upgrades of the UAE and Qatar had the anticipated effects, finds Alastair O’Dell

“It was a steep learning curve as we were going into

uncharted territory” SHAFI WAHID,

MuBASHER FINANCIAL SERVICES

Dreams to reality

QNB-Private-Aficionado 205x270 HR.pdf 1 11/16/14 6:44 PM


FInancIaL cEnTRES |

All of the financial centres in the GCC have enjoyed a sharp cyclical recovery in recent years, which is all the more impressive given the

global macroeconomic and regional geo-political challenges.

The Global Financial Centres Index, published by the Z/Yen Group, now ranks Dubai just one place behind Frankfurt at 17, up from 29 in 2013, Abu Dhabi one spot above Shanghai at 19, up from 32, Riyadh at 21, up from 31, and Qatar at 22, up from 26.

“Four of the GCC financial centres are already in the top 25 worldwide. That is fantastic news,” says Oliver Schutzmann, vice-chairman of the Middle East Investor Relations Society. “The structural strength of these centres remains their geographic location, sta-bility and the combination of financial resources and populations.

“Many federal and economic ties were tested successfully during this time – and they appear to be stronger as a result. The economic recovery, the return of interna-tional capital and upgrades to emerging market status are testament to the resil-ience and attractiveness of the regional financial centres.”

Schutzmann notes, however, that in recent contact with US investors he found there were still concerns regard-ing regional uncertainty and geopolitical challenges.

DemographicsAli Khalil, chief operating officer of the Kuwait Financial Centre (Markaz), says: “We are in the middle of changes and these changes will be ongoing for at least 10 years. Risk will be there for a while.

“But this has not impacted a lot of businesses – at the end of the day it is about consumption and this is driven by demographics, which are favourable. Governments have money and they are

spending it on infrastructure, so their economies are moving on. Local invest-ment companies have adapted to the uncertainty and are faring well. ”

The GCC has indeed remained stable and prosperous throughout the recent period of instability in nearby countries, from Egypt to Russia.

“Regional instability has impacted positively countries such as UAE, which

is considered to be a safe haven,” says Mazen Boustany, partner at Baker & McKenzie Habib Al Mulla. “There has been investment from countries such as Iraq, Syria and other ones that have been negatively

affected in the region such as Egypt. A lot of companies have relocated here [Dubai] and brought their wealth with them – the misfortune of these countries has been to the benefit of others.”

Such money has brought with it con-cerns around how it was acquired, especially with an international focus on anti-money launder-ing (AML), and this has increased the workload of regu-lators across the region.

Daniel van Don-gen, senior manager, markets, at the Dubai Financial Services Authority (DFSA), sayds: “The Dubai International Finan-cial Centre has a robust regime of looking into AML issues and that applies to each and every firm that applies for a licence – and they will continue to be monitored

“While there are certainly concerns that this region is different to the US or Europe, all in all we see a very compliant population of companies. It certainly has our close and continuing attention.”

The internationalisation of Saudi Ara-bia certainly brings opportunities for

other GCC financial centres. But as it has already moved 10 places up the inter-national index and dominates market capitalisation in the region – and with memory of the declines of Bahrain and Beirut – it also brings challenges.

“More funds will go into Saudi Arabia, undoubtedly, but will not dilute the UAE,” says Khalil. “It takes more than just an active market to become a financial centre. It is very difficult to displace an ecosystem that has already been built – from the tal-ent pool to the supporting businesses.

“There has to be a decision to be open. In Saudi Arabia – and for us in Kuwait – there has been a decision not to become totally open. It is not as easy for foreign companies to set up there as in Dubai. The movement of labour is not as easy as in Dubai. I do not think Dubai is going anywhere.”

There has been plenty of regulation pro-duced in Dubai, most of which has gone down very well with market participants, but in many cases the enforcement of that regulation has not yet been properly tested.

Van Dongen says: “We at the DFSA enforce our regulations – there is no

doubt about that. But I would say that the initiatives taken are always aimed at avoiding an undue regulatory burden in addition to pro-viding the investor community with internationally rec-ognised standards of disclosure, licensing, ongoing reporting

and even for market abuse and insider information disclosures. Everything we do is as much as possible aligned with Euro-pean Union regulation and directives.”

Indeed, the DFSA is making a concerted effort to attract more funds. For example, it has just launched an initiative to intro-duce qualified investor funds which “has a very light-touch licensing regime – in a matter of a week you will have your fund up and running,” says van Dongen. g

“Four of the GCC financial centres are already in the top 25 worldwide. That is

fantastic news” OLIVER SCHuTZMANN, MIDDLE EAST

INVESTOR RELATIONS SOCIETy

“The DIFC has a robust regime of looking into AML issues that applies to each and every firm that applies for a licence – and they will continue to be monitored”

DANIEL VAN DONGEN, DFSA

Hot competitionGCC financial centres are rapidly climbing up the international rankings, finds Alastair O’Dell


mIDDLE EaST aWaRDS |

Market movers The Global Investor/ISF Middle East Awards 2014 recognised the region’s top performers in financial services at its fifth annual gala ceremony in Dubai on October 29

Regional AwardsCEO of the year: Shayne Nelson, Emirates NBDRegional Asset Manager of the year:

qNB Asset ManagementRegional Broker of the year: Mubasher

Financial ServicesEquities Manager of the year: NBK CapitalFixed Income Manager of the year:

Emirates NBD Asset Management Sharia Fund Manager of the year:

Rasmala Investment BankSukuk Manager of the year: BLMEGlobal Custodian of the year: CitiSub-custodian of the year: HSBCExchange of the year: NASDAq DubaiGCC Financial Centre of the year: Dubai

International Financial Centre MENA Financial Centre of the year:

Casablanca Finance CityWealth Manager of the year: Barclays Cash manager of the year: Arab BankTransition Manager of the year: CitiFund administrator of the year: Deutsche BankConsultancy Firm of the year: Insight DiscoveryBest Newcomer of the year:

Lazard Asset ManagementBest Newcomer Fund of the year:

NBAD Asset Management

CEO of the year

– Shayne Nelson

Equities manager – NBK Capital


Regional asset

manager – qNB Asset

Management, and qatar

broker – qNB Financial Services

Regional broker and Bahrain broker – Mubasher Financial Services

Sharia fund manager – Rasmala Investment Bank Wealth manager – Barclays

Newcomer – Lazard Asset Management

Lebonon broker – MedSecurities Investment

Asset Manager of the yearSaudi Arabia: Al Rajhi CapitaluAE: union National Bankqatar: The First InvestorEgypt: CI CapitalBahrain: Al Baraka Islamic BankLebanon: Blominvest BankOman Asset Manager: Bank

Muscatjordan Asset Manager: AB

InvestKuwait Asset Manger: Markaz

Broker of the yearSaudi Arabia: EFG HermesuAE: ADS Securitiesqatar: qNB Financial ServicesEgypt: EFG HermesBahrain: Mubasher Financial Services

Lebanon: MedSecuritiesOman: Bank Muscatjordan: AB InvestKuwait: NBK CapitalPalestine: Al Wasata Securities


cuSTODy nETWORKS |

Changes in liability stand-ards, largely as a result of the Alternative Investment Fund Managers (AIFM) direc-tive and soon Ucits V, is will

drive further integration between sub and global custody. The ability to manage the risk end to end is becoming increasingly important and a number of options are emerging to achieve this. The most radi-cal of these options is to become your own custodian in the key markets, but this is often prohibitively costly.

John van Verre, head of global custody HSBC Securities Services, says pan-European asset servicing capabilities are required to fully realise the potential of Target2-Securities (T2S), which will change the landscape for sub-custody businesses in Europe as cross-border cen-tral securities depository (CSD) access with pan-European asset servicing capa-bilities can be achieved without the use of sub-custodians.

According to van Verre, increased liability standards are likely to drive buy-ers of global custody services to stronger counterparties that offer a wide network, allowing buyers to more simply under-stand their end-to-end sub-custody risks and exposures.

“These changes may also drive more

innovative solutions, such as risk sharing between the global custodians and exter-nal agents or the development of industry utilities for functions that do not provide competitive advantage, for instance cor-porate action processing.”

T2S in particular has created an envi-ronment where the global custodians have been able to start developing direct rela-tionships with CSDs, which enables more efficient processing of commodity-type functions such as settlement, over-laid with expert providers in asset services to provide the more complex corporate action processing and local tax services, observes Andy Osborne, senior vice-pres-ident Northern Trust.

“While over time this is expected to become the model in major markets, there will be markets where such direct connectivity will not be possible, in which case there will be a requirement for sub-custodians.”

Regulations are also creating new revenue stream opportunities for cus-todians, according to Oliver Wyman

partner Axel Miller, for example insourc-ing of back-office functions, new reporting requirements and collateral management.

“The main difference to historic strategy development is that a ruthless approach to focusing and prioritisation is required. Beyond this, innovative partnership models are more important than ever. Custodians that do not have a global pres-ence will need to be even more disciplined

around their cus-tomer and market coverage. Creating and maintaining a unique selling point in local or regional markets is key – this is often driven by local market knowledge and the develop-

ment of related services such as regulatory reporting or tax services.”

Daniela Peterhoff, also of Oliver Wyman, refers to a natural limit to self-custody given the significant setup costs of a new CSD and the add-on costs of tailor-ing the offering to T2S. She adds that there is a group of regional, mid-sized custodi-ans that risk being “stuck in the middle” between global custodians and those that concentrate on customer segments with

“There will be markets where direct connectivity will not be possible, in which case there will be a requirement for sub-

custodians” ANDy OSBORNE, NORTHERN TRuST

New world orderRegulatory developments are contributing to a multi-tiered custody market where sub-custody will become more regionally focused and mid-sized providers face being squeezed out, says Paul Golden


largely domestic needs, such as local pen-sion funds.

“However, there is clear economic potential for regional sub-custody net-works – for instance, in emerging markets where such pressures are not yet as accen-tuated, particularly due to a lower degree of consolidation.”

Barry Muir, senior vice-president and chief operating officer global operations UK, Middle East and Africa at State Street, agrees the use of a diversified set of sub-custody relationships remains a strength on many levels, including opportunities to mitigate against concentration risks and to nurture appropriate sub-custody con-tingency arrangements.

Peterhoff adds that there is still a long tail of smaller custodians that will likely come under increased pressure. “Beyond this, we anticipate consolidation into a number of focused, partially consortium-led custody utilities in markets where industry convergence and economic pres-sure is particularly high.”

BNP Paribas has responded to regu-latory developments by expanding its presence in key markets such as the US, which enables it to keep approximately 90% of its assets in-house, explains Philippe Ruault, head of clearing, settle-ment and custody products. “I have seen other global custodians making similar moves and taking a more direct approach in certain markets. Customers are increas-ingly demanding that their assets are segregated and are looking to outsource collateral processes.”

On the issue of self-custody, he says competitors and partners are looking at more direct links to infrastructures in order to deliver a better service for cus-tomers, for example in terms of cut-off times. “The issue is that even with T2S it is quite expensive to set up direct links to a market. You need to have resources on the ground to cooperate with CSDs and issu-ers as well as process tax and corporate actions and so on.”

In April 2013, ING announced it had reached an agreement to transfer its local custody services business in seven coun-tries in central and eastern Europe to Citi and Ruault expects other regional custo-dians to considering exiting the market. “You need a lot of volume in this busi-ness to sustain the level of investment required,” he concludes.

Rowena Romulo, JPMorgan’s head of direct custody and clearing, says there is a move away from the traditional custody model towards sponsored access or more segregated-type models and for more unbundling of services. “This trend is part of a two to three-year cycle in which some custodians are further advanced than others. But what you may see is the large global custodians and investment banks settling on a similar strategy.”

Stricter selectionThe increased level of liability introduced through the AIFM directive will rein-force the need for stricter selection of sub-custodians and a detailed, robust due diligence process, Romulo says. In mar-kets where the level of risk is deemed too high, it may precipitate the internalisa-tion of risk by global custodians that could open accounts directly with CSDs.

“Barriers to entry are rising all the time and clients are under pressure to reduce costs and simplify their processes. Regional sub-custodians will need to reorganise to become more regionally integrated and efficient and we are seeing some starting to offer collateral manage-ment services.”

Muir describes involvement in the pol-icy development discussions that shape the industry as a valuable tool to mitigate the impact of regulation. “Internally we have found it indispensable to arrange a formal, cross-organisational regula-tory reform programme that effectively addresses identified issues, finds synergies in compliance requirements and leverages changes to add value.”

In addition to being present when reg-ulations or their implementation rules are being discussed, Guillaume Heraud, global head of business development financial institutions and brokers at Soci-ete Generale Securities Services, suggests supporting initiatives for truly pan-Euro-pean or even global standards, rules and regulations and a common interpretation and implementation of such initiatives.

He says the new regulatory environment pushes for managing direct relationships with local market infrastructures, increas-ing the value of local and direct custody. “However, the cost of managing this multi-local asset servicing layer is not bearable for all institutions. Custody is increasingly a scale business.”

Mercer senior associate Jessica Hynes says the consolidation of the late 1990s in particular limits the scope for further rationalisation of global custodians. “Where I would expect to see consolida-tion is among the small regional European banks because of T2S. The intermediaries are going to be disintermediated as the buy side is connected directly to the sell side.”

Northern Trust global head of industry management Justin Chapman similarly sees no evidence of retrenchment at global level. “We will continue to see attri-tion in the sub-custody space but I don’t expect this to be replicated among global custodians.”

The days of the mono-market local cus-todian are becoming numbered, at least in the T2S zone, Heraud continues. “While there is a move towards the unbundling of services, our clients are not looking to mul-tiply the number of providers. What we notice (and some recent press announce-ments go clearly in this direction) is that the services are now being purchased from perceived best in class providers in each domain, but on a regional rather than a single market basis.”

He concludes that consolidation is inevitable, either at agent bank and custo-dian level or among CSDs, although there will remain niches for smaller outfits and markets that take longer to fully embrace common market practice and are low down the priority list for driving change in current models. g

“Custodians who don’t have a global presence will need to be even more disciplined around their customer and market coverage”

AxEL MILLER, OLIVER WyMAN

“Barriers to entry are rising all the time and clients are under pressure to reduce costs and

simplify their processes” ROWENA ROMuLO, jPMORGAN


TaRGET2-SEcuRITIES |

Target2-Securities (T2S) will soon be introduced progres-sively across much of the EU, but rather than simplifying settlement arrangements it is

so far leading to a proliferation of business models.

The aim of T2S is to end fragmenta-tion in eurozone securities settlement by providing a single platform to settle transactions in central bank funds across borders. The service will be offered at a flat price for all participating central securities depositories (CSDs) with no difference between domestic and cross-border transactions.

The initiative is introducing competi-tion between European CSDs that have previously largely enjoyed the status of natural monopolies. A European securi-ties settlement engine will enhance their ability to expand within the EU and, although it will not be completed until March 2017, CSDs are already positioning themselves for their opening moves.

As a core part of a CSD’s offering will be irrevocably outsourced to a third party, each will need to increase the scope of its services to counterbalance lower mar-gins from settlement. There will be some services CSDs will need to hang on to in each country, such as corporate actions and issuance, as these tend to operate in accordance with local laws, but the prize will go to those that develop cross-border settlement services, as well as increasing the value they add in asset servicing, con-sultancy and collateral operations.

“There will be a great incentive to oper-ate throughout Europe and to be able to move collateral from one country to another,” says Henry Raschen, head of regulatory and industry affairs for Europe at HSBC. “Countries with large volumes of

collateral to move will be attractive, and it will be interesting to see how collateral in smaller national markets is serviced by the larger CSDs compared to the country’s own CSD.

“Three main options seem to have evolved for participants – first, to build your own CSD. This is advantageous if you have the volume of assets, range of services and cli-ent base to achieve economies of scale. Second, some will consolidate set-tlement activity through their net-work of eurozone offices to be able to use one route into T2S using the CSDs with greatest functionality and lowest cost. Third, and possibly combined with the second option, some will become so-called directly connected participants (DCP).”

HSBC will become a DCP in the German market, its biggest securities settlement operation in the eurozone by trades set-tled, when settlement migrates to T2S in September 2016.

Mixed modelsSome larger banks are selecting a mixture of the DCP and ICP (indirectly connected participant) models depending on the market and provider in that market.

Owen Jelf, global managing director of Accenture’s Capital Markets practice, says: “Many banks are still deciding or have not yet taken any action – they want to see T2S implemented first and evaluate their options after the big volume players are on board.

“The complexity shift of providers can

be difficult and costly as interfaces and processes are typically embedded within a bank’s organisation. However, there are sizeable benefits, especially in liquid-ity pooling considering the markets’ risk and regulatory environment, which is why some of the bigger banks have already made the investment in defining a renewed network strategy including con-

nectivity to T2S.”JPMorgan plans

to insource settle-ment in six major European markets where the firm has critical mass, in wave two of T2S. “It is an opportu-nity to consolidate settlement on a

single platform,” says Diana Dijmarescu, managing director global markets infra-structures, at JPMorgan. “We think it will improve efficiency and allow us to manage our liquidity and collateral efficiently.

“We are already seeing a large a number of CSDs able to offer multimarket solu-tions but it depends on the type of client they are targeting – in most cases a domes-tic audience that is using existing gateways to local CSDs to access other markets.”

T2S’s first-wave user acceptance test-ing is now underway, and reports indicate progress is good, although history sug-gests that CSD system upgrades can be challenging.

Monte Titoli, an Italian CSD in the first wave, is focused on building market share. It has scrapped T2S adaptation charges for clients, and will bear ¤30m ($37m) in costs, which its general manager, Mauro Dognini, says covers its overall invest-ment from 2006-16 and includes its new asset servicing capabilities and collateral

“There will be a great incentive to operate

throughout Europe and to be able to move collateral from

one country to another” HENRy RASCHEN, HSBC

CSD ascendencyTarget2-Securities will mean that CSDs will need to expand their offering in areas such as collateral management to remain competitive, finds Ceri Jones


management platform.“We have taken a clear strategic decision

not to pass on the costs of T2S implemen-tation to our clients, unlike some of our competitors,” Dognini says. “As a first-wave participant in T2S, we believe there are opportunities to increase our volumes, which will in turn allow us to recoup the investment we have made.

“We are already developing collateral management services that can be inte-grated within our core business. London Stock Exchange Group has also recently launched a Luxembourg-based CSD, GlobeSettle, which will leverage the IT and operations expertise from Monte Titoli.”

Global scaleCurrently 24 CSDs have agreed to join T2S but only a handful are large enough to offer a truly global custody business. However, most are struggling with basic infrastructure deficiencies, such as a local operational presence and meaningful asset servicing.

“Some are looking to build an asset ser-vicing capability, such as Monte Titoli,” says Reto Faber, Emea head of direct cus-tody and clearing at Citi. “We keep telling them that this is an audacious approach given that they have to get ready for T2S. The build-out is costly and takes time and experience.

“There is a lot of debate about the credibility of the new CSD models. The question is whether they have sufficient bandwidth to close the functional gaps that prevent them currently from offering a comprehensive custodial service.

“Sub-custodians typically do not have core competencies in collateral manage-ment and are not likely to develop these in the near term. Undeniably collateral is increasingly important and CSDs with those skills will have an advantage.

“Asset servicing is about know-how and local involvement – there is a big gap in having the foot-print and skill base to perform these local services.”

Agent banks can therefore differenti-ate themselves from CSDs by providing superior asset servicing by local experts, argues Alan Cameron, head of relation-ship management for international banks and brokers at BNP Paribas Securities Services. “Having fewer parties involved allows this to be provided seamlessly and more quickly. This is very important for active investors such as hedge funds that believe it is advantageous to have as few

links in the chain as possible.”BNY Mellon’s new Belgium-based CSD,

so far a unique model, has its first client in CME Clearing Europe. However, Chris Prior-Willeard, CEO of BNY Mellon CSD, says others are looking to follow suit and that, for clients under pressure from new regulations such as Emir and the need to clear over-the-counter derivatives, removing a layer of the process is a major positive.

“As people look at the rules there will be a great deal more buy-side involvement because of risk reduction and control of assets and collateral, as the regulators

have piled on pressure,” he says.

“Two or three of our large buy-side clients are reluctantly saying that soon they will have to interact directly and settle securities into

their own account on a CSD instead of going through an agent, which adds cost, risk and time.”

Issuer CSDs are inclined to partner in an outsourced vendor model, such as the recent deal to connect Northern Trust directly to a number of European mar-kets via Euroclear, while Deutsche Bank will service assets held in Northern Trust’s

accounts directly at Euroclear’s Investor CSD.

Another approach is the Liquidity Alli-ance driven by Iberclear and Clearstream and the South African, Australian, Bra-zilian and Spanish CSDs, which claims it will improve collateral management capability.

“The post-T2S world is going to be very similar to the cash equity clearing busi-ness, especially after the implementation of central counterparty inoperability,” says Robert Almanas, MD for International Services at Six Securities Services. “Some new CSDs will emerge but, over time, there will be consolidation. The challenge for CSDs with a domestic bias is that to be effective they are going to have to compete cross-border, requiring substantial invest-ments in people and technology.”

“Institutions that would normally con-nect to a CSD via an agent bank are now talking to us, thanks to T2S and the grow-ing need for asset safety. They are realising that they will reap the benefits of better pricing, asset safety via infrastructure and managing their euro liquidity via a single pool.”

Tough competition While the industry has talked about con-solidation in this market for decades, we are now seeing proliferation – and there is mixed opinion about whether CSDs will be allowed to fail.

“Weaker CSDs will disappear,” argues Prior-Willeard. “Partnership discussions will keep some of the smaller CSDs on the register but service provision will be done by someone else. There are some smaller successful CSDs and there are some with unsustainable volumes, but if there was blatant state aid, the EU would want a conversation.”

According to Raschen, although large CSDs will win over time, “there is still scope for niche operations based on intel-lectual property in a particular market, especially if it is not sufficiently large to be of interest to others, or if there are high barriers to entry for local procedures, reg-istration and tax processes”.

Market participants typically foresee that either settlement fees will rise or a longer period of cost recovery will be needed.

“The cost of T2S was huge even at the start, when the business plan had been predicated on higher volumes,” says Alex De Schaetzen, director, product manage-ment T2S, at Euroclear. “£1bn needs to be recuperated. Scale will be important because liquidity is sticky and there will be no service depreciation, only improve-ments.” g

“We are already developing our collateral management

services that can be integrated within our core business”

MAuRO DOGNINI, MONTE TITOLI

“There is a lot of debate about the credibility of the new CSD models”

RETO FABER, CITI


nET STabLE FunDInG RaTIO |

While banks have already begun to adapt to the increasing cost of doing business under Dodd-Frank, Emir

and the liquidity coverage ratio (LCR) the industry is still getting to grips with the net stable funding ratio (NSFR), which could have a significant impact on an array of activities from 2018. On October 31 2014, the Basel Committee on Banking Supervision released its final standard for the NSFR addressing some, but not all, of the industry’s concerns about the draft proposal issued at the start of the year.

The NSFR is the second pillar of the Basel III liquidity legislation for banks, which is in its observation period following the release of the final standard. Similar to the LCR, it is likely to be adopted well before its implementation date of 2018. The NSFR is a ratio of the available sta-ble funding (ASF) and the required stable funding (RSF). Compliance means the ratio should be equal to or greater than 100%.

The ASF consists of the bank’s capital, deposits, preferred stock, liabilities and cash with key maturities of at least one year. By default it favours deposit-taking institutions. The RSF is calculated as the weighted sum of the value of assets held and funded by the entity, including off-balance sheet exposures where weights are assigned to each RSF asset category. The RSF is higher for illiquid assets and lower for liquid assets, although still 50% for main index equities – eligible level 2B HQLA assets – and 85% for other assets.

The ASF is high for a long-term stable source of funding and lower for short-term unstable sources.

The NSFR extends to all internation-ally-active banks on a consolidated basis, with encouragement to use the framework for other banks and subsidiaries, and will be a continuing requirement.

Impact on equitiesPre-crisis financial institutions suffered from two common traits – overreliance on wholesale funding and large holdings of short-term, low-quality liquid assets. The need to support this unstable structure drove the Basel Committee to institute the LCR and NSFR as the pillars for liquid-ity. The LCR intends to be a stress metric, ensuring banks remain liquid in peri-ods of stress lasting 30 days. The NSFR addresses a struc-tural funding issue, when the availabil-ity of funds does not match demand.

The intention of these regulations was sensible and readily accepted. Nevertheless, the revised January 2014 draft of the NSFR was considered by many banks to be too conservative and in some cases counterintuitive to its stated aims. The most widely debated topic was the treatment of equities relative to other assets. In its first draft the BCBS treated long level 2B inventory as 50% RSF and all other assets as 85%. Yet while many banks and a few key financial bodies such as the

Institute of International Finance and the International Capital Market Association raised concerns, the final standard per-sisted with this treatment.

A recent Oliver Wyman document, Impact of NSFR on Equities markets: Con-siderations for implementation, indicated

the numerical value of the equity market was $65trn for wealth creation and $600bn for capital formation. Public compa-nies rely on liquid equity markets at

every stage of their development, from initial public offering and strategic capital raisings to continuing liquidity. The fluid-ity of all of these activities is likely to be challenged following the implementation of NSFR.

The increased cost is also likely be passed on to end-users. For example, underwrit-ing institutions will have to fund 50% of the value of their short-term holdings

Net winThe Basel Committee has listened to the concerns of the industry regarding the net stable funding ratio and has incorporated many of them into its final draft

The final draft acknowledges interdependence of the

liabilities and assets of a financial institution


for more than a year but they will clearly not bear this cost – it will filter down to investors and the listed company and act as a disincentive to new listings. Counter-intuitive to the intention of the new rules, the increased cost of doing business could end up having a negative impact on liquid-ity as some market participants are forced to exit.

Securities finance transactionsOne of the key changes in the January 2014 draft was the inclusion of securities lending from, loosely defined, non-banks being treated as 50% RSF, irrespective of maturity or asset type. In the final draft, following feedback from the industry, the asymmetrical treatment of short-term – below six months – reverse repos with non-bank financial institutions against which the industry argued was lowered from an RSF of 50% to 10% for level 1 col-lateral and 15% for other collateral. The 15% RSF treatment includes both secured and unsecured loans to banks below six months.

In the original draft, the Basel Com-mittee included a carve-out for securities finance transactions with bank counter-parties, with a 0% RSF. However, this has now been assigned an RSF of 15%, similar to non-bank financial institutions. In making this change, the committee acknowledged calls to bring the treatment of banks and non-banks into line – but removed a credit it initially rewarded. The NSFR treats lent equities to cover shorts and borrowed secured cash versus equities in the same manner. While costs will not go up as much as the industry feared, they will still increase. Some banks have argued that as the reverse repo with banks is no longer 0% RSF, the 10% long-term fund-ing will need to be factored into the price. So the net effects at the desk level may be detrimental to business – even though the industry as whole will see this change as a net positive.

Principal lenders and significant cus-todial lenders may see a dichotomy. They are likely to see an increase in lending revenues, but only if they are able and pre-pared to go down the term route. Many have adopted the 30 to 90-day term and are being rewarded for it. However, other lending entities – such as Ucits funds – are precluded. It remains to be seen whether this term increment is beyond the reach of some participants.

The enhanced yield could start to free up large pockets of trapped liquidity. In itself this is positive but, as costs rise, demand from short-side participants could fall. It is uncertain where this will eventually settle.

Interdependence One industry concern regarding the ini-tial draft was its inability to link trades. Due to their inherent interdependence, it requested these be treated as 0% RSF and ASF. The final draft acknowledges interdependence of the liabilities and assets of a financial institution, but states that national supervisors have discretion in limited circumstances to determine whether certain asset and liability items can be netted or the RSF moved to 0%.

There are five caveats that an asset and liability will need to sat-isfy in order to be deemed linked. It would need to be iden-tifiable and have the same maturity, which is achievable in most cases. However, the requirement for a bank to act solely as a pass-through unit and have contractual linkage of both trades with two different counterparties for each trade makes it

difficult to determine at this point which trades would benefit.

Observation periodNow the NSFR consultation period is over and we have the final proposal, the observation period begins and market participants can digest the impact on various businesses. While the committee clarified the scope of application as being all internationally active banks on a con-solidated basis, it remains unclear how the interaction of national supervisors and the actual ruling will play out.

The powers of implementation given to the national advisers opens the way for participants in different jurisdictions to have constructive dialogue with their supervisors but introduces uncertainty over how different supervisors will act, creating advantages and disadvantages, depending on where an institution is domiciled.

An opportunity has been missed in the definition of what constitutes a bank – entities such as central counterparties (CCPs) and insurance companies may still consider themselves treated unfavour-ably. However, loans to qualifying CCPs, broker-dealers and insurance companies could be seen in the finalised text as loans below six months to financial institutions with improved RSFs. In the main, this has remained unchanged in the final draft.

Over the past few quarters, overall behaviour in the market has changed as participants adapted to the LCR 30-day stress metric, Financial Stability Board and other regional recommendations. However, the move to a 365-day liquidity horizon, coupled with unfavourable treat-ment of equities, will present significant challenges. The 30 to 365-day increase, coupled with the requirement to term hedge relatively short-term assets and inventory positions, is likely to cause sig-nificant operational demands as well as increasing costs and a reduction in overall liquidity.

The final draft suggests that the Basel Committee listened to the industry’s

feedback but was unwilling to cede ground in all areas. It seems evident that the commit-tee’s intention is not to reduce liquidity,

market counterparts and efficiency, or to increase overall costs to the end-consumer or retail market. Nevertheless, in its cur-rent guise, the NSFR could have a serious impact on the industry, and it is hoped that any outstanding issues are resolved before the implementation process. g

In its current guise, NSFR could have a serious impact on the

industry


cOVER STORy |

Institutional investors remain guarded about the practice of secu-rities lending, even six years after the shock of the credit collapse. Faced with continuing concerns

over reinvestment, liquidity and coun-terparty risk, some former or would-be beneficial owners remain content to stay on the sidelines, or partake in lending on an ancillary basis only.

For those more actively involved, cus-tomisation of services, including bespoke programmes tailored to owners’ specific risk-return char-acteristics, is the key to maintaining the securities lend-ing arrangements, as is a heightened emphasis on trans-parency and safety.

With interest rates offering lit-tle in the way of comfort for investors, asset managers remain open to any plau-sible alpha-generating opportunity that meets their due-diligence standards. To provide owners with sufficient clar-ity around collateral arrangements – as well as more dependable and precise reporting, execution and governance data – sell-side intermediaries require top-tier technologies for streamlining client com-munications, complemented by in-depth

client consultations. Additionally, the divergence in benefi-

cial owners’ programme objectives means providers must have the dexterity to offer guidance appropriate to each client’s spe-cific risk profile.

No doubt, the sharp shift in ben-eficial owner psychology has had an indelible impact on the lending indus-try. But according to global data provider Markit, as of Q1 2014 the pool of lendable assets was virtually identical to pre-crisis levels – $14.9trn versus $14.8trn entering

2008 – while both utilisation and therefore the value of on-loan bal-ances has dropped by nearly a half through the same period.

“In general , beneficial owners

returning to the lending market post-crisis have remained conservative in their reinvestment strategies,” says Craig Starble, CEO of Boston-based securities-lending agency eSecLending. “However, we are also seeing some owners pursu-ing certain market opportunities, among them emerging market lending, where limited supply and increased hedge fund demand has resulted in larger spreads for our clients.” This has mainly been done

through the intrinsic lending portion of the programme, rather than by relaxing collateral profiles, he says.

All of this underscores the need for providers to adopt new approaches – and the ability to offer beneficial owners more diversified, flexible and risk-managed arrangements across a broader base of potential borrowers is a key part of this effort. According to recent Citi findings, helping beneficial owners optimise their lendable supply across agency, princi-pal and synthetic opportunities, while also meeting their demands for quality collateral, could go a long way towards addressing the utilisation gap that has recently stymied the industry.

Critical factorsCustomisation, transparency of data and enhanced reporting remain critical to the lending experience, concurs Paul Wilson, global head of agent lending product for JPMorgan. To that end, the company has continued to deliver granular programme and performance analysis for owners that require such levels of detail.

Wilson says: “Furthermore, whereas lending was once almost exclusively a back-office function, in terms of pro-gramme oversight and ownership, in our view there is now more equilibrium between the front office, risk and opera-tions teams. They have all essentially

Safety in numbersInstitutional investors are demanding increasing levels of data and transparency to remain comfortable with their lending programmes, finds Dave Simons

“We have seen interest rates move negative in Europe, which

has definitely helped keep lending at the forefront”

PAuL WILSON, jPMORGAN


become key stakeholders within the lend-er’s organisation.”

Although the strategies utilised by ben-eficial owners may vary according to their goals and asset mix, John Kemp, manag-ing director, investment operations and risk, Pennsylvania Public School Employ-ees’ Retirement System (PSERS), says all owners should require complete transparency con-cerning the status of their existing loans, in particular the collateral held by the agent lender.

“Clients [own-ers] have generally been more conservative around the rein-vestment of cash collateral post-crisis,” notes Kemp. Owners are also continuing to scrutinise their agent lender’s ability to provide transparent indemnification coverage for their securities lending pro-gramme. This, says Kemp, “helps explain why agents that are able to offer indem-nified repo strategies have been winning more new mandates”.

Because of new regulations, certain agent lenders may be limited in their abil-ity to offer indemnification of any kind, adds Starble, or may do so at an increased cost to the client. “These regulations have beneficial owners asking whether their

agent lender can continue to support the owner’s preferred trade structures at his-torical margins, with the counterparties approved in their programme.”

Following the crisis, the new normal is for beneficial owners to be far more inquisitive about their programmes, requiring solutions for measuring like-for-

like agent lender p e r f o r m a n c e , risk-management capabilities and other integral data. Meanwhile, the continuing empha-sis on value lending – including issues that trade hot,

warm or special – underscores the need for increasingly transparent, fully-automated trade processes.

This was the impetus behind the 2012 launch of DataLend, the market-data platform devised by New York-based EquiLend, a provider of trading and operations services for the global securi-ties finance business. With complexity inching upward, Ben Glicher, head of DataLend, and chief investment officer of EquiLend, says delivering information to clients in the most efficient way possible will become expected.

“For instance, it does not make sense to try to benchmark an agent lender’s perfor-

mance across all securities,” says Glicher. As an example, he cites high-flying camera manufacturer GoPro, which has recently commanded daily fees of up to 9,800 basis points. “If an agent lender does not have GoPro in their inventory, the results will be inaccurate. Thus, having the ability to match at the security level is a must.”

The same holds true for peer group matching, adds Glicher. “An Irish Ucits fund, for example, should only be com-pared against other Ucits funds, rather than ordinary mutual funds with different risk appetites, tax treatments and collat-eral requirements.”

The ability to drill down to view the performance characteristics of specific securities is another compulsory func-tion. “Most clients will start off viewing their performance at a high level, looking at scorecards, individual fees or utilisa-tion metrics at the portfolio level over time,” says Glicher. “However, during times of market volatility clients want to see which specific securities were driving performance.” The DataLend Client Per-formance Reporting suite supports both programme-level views and granular security-level performance metrics.

Risk budgetsWhile acknowledging a marginal increase in owner risk appetite, such activity still lags behind “risk-on” moves seen in other segments of the market in recent years, says Kemp. “Which is not that surprising, given that for many clients, securities lending represents a comparatively smaller por-tion of the overall investment approach, secondary to allocation and manager selection decisions.”

Such is the case at PSERS, which con-tinues to view lending as a purely ancillary activity. “Accordingly, our appetite for securities lending risk exposure has been minimal, as we have focused instead on budgeting risk across our core investment strategies,” adds Kemp.

Though still relatively low on the risk spectrum in comparison with other investment strategies, some owners have nonetheless shown a willingness to explore lending revenue opportunities further, particularly those with greater programme flexibility. For instance, expanding the breadth of accepted col-lateral – including moving from cash to non-cash collateral including equities – allows owners to broaden their distribu-tion over a much wider range of borrowers, says Wilson.

“There are other opportunities as well, including structured transactions such as collateral upgrades, including term and evergreen trades to match borrowers seek-

“During times of market volatility clients want to see

which specific securities were driving performance” BEN GLICHER, DATALEND


cOVER STORy |

ing balance-sheet efficiency, in addition to corporate action-related transactions,” he says. “The point being, we have seen more of this kind of activity taking place in recent times. There is definitely greater opportunity as well as appetite among beneficial owners to engage in these trans-actions, which we feel is a good sign.”

For those preferring a more limited approach, achieving a modicum of incre-mental income without taking on a lot of risk is often good enough. Glicher says: “For example, if one is simply looking to offset a portion of their bank-related expenses, they might consider having strict lending and cash collateral rein-vestment parameters such as using only overnight government repo or accepting just [certain] securities as collateral, thus limiting their lending opportunities.

“On the other hand, a lender seeking to produce additional alpha or income to reduce significant unfunded liabilities, considerably lower portfolio expenses or outperform competitors’ funds may be willing to invest the cash collateral in a 2a-7 [a US regulation requiring money market funds to restrict underlying hold-ings to more conservative investments] or money-market-type structure and take advantage of additional lending opportunities.”

The inexorable march toward cen-trally-cleared OTC derivative products is also likely to have an impact, as regu-latory regimes such as Dodd-Frank and the European Market Infrastructure Regulation bring with them the need for higher-quality collateral – and much more of it. Accordingly, collateral management teams have taken on an increasingly important role in the securities lend-ing trade.

“These groups may have access to buckets of col-lateral that can be lent out to broker-dealers in search of high-quality collat-eral,” says Glicher. While not nearly as lucrative as the initial public offering mar-ket, collateral loans still represent a source of low-risk revenue for these teams, says Glicher.

With demand for government-backed securities on the rise, PSERS has seen fit to lend at competitive market rates to cred-itworthy borrowers capable of delivering high-quality collateral, especially cash, in return. Still, PSERS will not raise its inventory any further, says Kemp, “mainly because of our ongoing view of securi-

ties lending as a second-level investment programme”.

While participation in collateral trans-formation opportunities – whereby collateral such as government-backed securities that have been delivered to lenders are then lent back into the mar-ket – cannot be ruled out, for the time being the risk-reward benefits do not sup-port current involvement. “It is certainly something we will continue to monitor, however,” adds Kemp.

With margins continually under pressure, not everyone will have the wherewithal to stay engaged. Wilson admits: “All of this extra due diligence and added cost may have the effect of pushing some owners out of the market altogether. The fact is, opportunities such as collateral upgrade trades, emerging markets strat-egies and the like do require increased beneficial-owner involvement, due to the additional complexity inherent in these strategies. Nevertheless, for an increasing number of beneficial owners the potential rewards are well worth the effort.”

Due diligenceThough the recent market momentum may support a rise in confidence, owners need to remain vigilant. As noted in the recent BNY Mellon/Deloitte report Invest-ment Opportunity: A Market Perspective on the Changing Securities Lending Land-scape, due diligence guidelines should include continual monitoring of counter-party creditworthiness and concentration, ascertaining the value of securities on loan, as well as determining agent lend-ers’ continuing financial stability.

Glicher believes the increased focus on risk management and transparency will go a long way towards boost-i n g o w n e r i n v o l v e m e n t . “Giving benefi-cial owners access to reporting data empowers them to seek out infor-mation regarding

industry trends, performance attributes, price discovery and benchmarking.”

Kemp agrees the move to incorporate more robust due diligence standards will benefit owners by providing a much clearer view into their securities lending exposures, allowing them to intervene should conditions warrant. As such, “bet-ter transparency and reporting could encourage owners that exited securities lending during the past financial crisis to re-enter their programmes”.

Agent lenders must step up to the plate to ensure that information and reporting sent to the beneficial owner is clear, easy to review, and customised to their exact specifications, suggests Starble. “If pro-duced correctly, transparent reporting should alleviate the burden of managing a securities lending programme, thereby making compliance checks and internal reviews faster and more efficient,” he says.

Starble also sees clients continuing to emphasise education and support around their lending programmes, well after the initial implementation has been complete. “As an example, many of our clients use our on-site client representative offer, which helps to strengthen our ability to support the day-to-day management of a client’s securities lending programme while also providing an on-site resource for any secu-rities lending-related questions.”

While demand fundamentals continue to be muted – due in part to more stringent capital, leverage and liquidity require-ments under Basel III and Dodd-Frank – Wilson believes the future still holds promise. “While many have modified their lending parameters somewhat, I think it is evident that most beneficial owners have managed to put the events of 2007-08 behind them,” notes Wilson.

“We have seen new lenders continue to enter the market, as well as current lenders rotate their books of business in an effort to boost their revenue streams. Bond yields remain very low and we have seen interest rates move negative in Europe, which has definitely helped keep lending at the forefront as asset owners look for incremental ways to add value to their portfolios.” g

“Transparent reporting should alleviate the burden of managing a securities lending

programme” CRAIG STARBLE, ESECLENDING

“Better transparency and reporting could encourage

owners that exited the securities lending during the

past financial crisis to re-enter” jOHN KEMP, PSERS

The Eurex Repo worldwidedirectory ofsecurities lending and repo

2015Global Investor/ISF is launching the 2015 Directory in January at the Clearstream GSF Summit.

Thousands of print copies will be distributed to subscribers and at all major securities finance events in 2015 across four continents.

Contact Tim Willmott to request a copy: [email protected] +44 207 779 7216

It is also available free online on the Global

Investor/ISF website, via the following link: http://bit.ly/1gRotj0.


cOLLaTERaL manaGEmEnT |

Most US mutual funds, and increasingly pen-sion funds, manage their cash collateral inter-nally, but the practice is

under scrutiny as regulatory change forces more effective management.

For example, borrowers will be incentiv-ised to cover general collateral (GC) shorts from internal sources from January. Then, banks that are subject to Basel III are required to set aside regulatory capital to support their indemnified agency lending balances, which in turn will increase cost structures for agent lenders and put pres-sure on GC lending.

A second pending regulatory change relates to the net stable funding ratio (NSFR), another element of Basel III. Although the rule is still subject to interpretation by national regula-tors, it is likely to increase the cost to prime brokers of facilitating short sales collateral-ised with cash and encourage greater use of non-cash col-lateral. It may require as much as 15% of the short balance to be funded with one-year money, again adding to funding costs.

Currently US broker-dealers are pro-hibited from giving equities as collateral but the NSFR is reigniting interest in the use of equities as collateral in the region, since they would not incur the same funding requirement as cash collateral. Supporters argue that the use of equities as collateral in Europe has a good track record, performing well through the financial crisis – equities are easily priced and provide the benefit of being correlated with equity loans.

Market participants have convened working groups through the trade asso-

ciations and are developing proposals to address some of these regulatory changes. Although these are long-term initiatives, they are forcing asset managers and pen-sion funds to re-evaluate their collateral management processes. Many are con-templating whether to manage collateral in house or outsource the process through parties such as custodians or fund admin-istrators as their requirements become more complex. Both are viable models.

Internal managementManaging cash collateral internally allows an asset manager to deal with and priori-tise the greatest potential risk in the flow of securities lending. For those fund families with an internal money market capability, it can make sense to bring the function in house and facilitate changes to investment

guidelines as mar-ket conditions call for them.

Another argu-ment in favour of internal collateral management is the elimination of potential conflicts of interest. If the

lending agent also manages cash collat-eral, it may be incentivised increase GC balances to generate cash management fees, while the lender bears the principal risk on the cash pool.

The prime challenge is to create a suf-ficiently flexible framework to deal with different types of collateral. While there has been lots of discussion about a short-age of collateral, the real difficulty is in marshalling the collateral available, as most financial institutions remain divided into silos. Operations are often managed at desk level and, as they stand, cannot be rolled up to enterprise level – so tieing the plethora of disparate data together is a real challenge.

Stephen Bruel, vice-president, investor services and markets at Brown Broth-ers Harriman in Boston, says: “First and foremost, the collateral management system needs to incorporate the haircuts and concentration criteria of the collateral pledged. Cash is easy to value and easy to move but the key is to see that your system can accommodate any form of collateral, providing the flexibility to pledge differ-ent collateral to different counterparties at different points.

“Should equities be pledged, there is also an operational component to managing downstream processes such as substitu-tions in a timely fashion. Another factor is knowing the right piece of collateral to pledge. As the value of collateral required increases, acceptable use of equities and other such issues become more pertinent. There is a lot of discussion about corpo-rate bonds at the moment but the need for expanded eligibility is sequenced with increasing regulatory impact.”

OptimisationIncreasingly, collateral-related activities need to be undertaken prior to trades being concluded and it can therefore make sense for optimisation activities to be con-solidated with a firm’s treasury risk group as it takes a higher-level view, not only of the financing activities of the firm but also the other products and areas that interact with clients across the firm.

Optimisation is certainly a theme that

Taking controlUS beneficial owners are increasingly managing collateral internally and considering non-cash collateral, finds Ceri Jones

“As the value of collateral required increases, acceptable use of equities and other such

issues become more pertinent” STEPHEN BRuEL, BBH


needs more work. “Firms are focused on post-trade optimisation but pre-trade optimisation has not received much atten-tion, specifically in the cleared derivatives market,” says Neil Wright, industry adviser to Sapient Global Markets in New York. “Market participants need to consider what is the optimal combination of FCM [futures commission merchant] and CCP [central counterparties] for clearing their next trade to ensure that they take advan-tage of the optimal netting availability in terms of the initial margin required on a new trade versus their existing portfolio. Most firms have appointed multiple FCMs so it is an important factor to decide where they clear each new trade. Some of the FCMs are trying to address clients’ needs in this space but their offering is limited as they only have a view of their cli-ents’ portfolio that is cleared through themselves.”

Richard Glen, head of global securities financ-ing sales for UK, Ireland and Ameri-cas at Clearstream adds: “In the current climate, more sophisticated algorithms on optimisation are needed and are often required to be bespoke. There is currently a lot of discussion around how the regula-tions need to be interpreted – the vendor community is now playing catch-up.

“Post-trade optimisation largely depends on which of the available and eli-gible assets are cheapest to deliver. A lot of software vendors have rule-based solu-tions to address this need, as part of their collateral management offering.”

Examples of software providers in this space include Algo Risk and Lombard Risk, which are bigger in Europe, and SunGard and Calypso, which have larger market share in North America. In total, there are 23 collateral management ven-dors – some are stand-alone and others are part of a risk management package or trading platform.

External“They are all pitching different things,” says Virginie O’Shea, senior analyst at Aite

Group. “Most of the market is very far off understanding what good collat-eral management looks like at the global level. You’ll need it if you are heavily into swaps as that is challeng-

ing. A lot of the buy-side [entities] do not invest in derivatives so there is no real driver for their investment and they may already hold sufficient collateral assets.”

Mandated clearing has been imple-mented in the US, but is yet to start in Europe. “Many firms are therefore col-

laborating and sharing ideas about how to re-engineer their processes,” argues Ted Leveroni, executive director of strategy and buy-side relations at DTCC. “They are looking to be more efficient with their collateral without changing the way they trade. Nobody wants to have to tell the portfolio manager or trader in the front office that they cannot trade or that they must trade differently.

“Firms want to manage their collateral holistically, breaking down silos so they can be smart and see all their trades across the operation. Firms also want to overlay tech so they can manage the increased number of margin calls and also adapt industry standards so they can automate collateral management processes.”

Regulatory arbitrageThere may also be potential for regional arbitrage. In the US it has been proposed that variation margin for non-cleared derivatives has to be cash – regulators are currently consulting the industry. Varia-tion margin in cash is the tradition in the futures and options market but it is going to be a big change for OTC derivatives.

In Europe, it may be different; regula-tors have proposed that both initial and variation margin for non-cleared deriva-tives trades can be satisfied by a number of highly liquid security types as well as cash. Depending on how regulators in the US respond, it could create an unlevel playing field and an incentive to trade with firms based on their location.

There has also been pressure from the regulators to use better standards in related communications, as file transfer protocol and email are not very secure. ArcadiaSoft, and its messaging standard, is a good example of how standardisa-tion has evolved and been accepted by the industry as the provider for automating the messaging of collateral calls, to replace emails and faxes.

The landscape is still developing, however. For example, originally it was thought that many firms would provide collateral transformation services to con-vert low grade collateral to government debt, but this has not transpired owing to the high costs of capital for transac-tions with long tenors. It’s yet another example of banking regulation creating unintended consequences.

The use of securities as collateral has also led to renewed consideration of CCPs for securities lending as they attract a 2% risk weighting versus 100% for broker-dealers and 20% for banks. Currently, the US CCP, the Options Clearing Corp, is only used for broker-to-broker securities lend-ing activity. g

“Most of the market is very far off understanding what good collateral management looks

like at a global level” VIRGINIE O’SHEA, AITE GROuP

“Firms want to manage their collateral holistically, breaking down silos so they can be smart and see all their trades across

the operation” TED LEVERONI, DTCC


THOuGHT LEaDERSHIP: SOcIETE GEnERaLE |

Chair: I am sure you have seen the variety of estimates for the predicted collateral shortfall ranging from $800bn to trillions. Do you think it will be as large as some of the reports pre-dict and, if so, what strategies do you have in place?

Anne-France Demarolle: There were many reports warning of a collateral shortfall a year ago. If you look at it, to date, there has been no collateral crunch. One can point to many reasons such as the delays in implementation of regulation, especially European Market Infrastruc-ture (Emir) and the mandatory clearing of some OTC derivatives. In addition, the financial system is awash with both cheap cash and a large supply of high-grade government bonds that can be used as collateral. This is mainly due to the huge deficits run by some countries in Europe as well as the US and Japan. I do not think there will be a shortfall but see the focus being more on the process to realise the right collateral in the right place at the right time, to cover collateral needs.

Angela Osborne: I think the general consensus is that there will be a time lag between when Emir goes live and a poten-tial collateral shortfall. This is due in part to the fact swaps are only eligible for clear-ing upon execution versus grandfathering an entire book, so one would expect to see pressure on collateral build over time. The

question is, when will the collateral squeeze happen? Will it be in 12 or 24 months? Or, perhaps it may never materialise.

Looking ahead, problems could be mit-igated by additional asset classes being eligible for central clearing. For example, there is talk of allowing exchange traded funds (ETFs) and money market funds being accepted as eligible collateral at cen-tral counterparties (CCPs) and exchanges. Such measures should help widen the available pool of collateral for margin pur-poses and hopefully unlock any potential squeezes in the collateral market should they emerge.

Philippe Karriere: There are two sides to this equation. We have seen the figures being published. But taking just the sover-eign debt of the US and Japan, the amount of eligible collateral assets has increased by $11trn since 2007.

However, those reports and figures sometimes help market participants put collateral, as a topic, on the map. These headlines woke up the industry. It forced all of us to start to think about collateral management and optimisation.

Looking at the bigger picture, what are the main challenges facing market par-ticipants in managing and optimising collateral today and in the future?

Pierre Lebel: It depends on who you talk to. If it is the sell side and the larger banks, they have experience managing collateral in the bi-lateral world and are well pre-pared with the resources and personnel to deal with the additional requirements and reporting.

This is not necessarily the case with the small to medium-sized firms. They are not ready. Regardless of size, it still means

Collateral conundrumRegulatory change has propelled collateral management from a back-office activity to a boardroom priority. How prepared are market participants to manage the new requirements and what are service providers doing to help?

PARTICIPANTSAnne-France Demarolle, head of liquidity management at Societe Generale Securities

ServicesPhilippe Karriere, deputy head of client collateral management, NewedgePierre Lebel, group treasurer and head of client collateral management, NewedgeAngela Osborne, co-head of agency cash management, Newedge

Newedge is the fully-integrated Prime Services division of Societe Generale


having the processes in place to manage contracts and updating them to comply with the new regulation. It also involves manag-ing the independent valuations and margin calculations. These tasks not only include the back to middle office but also the front office functions. In the end, it opens new business opportunities for those that can provide collateral management services.

Demarolle: I see three challenges for market participants, although they will differ depending on their size. The first is that, due to the sheer number of regula-tions, firms have to figure out which rules apply to them and the jurisdictions where they operate. There are also different reg-ulations for different sectors, for instance banks have to meet Basel III while the insurers have to comply with Solvency II. Each one adds to complexity, but securi-ties services businesses can help clients navigate the regulatory landscape and understand which rules apply to them.

The second challenge is identifying your collateral requirements and collateral resources. Third – and this is one of the main issues – is the organisation and tech-

nology that firms will need to implement. All of these new processes come with a cost, and some of the functions that were seen as back office or treasury, such as collateral management, are increasingly becoming a front-office activity.

Karriere: Another issue that market participants will have to deal with is the eligibility of collateral. Some clear-inghouses have been reviewing their collateral schedules and others, such as Eurex, accept commodity certificates such as Xetra-Gold as eligible collateral. In terms of liquidity it is positive, but it also demonstrates the huge layers of com-plexity that have been added to the whole process.

How prepared is the buy side? Is the sit-uation similar to the one on the sell side, where the larger players are making the most progress?

Osborne: We have seen the buy side pre-paring for Dodd-Frank and Emir from a regulatory and operational perspective, but clearly the funding requirement has

been a lesser priority. For example, most of the tier-one buy-side clients, or those that are going to start clearing under Emir next summer, are clearly prepared in terms of choosing their clearing member brokers. But I think the bigger question is around the level of financing and the credit lines that they have in place. Are they com-fortable that they have adequate funding facilities in place to cover their initial or variation margin requirements in the event of a tail-risk event?

This all comes at a time when banks are reducing their balance sheets under Basel III’s liquidity coverage ratio (LCR). This generally does not impact the tier-one cli-ents that have access to adequate funding lines, but rather small and medium-size clients. The challenge for this segment is that they are not collateral managers by trade and would need to become repo spe-cialists. The clock is ticking and I believe clients should start focusing on alternative solutions and other agency-like products such as our Agency Cash Management (ACM) offering in the event they hit their credit limits with their primary lend-ers – particularly during times of crisis. The tri-party repo mechanism is a solu-tion for this community as it eliminates much of the operational work required to transform cash and collateral for clearing purposes. Our ACM offering accommo-dates tri-party repo across all four of the tri-party agents.

Demarolle: I agree that there does not seem to be the same pressure at the moment between sell side, where opti-misation of collateral is very high on the agenda, and the buy side, which, although depending the institution’s size, is not behaving in the same way. The small and medium-size clients seem to be in a wait-and-see mode and are reacting to what is happening on the sell side and what banks are willing to commit in terms of their bal-ance sheet.

Many of the larger banks are developing the same products and services, so how do you differentiate your offering?

Lebel: The Societe Generale offering is dif-ferentiated in the areas of optimisation and transformation. For example, firms manag-ing, say, half to one billion euros in assets might generate around 50 to 60 transactions per month. It would not be economically viable for them to have an optimisation engine for managing and posting the cheap-est collateral. It would also be expensive to have a team in charge of transforming ineli-gible or assets with deep haircuts via repo to go through the CCP.

“Transparency will be good but there is still some uncertainty

over parts of the regulation such as minimum haircuts”

PHILIPPE KARRIERE, NEWEDGE

“The clock is ticking and I believe clients should start

focusing on alternative solutions”

ANGELA OSBORNE, NEWEDGE


This opens the door for service provid-ers. We have a collateral management service for Newedge clients that has been expanded to the rest of Societe Generale’s clients. We are also working on a centrally managed pool of assets. We also offer mid-dle office services of valuation, reporting and dispute management in the OTC world. Although other banks are offering a global-investor solution, we have been doing it for a longer period of time.

Demarolle: I also think there is a pre-mium for service providers that can encompass the full spectrum of services ranging from connectivity for clearing members for collateral transformation and the necessary administration tied to the valuation and daily margin. Custodi-ans have moved into this space because the infrastructure needed to do collateral management or transformation is not very different from agency lending.

Karriere: It is not just about the cost, though. It is also about the expertise that a firm such as Societe Generale can bring in terms of generating outperformance on a portfolio return.

Osborne: In terms of us being separate from the rest of the pack, we have our ACM product that allows clients to trans-form cash and collateral in an efficient and transparent manner. We were the first to the market with this cash-and-collateral tri-party repo auction, designed for the buy side – it is what we call a bank-to-client (B2C) offering. It could potentially be client-to-client (C2C) offering – it is an innovative solution that, at this point, our competition does not have.

Many of the large sell-side firms are prepared for the new OTC regulation but some have had to restructure their operations. What has Societe Generale done?

Demarolle: You have to break down silos because whether it is cleared or uncleared OTC derivatives or securities lending, everything comes back to collateral. This means consolidating all inventories of assets to be able to post and check you have the right collateral in the right place, at the right time. It is a question of putting every-thing together. We have already looked at the different departments or subsidiaries of Societe Generale and have identified the building blocks.

Lebel: It was about integrating exist-ing services, such as the client collateral management of Newedge with the middle

office services of Societe Generale Secu-rities Services into a third-party offer. It enables us to offer new services and financ-ing to clients. With securities financing as well as prime brokerage, there comes col-lateral management. It is all intertwined.

However, we believe it is the right time to offer those collateral services to clients that cannot manage them internally, as they are too expensive, complicated or time-consuming to do. It is important to be flexible.

What role does securities lending play in the new world of collateral management?

Demarolle: I think securities lending is the basic transaction that you can do as a transformation trade so, when it comes to transformation of collateral, it will be a key feature. It means that institutions that need collateral or eligible assets will be able to find them. At the moment, there may not be a collateral shortage but some beneficial owners are not lending their securities and especially their high-quality liquid assets. The reward is not compelling for the time being – they are just waiting so their collateral is not on the market.

The other issue is that the terms under which the borrowers are ready to borrow are not always the ones that the beneficial owners want. The good thing is that the new regulations contribute to demystify-ing what securities lending is by providing more transparency on the use of assets, market participants and further details of the trades, while rejecting the most aggressive schemes. This is especially important when people see it fall under the label of shadow banking.

Karriere: I think transparency will be good but there is still some uncertainty over parts of the regulation such as mini-mum haircuts, which will need clarity and could add another layer of complexity.

Lebel: A large part of the need for collat-eral will actually be for variation margin. This has to be paid in cash, so the need to have an instrument that allows you to transform the security into cash to post the margin will be increasing. This means that if you only have securities, you have to change them quickly into cash via the tri-party repo mechanism. By combining this with our e-platform, ACM can help you achieve this in a fast and operation-ally efficient way. g

“Securities services businesses can help clients navigate the

regulatory landscape and understand which rules apply

to them” ANNE-FRANCE DEMAROLLE,

SOCIETE GENERALE

“It is the right time to offer collateral services to clients that cannot manage them internally, as they are too

expensive, complicated or time-consuming to do”

PIERRE LEBEL, NEWEDGE

THOuGHT LEaDERSHIP: SOcIETE GEnERaLE |


| InTEREST RaTES

Beneficial owners in the US will be among the first to be affected by the coming rebound in interest rates, which will have both positive

and negative implications for securities lending programmes.

While the US Federal Open Market Committee has reiterated its position that rates will remain at very low levels in the near term, the Fed ceased its huge asset purchase programme in October, almost six years after it started, and raising rates will inevitably be the next stage of mon-etary tightening.

Based on its current assessment of the US economy, the committee said the tar-get range for the federal funds rate would remain between zero and 0.25% for a “considerable time”. While its prediction is based on the assumption that inflation continues to run below the long-term tar-get of 2%, which could be exceeded, it is clearly anxious to minimise uncertainty around interest rates.

Fed chairman Janet Yellen has consist-ently said rates would be increased only in a measured fashion, but this has not

stopped speculation that they could go as high as 3% by the end of 2015 – espe-cially if the US economy continues to gain momentum.

Given that the collateral posted by bor-rowers is typically cash, US beneficial owners will be observing interest rate developments closely. According to Lou Maiuri, executive vice-president of State Street Global Markets and head of securi-ties finance, the impact of rising interest rates on US securities lending depends on a number of variables including the rate and transparency of interest rate changes and the degree of the lender’s asset-liabil-ity duration mismatch.

“It is helpful to focus on the most recent cycle to address this question. In June 2004, the Fed commenced the first of 17 consecutive interest rate changes, which eventually increased the funds rate from 1% to 5.25% over a near three-year cycle. During that period, it proved beneficial to augment floating rate product in reinvest-ment pools with opportunistic lending to raise cash and invest across a steepening yield curve.

“The higher yields not only kept pace with the funding cost resets that coincided with each tightening, but also resulted in materially increased revenues year-on-year for the aforementioned period.”

As interest rates rise, so do both the rebate rate and the reinvestment rate, so in theory the spread earned between these two rates should not change, observes James Slater, executive vice-president global collateral services and head of GCS securities finance group at BNY Mellon. “However, when rates pushed up against

US beneficial owners concerned about the impact of higher interest rates on their securities lending programmes could learn much from previous rate cycles, writes Paul Golden

History repeating

“With a sharp increase in interest rates, it is plausible to think that there would be a greater incentive to adopt

alternatives to cash collateral” jAMES TRESELER, SOCIETE GENERALE


InTEREST RaTES |

zero we saw some spread compression. As rates go higher we should expect some incremental pick-up in yields, but the effect is not going to be as dramatic as it would be for a simple cash investor, for example.”

The correlation between interest, rebate and reinvestment rates has remained consistent through previous interest rate cycles. While he accepts that the interest rate environment over recent years has been highly unusual, Slater still antici-pates only a modest widening of spreads as interest rates move back to more nor-mal levels.

Cash collateralThe impact of rising interest rates is differ-ent for each of the entities in the securities lending chain – the agent lender, ben-eficial owner, prime broker or end user, according to James Treseler, global head of cross-asset secured financing at Societe Generale.

“With a sharp increase in interest rates, it is plausible to think that there would be a greater incentive to adopt alternatives to cash collateral. I once read that Wall Street does not have a short memory, it has no memory. Dramatic rises in interest rates could lead to an inverted yield curve which historically has created a significant dislocation in the reinvestment strategies of agent lenders. We have seen this more than once and the impacts were costly.”

While there is uncertainty surrounding the likely speed of US interest rate rises, and their impact on the securities lending market, Maiuri says the prevailing view is that the Fed will take no action until at least the middle of 2015. “The spread between Libor [with one or three-month commonly used as a proxy] and the Fed funds rate – the cost of raising cash – shows no sign of widening before that period. In that context, clients that have created flexibility in their programme guidelines to include fee-based, non-cash collateral and reverse repo financing options have enhanced their total return opportunities.”

Moreover, when the Fed does choose to change monetary policy and begin raising rates, his expectation is that this will be preceded with forward guidance and done in a measured manner. “Nonetheless, without a crystal ball to guide us through its timing and scope, remaining defen-

sively positioned to mitigate an initial rate shock – with shorter durations and increased liquidity for cash investments and a greater tilt towards fee-based, non-cash collateral and reverse repo financing – remains a plausible and constructive strategy.”

Maiuri says history has shown that ris-ing rates do not equate to lower securities lending volumes unless there are shocks. “The Fed’s transparency or the market’s ability to predict or price in future inter-est rate changes may lead to a widening interest rate curve, which would support increased lending and revenue opportuni-ties. That said, surprise or shock interest rate changes may temporarily dampen such opportunities given the immedi-acy and more pronounced impact from higher funding costs unless defensively positioned to mitigate those risks with higher levels of liquidity, which would rather quickly act as a self-corrective mechanism.”

In that context, those that pursue aggressive reinvestment strategies or longer duration mismatches would be most adversely affected, he suggests.

“All in all, nominal interest rates are less relevant in this discussion. The spread between funding costs [the Fed funds rate] and reinvestment pricing [Libor] is the key area of focus and planning – in other words, the existence of any steep-ness to the interest rate curve.”

As the industry transitions to a future securities lending operating model amid eventually higher interest rates and regu-latory reform, Maiuri reckons the ability to utilise multiple reinvestment options to preserve and enhance the total spread of a transaction will be necessary and will serve to differentiate participants in the securities lending industry. Such reinvest-ment options include, but are not limited to, money market funds and government-backed repo.

“The convergence of these two forces will penalise those programmes that are too narrowly focused or perceived as not offering flexibility to both beneficial owners and counterparty – borrower – relationships.”

Asked whether it is inevitable that higher rates will lead to lower securities lending volumes, Slater also observes that a number of other factors affect demand, notably activity in the equity and fixed

income markets “although, if interest rates are having an effect on these mar-kets, by extension they are also impacting securities lending”.

Money market fundsSo how will higher interest rates affect demand for money market funds and gov-ernment-backed repo? “Money funds and companies that manage these funds are under considerable pressure – many funds have had to waive fees because of the low interest rate environment,” he adds.

“As rates transition to a more normal level, these fees will be reinstated and that will have a significant impact on the money funds market. But there are other develop-ments that will have an even greater effect on this market, such as market reform, which could see some funds forced to go to floating net asset value.”

According to Slater, there is also some speculation that there could be a migra-tion of investors from prime funds to treasury funds, which would place addi-tional pressure on a segment of the market that is already constrained by the avail-ability of government repo.

“The Federal Reserve reverse repo pro-gramme also has the potential to impact securities lending,” he concludes. “If and when the Fed decides to remove some of the stimulus in the market and rates go higher, there is considerable speculation as to how it might use the reverse repo pro-gramme to affect monetary policy. It has been tinkering with the programme over the last month or so, experimenting with different rates and caps on the capacity to assess its market impact.” g

“Remaining defensively positioned to mitigate an initial rate shock remains a plausible and constructive strategy”

LOu MAIuRI, STATE STREET

“As rates go higher we should expect some incremental

pick-up in yields” jAMES SLATER, BNy MELLON


| nORDIc LEnDInG ROunDTabLE

Chair: It has been a strong year for mar-kets and for M&A activity. We have also seen a slew of regulations. How have these affected the health of the securi-ties lending market?

Murphy: It has been a challenging year but stock lending is as important as ever as a liquidity tool within the financial mar-kets. Revenues have been challenged this year across some products in securities finance, but it is still an industry that offers an important return on assets in a difficult economic environment. Uncertain condi-tions also drive new demand from hedge funds, and encourages new supply into the market. I have not seen any beneficial owners choosing to leave this year.

Karczewski: This year and last year have been similar in respect to general flow, but the demand profile for securities is chang-ing a little. We are seeing stable demand on the equities side but an increase in demand for exchange traded funds and fixed income upgrade trades. With the regulation coming through the system there is going to be a squeeze on liquid-ity and an increase in downgrade-upgrade trades.

We have just issued a report for which our business advisory team canvassed 150 sovereign wealth funds, asset managers and hedge funds globally. Findings sug-gest the multibillion-dollar hedge funds see an opportunity to start financing their assets directly. Hedge funds do not have the same constraints as some of the more classic investors, as under Ucits rehy-pothecation is not allowed.

Rudilokken: I agree. This year our secu-rities lending business has improved. In Norway, when we came out of the finan-cial crisis in 2008-09, volumes were thin because suddenly everyone had pulled

out. Then, we saw the lenders came back to the market before the borrowers. After a couple of years international borrowers came back and during the last two years or so we have seen the local borrowers com-ing back into the market as well.

There are some demands from new requirements, especially requirements around equities which will need to be calculated in a different way. It will be interesting to see how the market devel-ops. Will it be the same players doing the same thing or will they differentiate them-selves more greatly in future?

Saebo: We are mostly lending assets in Norway and here we have seen increased demand versus last year. Especially, the Norwegian oil service sector is facing a tough time so there has been increased demand in that sector. And, this is in addition to high grade bonds for collateral upgrade-downgrade purposes.

Rudilokken: We are also working in the Norwegian market and see this increased flow, which looks to be specific to that country.

Murphy: We have seen strong flows but it has mainly been stock specific, with a slight increase in potential merger or arbi-trage in the final quarter and in small to mid-cap companies.

Karczewski: Did you see any change in pricing around oil stocks during the recent Scottish referendum? The UK was quite nervous generally with a lot of price fluctuation.

Saebo: We saw a little spike but the trend has been there for a while.

Chair: Have regulations and increased capital requirements already changed the securities lending business? And, what will be their future impact?

Karczewski: As a large US organisation, we are having to deal with Dodd-Frank and many other regulations. The impact on capital charges and balance sheets will be significant. We have to adjust the pricing accordingly, which the more sophisticated clients understand. The question is where do you pass on those charges? The issue is that we are currently not on a level playing field – capital is accounted for differently depending on the regulator of the bank or prime broker and whether it is Emea or US-based. Will the market start to pay less to borrow as a result? Or, simply use dif-ferent ways to source stock? A great deal is changing and new models are being adopted – this is the future for any large player.

Rudilokken: We see the same. We get

PARTICIPANTSCeri jones, chair Dan Murphy, head of equity finance, SEBDag Rudilokken, head of trading, securities finance, DnB jane Karczewski, managing director, prime finance and delta one, Citi jorgen Saebo, head of treasury, Folketrygdfondetulrik Modigh, head of asset management operation, Nordea

Northern exposureSecurities lending is expanding in the Nordics, albeit modestly and limited to certain sectors, but the issue of how the costs associated with new regulations will be spread between participants hangs over the market


nORDIc LEnDInG ROunDTabLE |

charged internally for the cost of this business now. But there is a lot of discus-sion about whether we should carry these costs. Do we carry it or pass it on to other counterparties in the market? That is the challenge.

Saebo: Some of the increased demand we have seen this year may be as a result of this. Due to a low risk-weighted asset weight, we are more and more often seen as a favorable counterparty.

Karczewski: The cost of servicing inter-nal desks is also changing. Where the cost sits internally could impact the efficiency of areas that cater to several businesses such as cash execution and liquidity.

Murphy: It is certainly forcing people to look at their models. We have the same discussions as Jane [Karczewski], but it is a more recent discussion in the Nordics because the banks here are cash rich and comfortable with Basel requirements.

Chair: Does the panel have a sense of where those charges will ultimately fall?

Karczewski: It would be hard to pass on in their entirety to clients. It is not about securities lending and short coverage, there are a variety of aspects to consider. Hedge funds and institutions all have much wider relationships with their pro-viders. I think it will continue to be priced into the strategic relationship with clients. One positive that has come out of this sce-nario is that we have become much more connected with other parts of the business – there is more understanding of what we do and our colleagues know that if we did not exist they could not execute on all strategies.

Murphy: There is more collaboration and a more holistic view of clients. We are definitely removing silos between parts of the business and are working with other departments on new structures.

Rudilokken: For us, there has also been a lot of thinking about silos in the busi-ness. Will every desk in future have its own profit and loss? So far we have only seen the beginnings of a possible change,

as it is just relates to the costs of collateral, but looking further ahead the rating of the counterparties will also come in.

Murphy: From a client view, you are going to be looking at which prime broker you are borrowing from and there will be more pressure to know your client. We do not yet have the answer on how far-reaching the financial transaction tax (FTT) will be. It would be a real impediment to market liquidity, and whether an exemption will be given is something all parties would like answered as soon as possible.

Rudilokken: One question is whether volume in the business is going to change very much. Spreads may widen to try to take up costs, but I do not think they will change considerably.

Karczewski: May I ask who is looking at central counterparties (CCPs), perhaps to help with the general collateral (GC) flow, or balance sheet optimisation?

Rudilokken: I guess everyone has to look at CCPs to some extent now. CCPs may take market share because capital requirements are less compared to trad-ing bilaterally. But not everything will move over to a CPP, because the business is relationship-driven. People like to know where their balances are and with whom they are transacting. We may be driven into using a CPP but then again, which CPP should we look at? If we are going to trade with international parties, we ca not use local firms.

Murphy: As you say, there are no CCPs that single-handedly cover every market. That means there is a problem implementing anything quickly on a wide-reaching basis.

Karczewski: Some clients do not want to lose transparency that the process of agency lending disclosure and so on. provides. They see the CCP as a differ-

ent concentration of risk, in the event of a default. It depends on how large your volumes are versus the exchange and your place in the pecking order in respect to an event of default. I think owners of assets are nervous.

Chair: As a beneficial owner, Jorgen [Saebo], what is your opinion on CCPs?

Saebo: We have not looked at it for securi-ties lending yet. It is in its early stages on the derivatives side and as a pension fund we are likely to be exempted for a while. But we are paying close attention to it and how it may affect pricing.

Rudilokken: The issue of CCPs resurfaces when people start talking about capital costs and balance sheets, but only a cou-ple of years ago people were talking down the possibility of there ever being a CCP in practice.

Karczewski: There were also concerns around transparency on pricing. How accurate is the transparency via the CCP, because of varying domiciles and types of provider?

Chair: How will the legal differences in the Nordic region make an impact?

Saebo: In the Norwegian market not many have participated on the lend-ing side because of regulation. At the moment there is a new proposal at the Ministry of Finance to make it easier for pension funds and other beneficial own-ers to lend their assets, and that is a good thing for the market. You are allowed to lend but there is legislation around the structure of diversifying across counter-parties and whether the cost of running the programme is charged to the fund or the management company. Many funds in Norway are too small to be players, but some are big enough and this regulation could help them into the market.

Karczewski: What percentage are we looking at?

Rudilokken: That is difficult to say because some of the biggest funds have business outside Norway. Right now we do not know if they will participate. Some

“Many [pension] funds in Norway are too small to be players, but some are big enough and this regulation could help them

into the market” jORGEN SAEBO, FOLKETRyGDFONDET

“We must expect that fixed income lending will be more attractive in future because the demand for highly-rated

securities will go up when we enter the Emir universe” uLRIK MODIGH, NORDEA

Offering: Commitment, Knowledge, Experience and Excellent Service

For further information please contact:

Head of Securities Services and Global Custody – Jan B. Penne: [email protected]

Securities Finance – J. Kenneth Hage: [email protected]

Products and Network – Bente Hoem: [email protected]

Client Relations Norway – Lene Bjørneberg: [email protected]

THE LEADING PROVIDER OF SECURITIES FINANCE, CUSTODY AND CLEARING SERVICES IN NORWAY

PROACTIVE, ADDING VALUE, DELIVERING QUALITY

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nORDIc LEnDInG ROunDTabLE |

clients we thought were in the lending business have told us their custodian says they are too small to be a player. It might vary between different custody banks.

Karczewski: If you want to go into a tra-ditional agency lending programme then there must be the critical mass to make it work, whereas a smaller fund may be bet-ter off on principal basis with one of the smaller banks here.

Chair: Is there a common cut off point across all the Nordic markets whereby a fund becomes better of operating on an agency basis?

Karczewski: On the equity side, anything below an asset pool of a billion is probably just as easy to trade on a principal basis. A lot depends on the intrinsic value of the portfolio and the turnover.

Rudilokken: If you have an index fund and it is invested around the globe, then it may only have small portions in every stocks so the cost to move the stock will be too high compared to a possible income, so yes, this probably needs to be done on a principal basis.

Chair: How does the Nordic client base compare to the rest of Emea?

Rudilokken: There is one big difference – in Sweden you have a hedge fund business.

Murphy: Also, what is different here is that pension funds are heavily invested in hedge funds and those pension funds ca not nec-essarily participate in lending pro-grammes owing to investment restrictions.

R u d i l o k k e n : There are rumours that some of the big fund managers who invest in funds of funds are pulling out of these investments, and that may have an impact on the flow.

Karczewski: It is also about the percep-tion of what is, and what is not, a hedge fund. We hope that conceptually people are beginning to understand our busi-ness – it is not just about aggressive shorting. There is a convergence between classic hedge funds and other asset man-agers using the same strategies. They are competing for similar investments, so competing for returns. They are all sensi-

tive to costs and pricing.

Rudilokken: There is pressure for fees to be reduced going forward. In Norway we do not have a classic hedge fund industry but we do have family offices investing long-short, which in central Europe might be regarded as a hedge fund. They are potentially going to be regulated more

like hedge funds in the future.

Murphy: We have many existing internal lender clients with an exposure to Russia, but demand is too sporadic and there are still problems regarding handling

of corporate actions such as back-dated record dates.

Karczewski: There is too much politi-cal instability in Russia specifically. In Poland, though, there is definitely an increased flow.

Murphy: There are a handful of names out of an index of 20 that we will look at. Generally, this has been the general prob-lem for a few years. The lender gets enticed in with a sexy new market but when you actually get around to it, it takes a while for that demand to filter through.

Chair: Which Nordic markets are likely to see most activity?

Saebo: Norway, specifically in the oil sector.

Murphy: Finland and Norway are where we have seen most special flow activ-ity over the last year with a high number of hard-to-borrow stocks. Sweden has picked up in the small to mid-cap segment where there will be more opportuni-ties in the future. Recently, an increased amount of corporate activity in the Nor-dics has created demand. In Denmark, the shorting ban continued a long time after everywhere else, scaring off hedge funds that might have looked at directional plays on the market.

Chair: Will the reduction in the set-tlement period in Norway from T+3 to T+2 have an impact on managing the business?

Murphy: Recalls will have to be a bit sharper, and covered in a timely manager to avoid any costly settlement fines.

Saebo: Operationally it is not going to be a problem as the lending market already operates on short settlement periods. However in the transition period there might be some increased demand coming out of this, which is good for us as a ben-eficial owner.

“The borrowers are being more selective about who they transact with, looking at who

can offer the most flexible collateral schedules”

DAN MuRPHy, SEB

From left: Dag Rudilokken, jane Karczewski, Dan Murphy and jorgen Saebo


Murphy: Yes, and with one extra day you will be starting to earn revenue sooner.

Chair: Are there any other oppor-tunities from all this regulation and scrutiny?

Murphy: The regulations have forced a bit of transparency into the market on costs and prime brokers are a lot more open with each other.

Rudilokken: Yes, now we have all the other costs coming in too. It comes back to the conversation we had earlier. Are we going to cover it ourselves or can it be put into the market one way or another? If you have a client who goes short over the quarter and you are carrying the costs, then that is a big loss business. Meanwhile, you need to have the long positions out for a long time to get rev-enue on them.

Murphy: The borrowers are being more selective about who they transact with, looking at who can offer the most flexible collateral schedules.

Saebo: More transparency is good for the market, particularly the Norwegian mar-ket. The general public has a tendency to looks at securities lending as only support-ing aggressive short sellers. They do not understand the good things this market does, such as increasing liquidity.

Murphy: There is a greater willingness to enter this market now. A recent con-ference I attended suggested the number of beneficial owners has grown exponen-tially. Dialogue has improved between the lenders and their beneficial owners, as well as between hedge funds and their prime brokers.

Chair: What has been the impact of regulation on borrower default indemnification?

Karczewski: At the top level, firms such as Citi are bringing together the businesses because that creates efficiency at all levels, including how capital costs are allocated. Sizeable and established agent lenders, such as Citi, have implemented robust col-lateral management models and a strong infrastructure. As a result, they are no longer always being required to provide indemnification as clients appreciate that it is not necessary. However, some more conservative beneficial own-ers, often pensions structures, require it to satisfy trustees and board require-ments but this could well come at a cost.

A good point was made at a recent conference. In most lend-ing programmes there are varied levels of indemnification depending on varying cri-teria, and not all clients are indemnified. A beneficial owner raised the question: if you have a scenario where some are and some are not, who is going to be covered first in the case of default? The indemni-fied or the non-indemnified client?

Chair: Are there also challenges stem-ming from Emir?

Modigh: Emir is creating quite a chal-lenge around eligible collateral for fund managers. Having to centrally clear deriv-atives as a part of the investment strategy will create challenges getting sufficient collateral, because equity funds, corpo-rate bond funds, high yield funds and so on will not have holdings that they can post as collateral. Further, new Ucits or

Esma legislation impose restrictions on the reuse of collateral or the reuse of bor-rowed securities for funds.

This means these types of funds cannot use repos or reverse repos to procure cash, because the regulation does not allow the posting of cash from a repo in a CCP. It can only be invested in money market funds. If these types of funds borrow eligible securities as a part of a security lending programme, it is not clear whether they are allowed to reuse this collateral in the CCP.

This is too rigid. It makes it very hard if not impossible for these funds to use derivatives, unless they have really big cash positions. If we face financial tur-moil and CCPs request more collateral, such funds will face a fire sale situation unless they close down their derivatives positions.

If these funds enters into a hedge strat-egy and they cannot use repo, reverse repo

or securities lend-ing programmes it will have a perfor-mance impact, due to the need for big cash buffers. This will be painful for funds following a benchmark as that they cannot be fully invested, and might affect the use

of derivatives going forward.We must expect that fixed income

lending will be more attractive in future because the demand for highly-rated securities will go up when we enter the Emir universe.

Chair: Finally, if you could ask the regu-lator one thing to improve the market, what would it be?

Karczewski: I would ask the regulators to coordinate. There are different rules for different company and fund structures across different jurisdictions, with local interpretations.

Murphy: I would politely ask the regulations to think carefully about the pros and cons of introducing the FTT, as it is going to have a huge impact on the GC market and on underlying capital markets as well. g

“There is a lot of discussion about whether we should carry these costs. Do we carry it or pass it on to other counterparties

in the market?” DAG RuDILOKKEN, DNB

“We hope that conceptually people are beginning to

understand our business – it is not just about aggressive

shorting” jANE KARCZEWSKI, CITI


FacE TO FacE |

The Massachusetts Pension Reserves Investment Manage-ment Board (Prim) exited its securities lending programme shortly before the dark days of

the financial crisis. With the global economy now

approaching something like normality, the institution, set up to assist the Massachu-setts Commonwealth with its unfunded pension liabilities, decided it was time to seek out incremental returns once again. It announced a request for proposals (RFP) to service its securities lending mandate in May 2014 and by September had selected third-party agent lender eSec Lending. Deputy chief investment officer and direc-tor of risk management David Gurtz is in charge of the programme and its prepa-rations to start lending in January 2015, albeit with a modest 3% of its $61bn assets under management (AuM).

Prim’s investment strategy entails a comparatively aggressive actuarial return target of 8%, based on a portfolio of global equities (43%), core fixed income (13%), value-added fixed income (10%), private equity (10%), hedge funds (10%), real estate (10%), and timber and natural resources (4%).

How does securities lending fit into Prim’s investment philosophy?Prim has a relatively risky profile com-pared to our public pension fund peers. From an asset allocation perspective, it looks more like an endowment.

Our investment managers mostly agreed that securities lending is a non-disruptive practice for their clients, but one of our managers was fundamentally opposed to the practice.

We always listen to our managers to understand their concerns. However, we ultimately made the decision to move for-ward with a securities lending programme.

Why did you suspend your securities lending programme in the past? We used to have an exclusive rela-t ionship with Goldman Sachs Agency Lending (GSAL). That con-tract was due to expire at the end of 2007 so Prim staff recommended to Prim’s investment committee that it issue an RFP in the fall of 2007. At that meeting, the investment committee expressed concern that secu-rities lending posed unknown risks and questioned whether the revenue justified them. Another argument against lending

was the growing focus on proxy voting at Prim – the exclusive relationship we had with GSAL meant some loss of control over votes.

If the revenue was not worth the risks back then, why do you consider it worth-while now?Securities lending offers perfect value e n h a n c e m e n t . While revenues are not immense, they are worthwhile. We want to max-imise our revenues however possible. According to Callan Associates, of the top 50 US public funds, with AuM larger than $15bn, only three, Prim being one of them, did not have a securities lending programme.

We feel that we now have a much bet-ter understanding of the risks involved in securities lending. I should stress that had we continued to lend during the 2008-09 financial crisis, theoretically our programme would have been fine

because our collat-eral reinvestment was mostly in US treasuries. Most of the programmes that suffered losses during the crisis did so through the reinvestment of

collateral. Nonetheless, at that time we did not have the understanding of the risks of securities lending that we do now.

Our new programme will also be dif-ferent from the one we had in the past. eSecLending offered us a revenue split

while the relationship we had with GSAL was based on a guaranteed fee split, so we had to periodically return to the market to verify rates.

Prim’s board approved eSecLending at our October meeting and we will officially launch the programme in January 2015.

We are building a very conservative, plain vanilla secu-rit ies lending programme with estimated average annual revenue of $15m. I must say it is not going to be

very sexy as we expect to have only some 3% of our total fund exposed to securities lending. Our cash collateral is going to be reinvested in very safe and liquid securi-ties – reinvestment will focus on treasury repos.

What attracted you to eSecLending’s offering? We really liked the fact that its business model has a single focus. Its industry-unique auction process definitely attracted our attention as well. Its securities lend-ing solutions allow unique price discovery and transparency and will create rev-enue for us at the same time as limiting counterparty exposure. In addition to its competitive fee structure, eSecLending will support us in retaining voting rights of securities on loan.

Was indemnification an important fac-tor in the selection process? eSecLending has a unique indemnifica-tion offering, in the sense that it is not correlated to the financial markets or a

Back to basicsMassachusetts Prim has returned to securities lending after seven years. Deputy chief investment officer David Gurtz talks to Paulina Pielichata about why it has been restarted with eSecLending

“If you monitor how you reinvest your collateral and

monitor counterparty risk you do not need indemnification”

“At the end of the day, more regulation is not going to

change the fundamental risks of securities lending”


bank’s bottom line. I do not think there is a right or wrong approach to indemnifi-cation. We asked all the candidates how often their indemnification clause was called upon. They responded that either it has never been utilised or they have used it only once or twice during the 2008-09 financial crisis. While I think it is a great safety net, if you monitor how you reinvest your collateral and monitor counterparty

risk you do not need indemnification. The overcollateralisation of securities on loan solves a lot of the issues. If you end up in a position where you need to use indemnifi-cation, something else has broken.

Do you think regulators have made securities lending safer?I do not know if they have made it safer but they are making it more costly for agents,

so it is becoming more complicated for securities lending to happen. Time will tell if the regulators are making it safer for beneficial owners. More compliance will perhaps be a good thing for us but, at the end of the day, more regulation is not going to change the fundamental risks of securities lending.

Is the current situation in the markets good for lending? How would your pro-gramme be affected by rising interest rates?We are not returning to securities lend-ing because of the timing of the market but because of the steady revenues that we can earn at a low risk. For the moment we will focus on lending assets that are in high demand.

It is very possible that next year inter-est rates may go up and equity markets’ volatility may increase, resulting in more short selling by hedge fund managers. As a result, the intrinsic value of specific stocks may be higher and there may be more stocks with high intrinsic value. In these circumstances it will be even more attrac-tive for beneficial owners to be the lenders of securities.

What concerns does Prim have about securities lending?One concern we noted from discussions with our investment managers was from an operational standpoint, recalling hot securities back on time to settle trades. We are very aware of this issue and will be watching it very carefully once the pro-gramme is in place.

On the whole, though, we believe that securities lending will not impair our investment managers’ ability to provide us with the alpha that we expect from them. If securities lending inhibited the ability to create alpha, we would not be doing it.

What are your medium to long-term plans for the programme? eSecLending’s unique auction process means that it is able to segment our port-folio into different, unique buckets and auction these to the highest bidders, giv-ing them, for example, exclusive rights to our German securities.

At this point in time we will stick to the old-fashioned way of loaning out indi-vidual securities. But we know of other eSecLending clients that use the auction process. We think it could be very inter-esting in practice, particularly because through auctions beneficial owners are able to discover the premiums available for individual sets of securities. I expect we will consider doing it as we grow and become more experienced. g


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juPITER HIRES GEM HEAD OF STRATEGyJupiter has hired Ross Tever-son as head of strategy, global emerging markets, a new role in which he will lead the emerg-ing markets equities team. Teverson joins from Standard Life, where he managed the unconstrained emerging mar-kets equity Sicav.

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Laurent Guillet, CEO of Amundi Alternative Invest-ments, said: “At this point in time of our history, we needed a global senior hedge fund professional such as Hart to raise Amundi’s position as a leading worldwide player in the alternative investment space.”

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Wiener will succeed Brian Rogan, who is retiring at the end of the year. Wiener will also serve on the executive committee, the company’s most senior management body, which oversees day-to-day operations.

He will continue to build the company’s risk management capabilities, including integrating enterprise risk data, report-ing, analytics, modelling and strategy.


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