HOW THEY SEE IT

Issue 22 | Winter 2013 | www.markit.com
magazine
magazine
Henry Fernandez
The man who
made MSCI
Yuan direction
China’s outward
investment
Orchestral
manoeuvres
From banker
to composer
2014
HOW THEY SEE IT
WELCOME
Rooting for recovery
A
s another year draws to a close, all eyes
will be focused on 2014 to see if the,
albeit shaky, signs of a return to
stability in the global economy can take root.
Markets weathered the recent government
shutdown in the US while in Europe, Ireland’s
exit from its bailout programme boosted
hopes for other eurozone nations in the
months ahead.
And, while the debate over the tapering of
quantitative easing in the US remains
uppermost in the minds of investors, the
resilience of the US economy can be seen in
the fact it didn’t fall over the fiscal cliff at the
start of 2013 and that it hasn’t so far defaulted
on its debts.
We continue to follow these events very
closely here at Markit. Indeed, November saw
the launch of our first US Services PMI
survey, which we believe will provide the most
accurate take yet on the US economy in the
months ahead.
We have also taken the pulse of 10 leading
lights of the financial world for their views on
what will drive the global outlook in 2014,
where the risks lie and who to watch.
Emerging markets also continue to be a key
area of interest, so we have taken a look at
how China’s external investment strategy is
evolving and who stands to benefit from it.
Conversely, we examine Chile’s efforts to
attract foreign direct investment to all areas of
its burgeoning economy.
We also bring you an insightful article
from BlackRock on short duration in the
fixed income market, and why investors may
be concerned about future performance in the
rate cycle.
Our environmental feature in this issue
looks at disruptive sustainability and the
opportunities it presents to save the world
without losing sight of the need for businesses
to turn a profit. The bottom line, though, is
that big change is needed.
Finally, our Markit Life section features
Peter Nostrand, who, after a highly successful
career in banking, turned his hand to
composing music.
We hope you enjoy this year-end issue and
we wish you all an enjoyable holiday.
Lance Uggla
Chief executive officer, Markit
External editorial board
Robert Barnes, Turquoise
Tim Frost, Cairn Capital
Matthew Frymier, Corrum Capital
Sal Naro, Coherence Capital Partners
Daniel Trinder, Deutsche Bank
Markit editorial team
Teresa Chick
Caroline Lumley
Alex Paidas
Industry contributors
Andrew McKeon
Alice Shone
Karen Shenone
Writers
Nicholas Dunbar
Jeffrey Kutler
David Wiggan
Editor
Mark Johnson
Chief sub editor
Karen Wheeler
Design
Lemonbox
Photography
Crown Copyright
Shutterstock
iStock photo
Enquiries
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necessarily reflect the opinions of Markit.
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Winter 2013
3
CONTENTS
16
Issue 22 | Winter 2013
REGULARS
COVER STORY
2014 – how
6News
All the latest from Markit
they see it
Business
8 Talking
MSCI chairman Henry Fernandez talks
10 leading lights of the
financial world take their
best shot at what may be
in store for 2014
focus
14Country
Chile
about turning cost into profit and creating
value for society
FEATURES
8
14
of America
29OTheut US
may have had a tough year, but investors
are not ready to cash out yet
direction
32Yuan
China is moving far beyond its traditional
resources-led investment strategy around
the world
arkit pages
37M
Nicholas Dunbar reviews Iain Martin’s ‘Making it
happen – Fred Goodwin, RBS and the Men Who
Blew up the British Economy’
54
hen rates rise
38W
Global asset manager BlackRock looks at
concerns about short duration and the next
rate cycle
world
40Disruptive
How the most urgent, eco, social and economic
40
challenges of our age also present big
opportunities for business
arkit life
54M
Orchestral manoeuvres - meet the bank ceo who
now conducts a different kind of life
COMMENTARY
commentary
42Market
Our analyst team puts the events of the last
quarter into perspective
58Infograph
What the numbers say about UK homebuilders
32
Winter 2013
5
MARKIT NEWS
Hong Kong firms choose
Markit compliance solution
Members of The Asia
Securities Industry and Financial
Markets Association have chosen
Markit’s Counterparty Manager
technology to help them comply
with the Hong Kong Securities
and Futures Commission’s
new electronic trading rules.
The new rules take effect on
January 1st 2014 and require
Hong Kong-licensed brokers to
attest that their electronic trading
systems are properly supervised,
tested and risk managed.
The rules also require customers
to acknowledge that they
understand the algorithms
and other technologies
used by their brokers.
Counterparty Manager will
help financial institutions
exchange the information
required under the new rules
easily and efficiently.
The solution offers an electronic
format of the questionnaire
designed by a number of industry
associations to assist the buyside
and brokers in exchanging
the required information.
Buyside firms will be able to
review the answers from each
broker dealer and electronically
acknowledge that they have
done so. This acknowledgement
will be transmitted directly to
their counterparties, allowing
sellside institutions to see which
customers have fulfilled their
compliance requirements.
“The industry-standard
questionnaire facilitates and
greatly simplifies the due diligence
process required to comply with
the new Hong Kong Securities
and Futures Commission rules,”
said Mark Austen, chief executive
of the Asia Securities Industry and
Financial Markets Association.
“Markit’s technology will replace
the need for a mass of bilateral
conversations and the management
of a large volume of pages of
documentation that would be
required in the absence of an
automated solution,” he said.
Messaging service set to transform markets
Markit has launched an
open messaging network that
will enable people in all parts
of the global financial services
industry to communicate and
share information seamlessly.
To date, communication
between market participants
has been hampered by the
lack of system
interoperability.
The new network
removes barriers
to industry
communication by
allowing messaging
platforms, critical
to price discovery
and pre and posttrade operations,
6
Winter 2013
to connect to each other.
Markit Collaboration Services
allows users to see availability,
send instant messages, use
video and chat rooms and
exchange documents across
disparate messaging platforms.
Linking messaging
platforms in this way makes it
cost-effective for institutions
to offer the benefits of a
cross-industry collaboration
network to employees. The
federation service is powered
by NextPlane, the market
leader in cloud-based unified
communications (UC) federation
services for collaborative
business communities.
The new network also provides
the first open directory for the
financial services industry,
enabling people to find,
communicate and
collaborate with
one another.
The messaging
and directory
services can be embedded
in third-party applications,
workflows and other networks,
extending the functionality of
trading, processing, research
and other applications.
BofA Merrill Lynch,
Barclays, Citi, Credit Suisse,
Deutsche Bank, Goldman
Sachs, JPMorgan Chase and
Morgan Stanley have also
joined the network and will use
the federation and directory
services at the enterprise level.
These firms employ more than
one million people worldwide,
all of whom are eligible to use
the new network. The banks
will also invite their customers
to join the network.
MARKIT NEWS
BRIEFS
Hobart partners with
Markit for commission
management services
US Services PMI survey launched
Hobart Capital Markets, the
leading UK-based agency broker,
has partnered with Markit to
provide a commission
management solution for buyside
customers who wish to direct
commission sharing agreement
(CSA) related trades via an
independent ‘execution-only’
broker.
More awards for Markit
Markit has won Global Custodian
magazine’s inaugural award for
the most innovative market data
provider. The company was
recognised for the breadth of its
data and its processing offering,
which spans securities finance,
reference data, corporate actions
and OTC trade processing and
services custodians, prime
brokers and administrators
around the world.
Markit also won Best Data
Management Product and Best
Pricing/Valuation Service at this
year’s Buy-Side Technology
Awards.
The firm was also named Best
Enterprise Data Management
Provider at the Banking
Technology Readers’ Choice
Awards.
Bloomberg & Markit
sign cross-distribution
deal for EDM services
Bloomberg and Markit have
formed a non-exclusive
agreement to distribute their
pricing and reference data
through Markit’s Enterprise
Data Management platform
and Bloomberg PolarLake,
respectively.
Markit’s EDM services and
Bloomberg PolarLake provide
enterprise data management
solutions that enable the
acquisition, validation, storage
and distribution of data in a
consistent, fully audited
environment.
Markit mag app available
You can now access and share all
our articles via the Markit Magazine
app, which is
available free
to download to
tablet devices.
Go digital in order
to interact with
articles and let
us know what
you think.
The first ever US Services
Purchasing Managers’ Index
was released by Markit in
November, providing the
earliest available indicator of
business conditions in the $9.7
trillion US services sector each
month. The index will also
complement Markit’s Flash US
Manufacturing PMI data.
“We were the first organisation
to produce monthly service
sector surveys back in
1996,” said Luke Thompson,
managing director and head of
economic indices at Markit.
“Our monthly services PMI
series in the UK and eurozone are
now among the most closelywatched economic indicators
in the world and are eagerly
awaited by central banks,
economists and the investment
community each month. We
are therefore very excited to
now have comparable data for
the US services sector, which
represents over 70% of US GDP.
“Our US surveys have been
providing advance indications of
economic growth, employment
and price trends since we started
collecting data four years ago,
and will give valuable early
insight into official statistics such
as GDP, non-farm payrolls and
inflation,” Thompson added.
Markit’s survey panel is
comprised of more than
400 companies. Historical
data for the new index goes
back to October 2009.
The first Markit Flash US
Services PMI reading of 2014 will
be released on January 27th.
Markit and HKEx connect for clearing
Markit’s global electronic
trade processing service for
over-the-counter derivatives,
MarkitSERV, now connects
customers to OTC Clearing
Hong Kong, the OTC
derivatives clearing service
established by Hong Kong
Exchanges and Clearing.
OTC Clear started clearing
interest rates and FX derivatives
on November 25th 2013
and MarkitSERV is the
first global trade processing
middleware service to
connect to OTC Clear.
MarkitSERV will also
connect customers to the Hong
Kong Monetary Authority’s
new trade repository and will
provide workflows to facilitate
compliance with trade reporting
requirements in Hong Kong
from early December.
Capital markets course for New Delhi
Markit has set up a capital
markets course designed to give
students at Delhi Technological
University (DTU) an insight
into the world of finance.
“RE-FINE (RE-engineer
for FINancial markEts), a
DTU/ Markit Initiative”
covers the fundamentals of
finance, including financial
instruments such as derivatives,
bonds, equities and loans.
The course will provide
DTU’s engineering and
MBA students with a solid
understanding of global
capital markets and help them
start a career in the financial
industry. Markit provides this
course free of charge to the
students and the university.
“Programmes such as RE-FINE
are the best way to create the
desired partnership between
academia and industry and
prepare engineering and MBA
students for the knowledge
economy,” said Professor PB
Sharma, vice chancellor at DTU.
Winter 2013
7
TALKING BUSINESS
An “intrapreneur” with a “kernel of an idea”,
Henry A. Fernandez built a one-time Morgan
Stanley cost centre into an independent $1billion
revenue market leader, writes Jeffrey Kutler
Ready for
anything
T
o gauge the magnitude and after effects of
the 2008 market collapse, look no further
than major financial institutions’ earnings.
Even as profitability has been improving,
many lament the “difficult” or
“challenging” economic conditions that are
preventing more robust growth. They cite the still
incomplete implementation of the Dodd-Frank Act,
other regulatory reforms and the compliance costs
and capital requirements that will be weighing on
them for years to come.
An unfavourable banking and investment climate,
in turn, clouds the outlook for suppliers of data and
services to the financial industry. In its most recent
annual report, MSCI, the prominent global provider
of indices and other investment and risk analysis tools,
cited a “difficult operating environment” consisting of
macroeconomic uncertainty, financial market
volatility and, specific to its day-to-day business,
outflows from actively-managed equity funds and a
lengthening of the time it takes to close sales.
Yet, MSCI in 2012 boosted its net income 6.2%, to
$184.2million, while operating revenue increased
5.5%, to $950.1m. In the first nine months of 2013,
operating revenue was up 9.2%, to $768m and net
income rose 35.1%, to $175.3m. A spin-off of
investment bank Morgan Stanley that raised $252m
in a November 2007 IPO, New York-based MSCI is
currently valued at more than $5bn.
Those tough market conditions, it turns out, are
exactly what MSCI was built for. Then again, the
company that chairman and chief executive officer
Henry A. Fernandez has been running, expanding
organically and by acquisition, and reinvesting in for
more than a decade and a half – enhancing that
original index business with performance and risk
management offerings and governance and
compliance support – may just be in a position to
thrive in any given part of the cycle.
8
Winter 2013
There will always be demand for performance
analysis, attribution and benchmarking. And, as
Fernandez puts it: “The world isn’t becoming less
transparent.” All of that plays into MSCI’s strengths.
“Pretty much all the things that have happened
over the last five or six years have developed into very
strong, positive trends that propel our business,” says
Fernandez.
Regulatory changes are not the least of those
positive factors.
“Regulation is something we benefit from
immensely,” Fernandez adds. “We may not agree with
it sometimes, but once it is done, people have to
comply. A meaningful part of our business, especially
risk management, is driven by regulations.”
“Once you are in the business of developing tools
that enhance performance, create transparency and
help manage risk, a lot of good things happen,” he
says. “For example, there has been an increasing
allocation of assets to passively-managed portfolios.
We have great products [indices] that provide for that.
There has also been an incredible focus on risk
management and transparency of performance; we
offer tools for risk management and performance
attribution. In commercial real estate today, the
market is clamouring for products and services that
will institutionalise and globalise the market. We are
right there with those tools.”
MSCI was not always “in the business of tools” – at
least not as Fernandez came to define it. That is the
difference he made as a strategist and leader.
A meaningful part of our business,
especially risk management, is
driven by regulations
Winter 2013
9
MSCI timeline
1968
The first Capital International
indices are published
2007
1998
MSCI completes initial public
offering, listing on the New York
Stock Exchange; Morgan
Stanley retains controlling
interest
MSCI Inc. is formed, owned and
operated jointly by Morgan
Stanley and Capital International
2004
MSCI acquires portfolio and
investment risk management
systems provider Barra
1986
Morgan Stanley obtains
exclusive rights to license the
indices, under the Morgan
Stanley Capital International
(MSCI) brand
The Mexico City native, now 55, entered finance
after earning his MBA degree in 1983 from Stanford
University Graduate School of Business. There,
Fernandez recalls, “if you were not an entrepreneur,
you were nobody”. He was no exception to that rule,
but for the career direction he chose.
“I am not a technology fellow and not a venture
capitalist,” he remembers thinking. “I asked myself,
‘What can I do that is an extension of what I am
studying and of the Silicon Valley environment I am
living in?’”
As one who desired “pure-play entrepreneurship” and
“liked finance”, Fernandez was drawn to the boutique
firms of Wall Street, and he went to work for Morgan
Stanley. “It had 2,000 people when I
joined in 1983,” he says, illustrating how
the scale and culture of Wall Street have
changed since. “MSCI has more people
than that today” – over 3,000, while
Morgan Stanley has 56,000.
Over the years, Fernandez had the rare
chance to be exposed to many of Morgan Stanley’s
then very siloed businesses: investment banking and
corporate finance, fixed income, mortgage finance,
mortgage trading and equities. However, he left the
firm in 1991 and spent three years working in private
equity, financing acquisitions in Mexico at the time
of the North American market integration.
Fernandez returned to Morgan Stanley in May 1994.
“My former boss from the fixed income division, John
Mack, had become president and was looking for
somebody to help open up broker-dealers in all the
major emerging markets,” says Fernandez. Mack
“needed a business man, almost a venture capital kind
of person, who would understand the drivers of these
local businesses and how to put them in place”.
A year later, as a result of market conditions such as
the Mexican peso crisis, the brokerage initiative
slowed down. In 1995, Fernandez “focused a lot of
my efforts on understanding other parts of Morgan
Stanley. I was becoming itchy. I wanted to become an
entrepreneur again.”
Fernandez notes that Wall Street is haunted by the
ghosts of firms that failed to adjust to changing times
and circumstances, in contrast to Morgan Stanley
and Goldman Sachs. That unforgiving competitive
reality “generated an incredible amount of
entrepreneurship within finance”, he says. “Morgan
Stanley people were most proud of its ability to
reinvent itself every so often.”
MSCI, the indexing operation then officially known
as Morgan Stanley Capital International, appeared in
I was becoming itchy. I wanted to
become an entrepreneur again
3,000+
Number of MSCI employees today
10
Winter 2013
Fernandez’s entrepreneurial sights as a strong
candidate for reinvention. It was carried on the bank’s
books as a cost centre, with annual client revenues of
$9m plus $6m from Morgan Stanley, falling short of
its $18m in expenses. Envisioning greater possibilities,
he began to contemplate “instead of becoming an
entrepreneur, why not become an intrapreneur?”
While his “day job” was overseeing equity
derivatives sales and trading for Latin America,
Fernandez took charge of MSCI part-time in February
1996. Two years later, the unit was turning a profit
and Fernandez wanted to dig in deeper. He proposed a
restructuring that would make him the full-time ceo;
by April 1998 he was based at the index headquarters
in Geneva, initially overseeing about 50 employees.
What had been a Morgan Stanley department became
the Delaware-incorporated legal entity MSCI Inc.,
TALKING BUSINESS
2010
MSCI acquires RiskMetrics and
its corporate governance
subsidiary Institutional
Shareholder Services and, in a
separate transaction, Measurisk
2009
Morgan Stanley sells remaining
shares and fully separates from
MSCI
2013
MSCI acquires InvestorForce, a
leading provider of performance
measurement tools for pension
fund consultants
2012
MSCI acquires leading
commercial property data and
analytics provider IPD
Source: msci.com
operating as a standalone business, 90% owned by
Morgan Stanley and 10% by Capital International.
The latter began publishing indices in 1968 and
continued to be responsible for their creation and
production after Morgan Stanley bought the licensing
rights and launched the MSCI brand in 1986.
By deeds and results, Fernandez made his case for
intrapreneurship. Before the turnaround, MSCI had
the dual disadvantage of being a small operation
inside Morgan Stanley, while also having to answer to
a second parent organisation. That made it difficult
“to get the nurturing, the resources, the right people”,
says Fernandez. He says he was fortunate to be able to
follow his entrepreneurial instincts with support from
the senior management and directors of both Morgan
Stanley and Capital International. They gave him the
freedom to “reinvest the profits back into the
business, which fixed a lot of things and began our
long trajectory of growth”.
The ceo also had a solid core business to build on.
Today, MSCI has a total of approximately 8,000
institutional clients. An estimated $7.5trillion of
assets worldwide are benchmarked to MSCI indices,
and they are the basis for around 600 exchangetraded funds, itself a significant growth segment.
Operating revenues from index and ESG
(environmental, social and governance) products,
which are reported together, jumped 18.2% year-overyear in the first three quarters of 2013, to $383.2m,
half of the companywide total. Even the loss this year
of some $25m in licensing revenue from Vanguard
Group, which took more than 20 of its ETFs
elsewhere, was offset by market share gains by those
MSCI retained.
Fernandez’s great insight – he says it began as “the
kernel of a vision, or an idea” – was that indices
represented only a fraction of the potential business
opportunity.
“When I took over the business” he says, “I believed
our mission was to enhance the investment process.
Equity indices were performance tools” but MSCI’s
mission “had to be broader than equity indices to
capture the full potential.
“We started with a global business – a great brand,
following and reputation – a lever, so to speak; and had
the kernel of an idea that we could create a lot of
different types of tools for the investment process,
starting with equity performance tools in the form of
indices. To that we kept adding over the years to build a
larger set of tools that would complement one another.”
Going the acquisition route, MSCI started with
portfolio risk analytics company Barra in 2004. The
pace picked up in 2010, nearly three years after the
IPO, when MSCI paid $1.6bn for RiskMetrics
Group, which brought with it other brands
including proxy voting and governance servicer
Institutional Shareholder Services (ISS). Also in
2010, MSCI bought Measurisk, a leading provider
of risk transparency and measurement tools to
hedge fund investors.
In November 2012, MSCI purchased
IPD Group, filling a gap in
commercial property data and risk
analytics, for $125m. Two months
later it added
Investor
Force
Holdings,
whose
Fernandez has steered
MSCI into a global
power brand
11
TALKING BUSINESS
What motivates us
here at MSCI is that
what we do creates
value for society
Fernandez facts
Born: Mexico City, raised
Nicaragua
Age: 55
Spouse: Alexia
Children: 3
Favourite sport: Running
Currently reading: Steve
Jobs by Walter Isaacson,
The Outsiders: Eight
Unconventional CEOs and
Their Radically Rational
Blueprint for Success, by
William Thorndike
$7.5tn
Amount of assets benchmarked to
MSCI indices globally
12
Winter 2013
InvestorForce performance measurement tools serve
the pension fund consultant market, for $23.5m.
Not everything is a perfect fit. Last March, MSCI
sold forensic accounting and research firm CFRA
(Center for Financial Research and Analysis), which
was part of RiskMetrics, to Peter de Boer, formerly of
McGraw-Hill Financial and now its ceo. In October,
Fernandez announced that MSCI was “exploring
strategic alternatives” for ISS.
With clients spanning the categories of asset owners
(e.g., pension funds and sovereign wealth funds), asset
managers of all types, and the traders who make
markets and execute for the asset managers, MSCI
claims a top market share in each of its key business
lines. “We are very happy with that leadership
position and thank our clients for it. But you have got
to earn it every day,” Fernandez says. “To earn it, you
have to innovate constantly, provide value to clients
and stay ahead of the competition. If we do that well,
the rest will take care of itself.”
The challenge is increasingly technological. In
October, MSCI hired Chris Corrado, most recently a
UBS managing director who spent 11 years earlier in his
career with Morgan Stanley, as its first chief information
officer. Fernandez calls the appointment “the ultimate
recognition that MSCI is a technology company”.
Toward the goal of developing “mission-critical
tools that enhance the investment process in each of
the major asset classes and the combination of them”,
as Fernandez states it, the build-out of MSCI falls
logically into place.
“Barra added performance and risk tools and
portfolio construction tools for the equity investment
process,” says Fernandez. “When we had the
opportunity to buy RiskMetrics, it was performance
and risk tools for the multi-asset class investment
process. When we bought IPD, it was performance and
risk tools for the real estate investment process” –
which, Fernandez adds, will be “a catalyst for the
acceleration of the institutionalisation and globalisation
of the [real estate] investment process. There is no
reason why a pension fund in Canada cannot have a
portfolio of properties in 20, 30 or 50 cities around the
world, just like it has equities or fixed income.”
But there is no end to the tool-building. Fernandez
speaks of bringing everything together for total
portfolio analysis visibility, and there are gaps to fill
along the way.
“How do we combine all those asset classes into a
total portfolio to be able to provide performance and
risk management tools, especially for the asset owners?”
says Fernandez. “They don’t live in a world of single
asset classes; they want to put it all together. The biggest
pension funds in the world use our tools to aggregate all
their asset classes, to understand the performance
attribution and the risk of the total portfolio.
“To be effective in the multi asset class setting, you
have to be effective in each asset class. It is a big
endeavour for us... The holy grail is to be able to be
good in equities, good in fixed income, in hedge
funds and private equity and real estate, and to be
able to combine all of that in a seamless way on a
highly frequent basis for the owners of the assets.”
“There is still a way to go,” says Fernandez. “What
motivates us here at MSCI is that what we do creates
value for society. If we can improve the performance
of all these portfolios by a meaningful amount, then
we have helped to achieve a better living for people in
their retirement. So we get very excited by all of this
and the innovations that we make.”
Jeffrey Kutler is editor-in-chief of Risk Professional
and is based in New York
The road to
Santiago
Chile is now South America’s
most prosperous nation and all
investors are welcome, writes
Mark Johnson
Y
ou can always tell that something is going
well when the luxury brand names move
into town, and in South America it seems
like everyone is setting up shop in the
Chilean capital of Santiago.
According to a November 2013 report from the
Chilean Asociación de Marcas de Lujo (or AML, the
luxury brands association), Santiago now trumps São
Paulo and Buenos Aires as the new hotspot for luxury
retailers.
Sales of luxury items in the country have reached
$30 million so far this year and much of this is put
down to financial stability in this most southerly of
South American nations.
Chile’s current consumer growth is being fuelled by
one of its key industries, copper mining. The rise in
employment in the sector has bolstered the growth of
a new middle-class where miners are paid handsomely
for their work to the north of the country.
However, Chile’s export-led economy is dependent
on the health of the global economy. Growth
outlooks for large consumers of its products, such as
China and other emerging nations, have been reduced
over the past year and this may have an impact on
shortterm growth.
The rise in consumer spending in Chile, though,
was given a boost in October when the nation’s
monetary authority surprised the market by cutting
interest rates from 5% to 4.75%.
There was much speculation around the timing of
the cut, which some observers noted may have been
to avoid any suggestion of political motives around
the November 17th presidential elections in the
country.
However, Chile’s growth and development continue
to attract strong interest from investors. The country
has become increasingly recognised for its progressive
approach to financial stability and its financial system
is viewed as so sturdy the country is now often
COUNTRY FOCUS
CHILE
referred to as the Luxembourg of Latin America.
After decades of consistent and progressive efforts
to liberalise its financial markets, Chile is rapidly
becoming the envy of the region. In 2010, it became
the first South American nation to join the
Organisation for Economic Cooperation and
Development.
Chile’s membership of the OECD was seen as
recognition of its efforts to improve regulation, and
the country continues to push ahead with its
regulatory reforms. Indeed, new rules came into play
in 2013 aimed at creating more transparency, stronger
risk management measures and improved compliance
in Chilean markets.
For example, in January a new rule of the supreme
court came into force requiring bank supervisory
the Chilean CCP and OTC derivatives settlement
and clearing house, is estimated to save about $210m
a year for local Chilean banks.
Large regional players such as Suramericana and
BlackRock are establishing alliances to facilitate the
insertion of such instruments into their investment
portfolios across the region.
New products are also being created. At the end of
August this year, Brazil’s Banco Itau launched its first
exchange-traded fund tracking the most liquid stocks
listed on the Santiago stock exchange.
The ETF is focused on domestic investors as it is
priced in the Chilean peso and is listed on the
Santiago stock exchange. The Financial Times
reported in September that the ETF was seen as an
“important first for the ETF market in Chile”.
Other funds focused on the Chilean
market include currency hedged products
issued by iShares and db x-trackers range.
Chile is also investing in its
infrastructure and is keen to attract foreign
direct investment across a range of projects.
According to a February 2013 Bloomberg
news article, Chile’s foreign direct
investment committee reported that FDI
grew 63% last year to $28 billion.
Around 50% of FDI usually heads towards the
nation’s mining sector, 26% to services and 10% to
utilities. However, the country is also aggressively
marketing investment in other areas.
In October, the nation’s foreign investment
committee held a forum in London offering
opportunities to investors in a broad range of sectors
in addition to those above, such as manufacturing,
financial services, biotechnology, tourism and
infrastructure.
A similar event took place in Dubai in November
and the Chilean investment committee will host a
major investment forum in Santiago in mid-January
2014.
Chile... is keen to attract foreign
direct investment across a range
of projects
agents to reveal publicly all audits and reviews made
to financial institutions in Chile.
Chile’s progress in developing its markets has also
led it to forge important alliances across the region. In
a move aimed at competing with larger equity
markets in Latin America, such as Brazil, the
Santiago stock exchange signed a deal with exchanges
in Peru and Columbia, which led to the creation of
the Latin America Integrated Market, or MILA, an
integrated electronic equity market system that allows
investors to trade stocks from all three countries.
This boosted the need for new technology and
better practices connecting issuers, investors and
brokers among the three countries.
Moreover, the creation in 2012 of COMDER, as
Top: Santiago’s rising
cityscape.
Inset: A Chilean copper
mine, Chilean pan pipes
and Easter Island
Winter 2013
15
2014
S
N
O
I
T
C
I
D
PRE
Once again, the global economic
story dominated the world news
agenda throughout 2013, but what do
the next 12 months look like?
We have brought together 10 leading
voices of the financial world to give
us their insights and expectations of
what to expect in 2014.
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4
2014 PREDICTIONS
S
Capitol Hill:
Eyes on the US
recovery
Elizabeth Piper/Bach
Chair, IMCA
1. View 0f 2013
Without a doubt, 2013 will
be remembered as the year the
US government kicked the
can down the road one more
time in regard to increasing
the national debt ceiling and
approving a new budget. It only
took 16 days of a government
shutdown to postpone the
inevitable decisions to the next
deadlines of January 15th and
February 14th 2014.
2. Best decision
Photograph: Shutterstock
Initially, we were
contemplating changing our
actively-managed large-cap
strategies into passive strategies
and using the expense savings
to leverage into a more heavily
weighted small-cap strategy.
By deciding to remain in active
large-cap management during
this year of volatility, we added
a meaningful amount of return
to our portfolios.
3. 2014 focus
Household balance sheets have
grown stronger and now are
comprised of lower debt and
higher values attributed to
stocks and housing. So, for
2014, we continue to see a lot
of pent-up demand for
housing. With market volatility
continuing in the US for 2014,
sectors of interest are US
consumer staples and energy;
commodities will provide a
buffer for downside protection.
4. Major changes
On the macro level, the US
economy will continue to
recover, but ever so slowly as
change must come while dealing
with the nation’s fiscal policies.
With prices high in the US and
cheaper in Europe, I believe we
will see investors heading back
into the developed countries
overseas. Japan is still a guess,
but it is looking brighter.
5. Power people
Janet Yellen, vice-chairman of
the Board of Governors at the
Federal Reserve and the top
contender to succeed Ben
Bernanke as Fed chairman,
will have the opportunity to
have the greatest impact on
the industry. Recession
avoidance is the Fed’s concern,
so it will continue to
accommodate the economy’s
need for stimulus activity as
long as necessary.
6. Strategy
Retirement readiness and
retirement income strategies.
We find many individuals still
don’t save enough to be able to
retire. We will be focusing on
driving home the importance
of early saving for a comfortable
retirement. For those who are
retired, our focus is helping
them to find income-generating
investments.
7. Biggest concerns
We have had a 150% growth in
the market since 2009. No one
sees the market or interest rates
as likely to do anything rapidly
over the coming year, as the Fed
continues to provide stimulus to
the economy. When the Fed
begins to taper, my worry is that
investors will fear the results
and race to the sidelines,
causing even more volatility in
both bonds and stocks.
8. Women in power
Our annual conference, the
NADA Convention & Expo,
provides an opportunity for
women to gather for a firstclass networking event
designed to encourage
mentorship by, and meeting
opportunities with, successful
women in the industry. The
goal of the event is to promote
continued interest and career
growth among women
within our industry.
9. Green credentials
Our firm will continue
environmental initiatives in the
workplace. We don’t currently
use ESG (Environmental Social
and Governance) factors or
impact investing in our
investment process.
10. Personal best
I stay on top of my game by
maintaining my
certifications, like the CIMA
certification, and attending
industry conferences, such as
the array offered by the
Investment Management
Consultants Association. The
content offered at these
events keeps me sharp and
gives me invaluable insight
into the bigger picture,
which is paramount to
helping me be the best I can
be in my role.
Winter 2013
17
2014 PREDICTIONS
David Craig
President, Financial & Risk
Thomson Reuters
1. View 0f 2013
2013 should be remembered as
the year the economy started
to turn around. It is the year
the industry recognised it
needed to change and begin to
restore trust – and it has
started to do so.
2. Best decision
One of the most important
things we did this year was to
focus on instant messaging
collaboration. The Open
Messaging initiative we
launched with Markit and
eight major banks will help
our industry vastly, especially
as the community expands.
We have also done a lot of
work on messaging
compliance, a hot topic right
now, and on expanding
connectivity to the buyside, as
we did through the integration
to the FXall community.
3. 2014 focus
4. Major changes
Scandals resulting from the
sins of the past show no signs
of abating and there is still an
estimated $30bn-$40bn in
18
Winter 2013
5. Power people
Federal Reserve chair Janet
Yellen. It will be interesting to
see if speaking clearly
stimulates the economy, as
recently mooted.
6. Strategy
Content and our partner
ecosystem are hugely
important and this will
include adopting linked data
and the cloud more widely.
Data is in abundance, but it is
about structured data and
visualisation, and about being
a filter for the industry,
finding needles in the
haystacks.
Our other focus will be on
pivoting from a product
business to a full enterprise
business, helped by further
rollout of Eikon and Elektron
platforms supporting
transactions, connectivity,
discovery and risk.
7. Biggest concerns
Further economic or banking
surprises – it is always what
you don’t know or expect that
can cause the biggest issues.
Other than that, further
8. Women in power
Yes. We are actively identifying
and developing our female
leaders to have a pool from
which to draw. Our approach
is both top-down and
bottom-up.
Our top team has recently
been joined by two of our
highest performing females:
chief content officer, Debra
Walton, and our head of go-tomarket strategy and
operations, Emily DiMiceli.
9. Green credentials
Environmental, social and
governance (ESG) issues
continue to be a focus for us.
The environment has returned
to the top of the agenda as
catastrophes, such as the recent
Typhoon Haiyan in the
Philippines, demonstrate the
unpredictability and power of
weather. People are at risk and
we need a global response. Our
clients also want to use ESG
factors in their investment
decisions and this is where
specialist data like Point
Carbon, Asset4 and predictive
analytics become important.
10. Personal best
Keeping fit helps and I plan to
continue running twice a week
and will try to get more sleep.
The odd bottle of good wine
with my wife and friends also
helps me relax.
Of course, staying embedded
with our customers and
partners and tracking the
innovators in the industry is
something I will do even more
of in 2014.
Photograph: Shutterstock
As an industry, we need to get
back to a mindset of
innovation and growth –
ideally 2014 will see a focus on
a more enterprise approach to
this. No doubt, our industry’s
cost challenges around the top
and bottom line still remain,
but this is very much the new
normal.
costs that the banking industry
needs to remove. This, along
with further regulatory
implications of over-thecounter markets, swap
execution facilities, money
laundering and the like, will
lead to further global
structural changes.
regulatory divergence between
US, Europe and Asian centres.
David Wright
Chairman, Iosco
1. View 0f 2013
2013 will be remembered
perhaps primarily as the year
when the first signs of the
ending of the financial crisis
emerged. Slow economic
growth began to show in the
OECD countries; the eurozone
looked far more stable and
sustainable after the bold
actions by the ECB in the
summer of 2012; and in
emerging market countries,
growth remained reasonably
strong, all things considered,
even after the mid-year US
Federal Reserve tapering
signals. But in the financial
services world 2013 saw the
emergence of the full effects of
the Libor scandal; rumours of
serious malpractice in other
market segments, such as forex;
record fines imposed on firms
for malpractice, misselling etc.
The restoration of the reputation
of the financial industry has a
very long way to go.
Photograph: istock
2. Best decision
I think Iosco’s best decision
this year has been to broaden
its scope and reach, engage
more widely and robustly at
the international regulatory
level and begin to develop a
policy to deliver a stronger
Iosco in the years ahead. Led
by our arguments, there is a
growing recognition that the
world is moving more towards
market-based financing models
which means the importance
of the role of the securities
regulator is set to deepen.
Iosco is now deliberately trying
to be more forward-looking
and proactive. This means
identifying risks early on;
developing standards early;
strengthening the Iosco
multilateral memorandum of
understanding; assisting our
emerging market securities
regulators; and building Iosco
into a more effective
international institution.
3. 2014 focus
Delivering the key pieces of
global financial reform.
Namely, resolving for good the
too-big-to-fail problem; OTC
derivative reform in all its parts;
shadow banking safety and
soundness; and ensuring the
new bank capital standards are
applied by all. In all these areas
there is a long way to go.
Implementation must be
effective and international
regulatory arbitrage avoided. A
fifth priority, usually forgotten,
is corporate governance,
behaviour, ethics and sanctions.
Have corporate governance
standards genuinely improved
in the financial industry since
the crisis took hold? A vitally
important question.
4. Major changes
We hope to see more OTC
derivatives being driven on to
regulated exchanges, and
cleared and reported accurately
to trade repositories. The
incentive structures have to be
right for this to happen. I think
we are also beginning to see
some serious efforts being made
by markets and regulators to get
financial markets to work better
for SMEs, longterm financing
etc. Reviving moribund
securitisation markets and
deepening liquidity in corporate
bond markets are also
important for widening the
scope of financial instruments
available for investors, market
participants and the economy
as a whole. The globalisation of
the industry will continue to
accelerate.
5. Power people
The behaviour of the
industry itself. More
regulation will follow if
the number of scandals
does not decrease.
6. Strategy
Strengthening Iosco in all its
forms. We need to start to
reflect on what type of global
financial institutions we want
for the more complex,
interconnected world we face in
20 years and beyond. A world
of many more big capital
markets, not just today´s simple
constellation of a few. If we stay
as we are with weak, nonbinding global financial
institutions the world faces
more fragmentation, not less.
We have two real institutional
options - either to enhance
regulatory co-operation and
co-ordination in pragmatic
ways (e.g. synchronising
political timetabling of
proposals to avoid first-mover
regulatory advantage; agreeing
more granular standards to
limit implementation
variability; converging
supervisory effectiveness and
intensity etc); or, beginning to
cement now the foundations
for effective global institutions
with some global regulatory
powers and binding disputes
settlement. Sooner or later we
will need the latter in the years
ahead. In addition, we must
continue to deepen our
knowledge about how financial
markets function (e.g. shadow
banking), be
prepared for new
threats (e.g. cybercrime) and
open to new ways to protect
investors (e.g. behavioural
economics).
7. Biggest concerns
A deterioration of global
economic prospects, further
unsustainable rises in public
debt leading to more austerity
and the danger of deflationary,
downward economic cycles.
The earlier the capital markets
can be brought into play to
address some of these
structural problems the better.
8. Women in power
I hope so.
9. Green credentials
In our small ways we should
all play a part to construct a
sustainable world environment
that is fair to all.
10. Personal best
By trying to keep fit; being
open to all views; by
recruiting the very best; and
by delivering our new
emerging vision for Iosco. Plus
the occasional game of golf to
keep everything in
perspective.
2014 PREDICTIONS
Dr Nasser Saidi,
Former chief economist,
DIFC Dubai
1. View 0f 2013
For deep US political divisions
and dysfunctional politics that
threatened US and global
markets by undermining the
notion of US debt being the
risk-free asset. Dysfunctional
US politics and divisions are
leading to uncertainty about
the future course of US fiscal
and debt policy in addition to
healthcare policy. It is telling
that the Tea Party, a minority
of Republican hardliners who
supported the shutdown due
to their opposition to
Obamacare, are able to dictate
their party’s policies. The US
political schism implies that
Obama has become a lameduck president even before he
enters the second half of his
second mandate. There will be
a growing question mark over
his ability to deliver on major
issues, such as the important
matter of US-Iran relations, a
potential game changer which
is critical to the security,
political and economic
landscape of the Middle East
and the GCC countries.
Photograph: Shutterstock
2. Best decision
To invest and support the
launch of a crowd investing
platform, Eureeca.com. It is
the first equity crowdfunding
marketplace offering a global
solution for start-ups and
SMEs to raise
Dubai: Gulf
markets will be a
focus in 2014
funding from the crowd in
exchange for equity. We have
already done cross-border
equity raising and hope to
launch in Central & Latin
America in 2014.
Crowdfunding can be a major
source of sustainable finance
for SMEs and improve access
to finance globally. It is a
disruptive development
utilising the ubiquitous
internet and interactive webbased financial services.
3. 2014 focus
Recapitalising European
banks, minimising the impact
of disruptive politics in the US
and avoiding the eruption of a
euro sovereign debt crisis as a
result of ongoing weak growth
in southern Europe and
France. We are entering 2014
with two major sources of US
policy risk: an uncertain
course for monetary policy and
the onset of QE tapering and
uncertainty on debt and fiscal
policy. Both could jeopardise
the anaemic US economic
recovery and weak global
economic growth.
4. Major changes
The internationalisation of the
renminbi and the growth of
the redback market, which can
become larger than the euro
debt market within the
coming decade. The world
needs the renminbi to be
the third global currency
alongside the US dollar
and the euro. It will be
the beginning of the
end of the exorbitant
privilege the US has
enjoyed since the
Second World War
and the competition
will eventually
impose debt
discipline on the US.
5. Power people
Janet Yellen will
initiate QE tapering
and start addressing
the more critical issue of
deleveraging the Fed’s balance
sheet. Where will the savings
originate to buy the assets the
Fed will eventually have to sell?
6. Strategy
increasingly international, war
in Syria; and an eventual
breakdown of the budding
détente with Iran, which could
deteriorate into military
confrontation and war.
Extending my advisory
business into Africa and
growing the links with
Chinese companies and
investors, who have become
the major source of funds and
capital flows into Africa and
increasingly the Gulf and the
Middle East. The other area
of focus is financial markets
in the Gulf with the
forthcoming reclassification
of the UAE and Qatar
markets from “frontier” to
“emerging”.
8. Women in power
7. Biggest concerns
10. Personal best
High youth unemployment in
Europe leading to
protectionism and extremism
and continued deterioration of
the Arab firestorm; growing
spillover from the ongoing,
I network extensively and am
involved with a number of
international organisations
including the IMF, OECD
and the UN, along with the
WEF.
Women already occupy more
than 50% of the senior roles in
my advisory business.
9. Green credentials
I am a public advocate of the
Global Reporting Initiative
and I work with stock
exchanges, regulators and the
investment management
industry in the Middle East
for companies to adopt GRI
and report on environmental,
social and governance issues.
Winter 2013
21
2014 PREDICTIONS
Jim Malgieri
Executive vice president
global collateral services,
BNY Mellon
1. View 0f 2013
In my view, 2013 will be
remembered as a period of
heightened awareness of
regulatory changes and how
they are reshaping business
practices.
leading services and solutions
for clients.
3. 2014 focus
Risk identification, mitigation
and control by all financial
institutions.
7. Biggest concerns
2. Best decision
4. Major changes
This is an easy one: continuing
to invest in global collateral
services, an innovative suite of
market-
One of the major changes to
watch for will be complete and
wholesale shifts in the
business models of some
companies to ensure
compliance with new
regulations as they take effect.
The complexity and cost, both
in terms of the opportunity
costs and the costs to comply,
will inform those decisions.
It isn’t so much of a worry as
an opportunity. There has been
so much change to the markets
over these past few years, then
add innovation and technology
to the mix.
To some degree, we are in
the business of helping clients
worry a little less. Global
collateral services was created
and designed to support the
myriad changes facing clients
as a result of regulatory
reforms and market changes.
5. Power people
8. Women in power
Regulators around the world
will have the biggest impact on
the industry in 2014.
We operate in a highly
competitive landscape and we
look to attract the best people
in the industry today and in
the future. That means
tapping into the widest talent
pools and ensuring diversity
of thought leadership,
inclusive of women. We value
diversity. In fact, every BNY
Mellon employee has a
diversity and inclusion goal in
6. Strategy
The key focus of our business
strategy continues to be
offering value-added
services, solutions and
collateral products to our
clients. As they face evolving
global regulations and
22
rapidly changing market
requirements, clients can
leverage BNY Mellon’s
products and services to
better manage counterparty
and market risk in their
collateral transactions, engage
in more investment
opportunities to help
maximise their investment
returns and access new
financing alternatives.
Winter 2013
their annual performance
appraisal.
9. Green credentials
Environmental considerations
do feature in our business and
corporate planning. We
publicly and voluntarily report
our environmental progress
with the CDP (Carbon
Disclosure Project) and through
our corporate social
responsibility report. We
surpassed our greenhouse gas
emissions reduction target of
10% by 2016, recording a 32%
reduction in greenhouse gas
emissions last year across our
owned and controlled US
property portfolio. We have
had a lot of success reducing
energy consumption with the
EPA’s Energy Star programme.
And, in terms of services, those
range from environmental,
social and governance screening
of assets to help assess and
manage risk to socially
responsible investment funds.
10. Personal best
For me, I really enjoy working
with our clients and shaping our
employee culture. I continue to
talk to our clients, enlisting
their opinions and insights on
the market and our products. In
terms of our employees, it is a
lot like coaching and we have
the best people in the business.
That is good for us and even
better for our clients.
2014 PREDICTIONS
Basel, Switzerland:
Capital rules now
having an impact
Philip Stafford
Editor, FT Trading Room
1. View 0f 2013
Post-financial crisis
regulation finally coming to
fruition across the north
Atlantic. Mandatory
clearing, trading on Swap
Execution Facilities and
trade reporting became a
reality in the US. Europe was
a little further behind, but
the technical proposals for
the European Market
Infrastructure Regulation
emerged and political
agreement on the review of
the Markets in Financial
Instruments Directive is
likely to come around the
end of the year. Progress was
made on the tricky issue of
extraterritoriality. The
impact of the Basel III
capital requirements for
banks also began to have an
effect.
Photograph: Shutterstock
2. Best decision
Much of my job relies on
others making decisions
about my work. But I was
proud of the Exchanges,
Clearing and Transaction
Services report in September.
A lot of work went into it designing, commissioning,
writing and editing - and
many people in the industry I
admire and respect have
complimented us on it, which
is very satisfying.
3. 2014 focus
Compliance with regulation
will continue to be an industry
priority, but as that beds down,
I’d expect to see emphasis on
companies trying to make a
commercial return from the
new world. There will be new
products like futures contracts,
outsourcing of collateral
management and streamlining
of the trading and data
operations of banks. There
should also be more focus on
Asia’s response to the G20
rules.
chairman of the Commodity
Futures Trading
Commission (assuming he is
sworn in). The priorities and
approach of the CFTC will
be one of the main themes
early in 2014.
6. Strategy
To focus on developing
new digital initiatives for
the FT Trading Room
website.
7. Biggest concerns
That the volume of news
will get in the way of
achieving that.
8. Women in power
It is still developing, but given
the breadth and depth of
investigations into the foreign
exchange market, I could see a
political push for an overhaul.
Moving it on to more
transparent, exchange-like
trading venues may be far
harder to achieve than
lawmakers think, though.
I have no inf luence in
promotions at the FT.
Having said that, there
are a lot of talented
women here, some in senior
roles, and it would be a
surprise if there were not
more in senior roles in 12
months’ time. As an aside,
I’ve always been impressed
that the market structure
world has far more women
in senior and important roles
than other parts of the
financial services industry.
5. Power people
9. Green credentials
Two candidates: Jeff Sprecher,
chief executive of
IntercontinentalExchange, as
he reshapes NYSE Euronext;
and Timothy Massad, the new
The FT itself has long been
conscious of the environment,
from encouraging employees
to recycle, to not taking
unnecessary flights. Going
4. Major changes
23
13
Winter 20
digital has an impact on our
business carbon footprint.
10. Personal best
The sheer weight of news
stories has been great, but it
comes at a cost sometimes. I
have been studying aikido, a
Japanese martial art, for the
past 12 years and I am a black
belt. Sadly I have missed many
training sessions this year.
They help me relax a lot and I
come back to issues from a
distance and with fresh
perspective. My aim is to do
more training.
Winter 2013
23
2014 PREDICTIONS
City of London:
May see a bull market
in 2014 says Oswald
Professor Andrew J Oswald
University of Warwick, UK
1. View 0f 2013
4. Major changes
Glimmers of sunlight in the
world economy, and the
lighting of a blue touchpaper
on an eventual house price
boom.
There is a good chance that
2014 will see a bull market in
stocks as people shake off their
pessimism and herd behaviour
takes over on the upside. It is
not a done deal yet, however.
afraid. Every year, however, I
worry about the
interconnectedness of the
world’s computers. One worldclass computer troubleshooter
whom I know prints off hard
copies of all his bank
statements, “For the day,
Andrew, when all the computers
fail and I have to prove to the
bank what cash I had.”
5. Power people
8. Women in power
If you mean the financial
industry in the UK, I imagine
it will be Mark Carney at the
Bank of England. Much will
depend on whether he reacts
strongly, one way or another,
to house price inflation
probably approaching 10% per
annum by the end of 2014.
Warwick University is doing
that constantly. Plus the new
PhDs in world economics are
very evenly divided between
men and women, so it is only a
matter of time.
2. Best decision
Going public on a formal
statistical demonstration
of the fact that high
home ownership rates in
the world lead to high
unemployment rates.
Owner-occupation
destroys the efficiency of
the labour market.
3. 2014 focus
24
Winter 2013
6. Strategy
Having ideas. Trying not to
run with the herd.
7. Biggest concerns
We are probably due a bad
global terrorist incident, I am
Still not enough, in my
judgment, but trees are
definitely in, I am pleased to say.
10. Personal best
Your question is ten years too
late. But the older I get, the
more I admire the wisdom of
the old.
Photograph: Shutterstock
Trying to work out
how to stop the boombust cycles of the
world. We have to
figure out how to stop
going from one
extreme to the other.
9. Green credentials
2014 PREDICTIONS
Sal Naro
Ceo, Coherence Capital Partners
1. View 0f 2013
War averted in Syria; record
highs in the US stock market;
massive movement in US rates
following the Fed’s threat to
taper which “talked” the
market back to a more
realistic yield curve; the
appointment of new Fed chair
Janet Yellen; Europe started to
emerge from recession;
Twitter went public.
2. Best decision
Overweighting in financials,
particularly Bank of Ireland
securities, and carmakers as
well as parts and suppliers
such as Continental, Shaeffler,
GM and Fiat.
3. 2014 focus
Continued US and global
growth; expansion of
quantitative easing in Europe
and tapering of QE in the US,
which should lead to
compression between highyield, lower-rated investmentgrade and high-grade spreads
and a higher dollar. Further
improvement in balance sheets,
both corporate and personal.
4. Major changes
Final adoption of various
regulatory changes, ranging
from bank capital to the
Volker rule and swaps
clearing.
5. Power people
Janet Yellen and Mario
Draghi.
Photograph: Shutterstock
6. Strategy
26
Investing in companies that
are new to the capital
markets, first-time issuers to
the high-yield bond markets.
Investing in spread
compression between lowergrade and high-grade as
balance sheets continue to
improve and businesses
continue to expand with the
undertones of continued low
global interest rates and
default rates.
Winter 2013
7. Biggest concerns
My biggest concern moving
into 2014 is that the US
economy is stronger than
originally predicted. This
could have the effect of
driving rates up very quickly
causing sticker shock,
illiquidity and an abrupt but
temporary suspension of
capital markets activity. The
last time we were in a
protracted rate rising
environment was 1994.
8. Women in power
Absolutely. We are an
emerging firm and as we bring
in more capital, we will be
expanding our staff. We have
some key positions to fill and
are strong believers in the
benefits of diversity.
9. Green credentials
We are green-friendly around
our office, but more
importantly we always look for
opportunities to invest in
socially responsible businesses.
10. Personal best
Work harder and work smarter
by continuing to combine new
cutting-edge technology with
sound fundamental research
and common sense.
Twitter: the most high
profile IPO of 2013
2014 PREDICTIONS
First class:
Royal Mail 2013
IPO was the first UK
privatisation of the
21st century
Tamara Box
Partner, Reed Smith
1. View 0f 2013
We will probably look back on
2013 and say that was the year
of market schizophrenia.
Optimistic growth projections
were countered by rumbles of a
looming disaster. Money in
search of an investment found
so little from which to choose
that the deals that did come to
fruition such as Twitter, and,
in the UK, the Royal Mail,
were all massively
oversubscribed, even as the
pessimists were predicting the
end of the financial world. I
heard one senior analyst
describe the situation as
“patting yourself on the back
as you go over the cliff”.
2. Best decision
Photograph: Shutterstock
Warren Buffett is known for
believing that the time to buy
is when everyone else is selling.
Early in the year, as law firms
were shedding people, we took
that as an opportunity to invest
in human capital, growing our
financial services capabilities.
3. 2014 focus
I hope the coming year will be
the year of reason, the time to
bring a longer term mentality
to the markets. I would like to
see an end to the seemingly
addictive use of “quantitative
easing” and have the markets
work without government
intervention.
4. Major changes
We all know that regulation
has the potential to both
correct and distort markets.
The unintended consequences
of enacting stronger controls
may mean that a limited few
will take advantage of the
distortions created by the very
rules designed to minimise
inequities in the system.
Regulatory capital rules, for
example, mean that those in
my market – structured
finance – may face entirely
new counterparties in the
future.
5. Power people
We are seeing the emergence of
new types of lenders, the nonbanks (or shadow banks as
they are more excitingly
referred to). Unconstrained by
the traditions and regulations
of conventional banks, these
non-banks serve a variety of
niches, from payday lending to
vertical market lending. These
nimble and diverse non-banks
may be the trendsetters to
watch in 2014.
6. Strategy
My business strategy for next
year rests on three legs:
knowledge, cooperation, and
innovation. In order to provide
the most creative and
innovative solutions to our
clients’ needs, we have to focus
on maintaining teams of
people with the collective
experience to produce efficient
and effective results. Rapidly
changing markets create
transient demands for
particular skillsets; ensuring
that our teams are proficient
and agile requires a
commitment to training and
cross-pollination of ideas, as
well as a belief that success
comes from cooperation.
7. Biggest concerns
We constantly seek out
professionals who can manage
complex and unique client
requirements; I worry that one
day the demand for those
skilled, talented and
interesting people may exceed
the supply.
8. Women in power
Reed Smith realises that
better gender balance in
leadership is a key to success.
For the third year in a row,
the Women in Law
Empowerment Forum
(WILEF) has named Reed
Smith to its select listing of
law firms deemed “Gold
Standard Certified” (meaning
we satisfy stringent
leadership, compensation and
promotion requirements). In
addition, in 2013 we were
awarded the Euromoney
Award for being the most
innovative law firm for
women in the UK. Finally, as
our chairman is a committed
member of the 30% Club and
with just over 30% of our
executive comittee being
women, we are “walking the
walk”.
9. Green credentials
Our commitment to all aspects
of the environment is always at
the forefront of our business
considerations and 2013 has
been our best year to date, in
terms of our recycling figures.
10. Personal best
I am lucky to work in a truly
supportive professional
environment that rewards
teamwork and collaboration.
Having a talented team, rich
in diversity of skills and
thought, means that I don’t
always have to be on top or in
front. I also work on
important initiatives like the
30% Club. Finally, I have the
joy of a supportive family.
What more could a girl need
to stay on top?
Winter 2013
27
2014 PREDICTIONS
LSE: Looking forward to
a resurgence of IPOs
Xavier Rolet
Ceo, London Stock Exchange
with customers, innovating
and cost extraction are
perennial strategies.
1. View 0f 2013
4. Major changes
7. Biggest concerns
2013 will be remembered as
the year that confirmed the
emergence of the green shoots
of economic recovery and the
resurgence of the IPO market
that we began to see in 2012.
We hope to see open access
across Europe’s derivatives
markets. In financial
infrastructure, there will be
further consolidation and
deeper levels of partnership
between venues and
customers.
The outcome of the European
Parliamentary elections.
2. Best decision
Without doubt the acquisition
of LCH.Clearnet – a truly
transformational deal for
London Stock Exchange
Group and our customers.
Photograph: Shutterstock
3. 2014 focus
Making sure SMEs in the UK
and across Europe have access
to the right type of finance to
fund their development. Their
success is central to the
recovery of the European job
market.
Winter 2013
5. Power people
Michel Barnier, European
Commissioner for financial
services – there are some vital
decisions affecting the future
of European financial
marketplaces to be taken in
2014, which will in turn
impact us all in our pursuit of
economic growth.
6. Strategy
Continuing to work closely
8. Women in power
Yes.
9. Green credentials
They are important to
us and we are focused
on doing what we can
to be greener, such as
encouraging recycling,
running our annual
‘green week’ and playing
an active role in the
communities in which we
operate.
10. Personal best
Every day since I arrived at
London Stock Exchange
Group four years ago I have
been both inspired and
challenged by the fantastic
people I work with, both in
and outside the firm: I hope to
continue to be – to learn from
them and to strive for success
and excellence in all that we
do.
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W
Winter 2013
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$$ the
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default caused widespread
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$$
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yields rose a paltry nine$$
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$$ $$ $$ $$
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$$
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$$said Michael Huenseler,
$$
$$
$$
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a portfolio
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$$ hit new highs on
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$$ $$ $$ $$
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the heels of$$
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of the relative security
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$$ $$
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$$
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$$
$$
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$$ 10bps$$
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$$
and 30bps,
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$$
$$
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$$risky
importantly to prevent
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$$
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$$
$$
from
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government
riskier
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$$
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the
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a weaker
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$$
$$
$$
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want to see
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banks$$
charged
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$$rose
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$$ $$ $$ $$ $$ $$ $$$$
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a currency strategist at Société Générale in London.$$ $$
and the
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$$
$ $$
$$
$$ $$
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$$ the dollar, perhaps the visible indicator
$$ $
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decline in the dollar would
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$$ $$ $$ $$ $$ $$ $$ $$
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$$
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rates,
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terms
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$ $$ $$ $$ $$ $$
$$ $$ $$ $$
$$
$$
$$
servicing
its mountain
of debt.”
economy, languished near an eight-month low against
$$
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$$ $$that$$
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Still, while the US current
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$$ $$ $$ $$ $$ $$ $$$$
$$
$$
concern,
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for
delay any decision
to
raise
interest
rates
and
that
the
$$
$$$ $$ $$ $$ $$
$$ $$
$$
$$
$$
$$
international
investors
to back
the
US. $$
First, $$
returns
resolution of the budget debate may be a temporary
fix $$
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$$ $$ $$ $$ $$ $$ $$ $$
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$$
$$
$$ $$
$$ solution.
on US assets are relatively high
compared
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$$
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developed
market
rivals.
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1947
until
2003 the
“The treatment of such
important
matters
not
$$
$$
$$in$$
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$$
$$
$$
$$
$$
US $$
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growth
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averaged
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and
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only
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the
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in the third quarter of this year. European
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credibility as a
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$$
$$
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$$
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$$
$$
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contrast,
has
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in
only
one
decade
in
the
benchmark currency and refuge
of
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said
$$ $$ $$ $$ $$ $$ $$ $$
$$
$$
$$
$$ $$
$$the$$
$$ $$$
$$
$$
$$
past$$
five, and
averaged
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between
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and $$ $$
Huenseler.
“Since
financial crisis originated in the
$$
$$
$$
$$
$$ $$ $$ $$ $$ $$ $$ $$$$
$$
$$
$$
$$
US, any
further
indications
that$$
international lenders’ 2012, according to World Economics. $$ $$ $$ $
$$ $$
$$
$$$
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$$
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US also
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some $$
outstanding
natural
justified interests are being disregarded
would$$
be $$ $$
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$$ $$ $$
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And$
there
the rub.
While
impact of the budget of vast stores of natural gas, which led to a 60% decline
$$the$$
$$
$$is $$
$$ $$ $$ $
$$ $$
$$
$$
$$
in prices
and$$
a welcome
boost $$
for competitiveness.
fiasco was quickly forgotten, the causes have
not
gone
$$
$$
$$ $$ $$ $$ $$ $$ $$$$
$$
$$
$$
$$ $$
$$US$$
“The US has outperformed
most $$
large economies
away$$
and net
debt $$
continues to grow, recently
$$ $$ $$ $$
$$
$$
$$
$$ $$ $$ $$ $$
$$
$$
$$
$$ $$ $$
$17tn
$$
$$
$$
30 years and it is likely to remain $$ $
topping
That means
the country
$$ is dependent over the past 20 or$$
$$ $$
$$ $$
$$17tn.
$$
$$ $$
$$ $$
$$money,”
attractive
place to make
said Randall
on foreign investors to keep its interest rates in$$
check$$an
$$
$$
$$
$$ $$ $$ $$ $$ $$ $$ $$$$
$$
$$
$$
$$
$$
$$
$$
$$ $$ $$ $$
$$
$$
$$
$$
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$$
$$ $$ $$ $$ $$ $$ $$ $$
$$
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$$
$ $$ $$ $$ $$ $$ $$ $$ $$ $$ $$ $$ $$ $$ $$ $$ $$ $$ $
30 $$ $$ $$ $$ $$ $$ $$
$$ $$
$$
$$ $$ $$ $$ $$ $$$$ $$ $$ $$ $$
$$ $$ $$ $$ $ $$ $$ $$
Current US net debt figure
Winter 2013
US ASSETS
exports created something of a problem, threatening
to increase the value of their currencies. Those
countries sought to offset that pressure by buying
dollar assets, pushing up the value of the greenback
and helping sustain demand for their exports.
As a result, China in August held $1.27tn of US
government securities, while Japan held $1.1tn,
according to the US Department of the Treasury. Total
foreign holdings of US debt amount to some $5.6tn.
“If you look at Chinese purchases of US Treasuries
it is driven not by any altruistic intention to support
the US economy, but entirely by the need to drive its
own exports by depressing the value of the renminbi,”
said Steve Tsang, professor of contemporary Chinese
studies and director of the China Policy Institute at
the University of Nottingham.
Another source of demand for the dollar arises from
its dominant role in global foreign exchange markets:
the currency is one leg in 87% of transactions,
according to HSBC. Meanwhile, global commodities
remain denominated in dollars, adding to appetite for
the greenback.
It is this dominant role for the dollar which guarantees
that, even if value drips away, the function of the
greenback will continue to fuel demand for US assets.
“In the end, people will go with what is cheaper
to trade and that is where the volume is, which is all
about the dollar,” said David Bloom, global head of FX
strategy at HSBC in London. “As the value continues
to decline, that starts to hurt the dollar’s function,
but at the moment there is no realistic alternative and
that gives the US an enormous amount of
control, and a huge advantage.”
The euro, when it was launched, was
conceived as a potential alternative to the
dollar, but the recent financial crisis and
subsequent collapse in growth has put
paid to that idea for now.
China has made noises about
diversifying away from the dollar, and
senior officials made no secret of their distaste in
respect of the recent budget furore, with prime
minister Li Keqiang telling Secretary of State John
Kerry that he was “highly concerned” about a possible
default.
However, moves to diversify have found little
success, and, of China’s $3.6tn in foreign exchange
reserves, about 60% remain held in dollardenominated assets.
Longer term, a viable alternative to the dollar may be
the Chinese renminbi itself, and Chinese authorities
have made well-publicised moves to increase the
role of the currency, loosening capital controls,
encouraging trade settlement and opening swap lines
in London and Paris.
However, few observers believe the renminbi will
offer a realistic alternative to the dollar anytime soon.
“If you look at the well-connected people in China
they still prefer to send their children to school in the
US and to buy their houses in Palo Alto and New York
and Boston,” said Tsang.
“That’s because it is a safe investment. Sure, the
politics in the US is harmful, but what other system
could survive that level of irresponsibility? I wouldn’t
write it off just yet.”
The US has outperformed most
large economies over the past
20 or 30 years
Germain, a professor of political science at Carleton
University in Ottawa. “What is more interesting is
the ability of investors to extract profits in a way that
does not get hit by a declining dollar, and certainly,
internationally, there is a gathering sense that the
current dominance of the dollar as an international
currency is a problem.”
Over the long term, the dollar is declining, and its
purchasing power between 1970 and 2010 fell by
some 80%. The DXY US dollar index, measuring the
dollar’s performance against a basket of currencies
including the euro, yen, sterling and Swiss franc, has
declined from a high of 165 in 1984 to 120 in 2000
and around 80 in recent trade.
However, as the dollar has declined, foreign
purchases of US assets have risen and foreign
ownership of “publicly-held” federal bonds jumped
from around 5% in 1970, to 46% today, according to
researchers at the London School of Economics.
Of course, behind this dynamic is the politics of selfinterest. Until the mid-1990s the US current account
deficit was in the range of around $100bn. However,
as Asia emerged as a centre for manufacturing, the
deficit ballooned, reaching $850bn by 2006.
For producer countries the surpluses generated by
Concerned:
China PM Li Keqiang was worried
about a possible US default
David Wigan is a freelance
journalist based in London
Winter 2013
31
CHINA INVESTMENT
Yuan
direction
Chinese foreign investment used to be concentrated
on resources, but now it is broadening its horizons
writes Alice Shone
E
$50.55bn
Amount China invested overseas in
the first half 2013
32
Winter 2013
ver since the Crystal Palace burned down
in 1936 there has been talk of rebuilding
the glass and steel pavilion originally built
for Britain’s Great Exhibition of 1851. Last
month, the talk appeared to turn into a
real plan – with the estimated £500million coming
from Shanghai Zhongrong Property Group and a
consortium of other Chinese developers.
Chinese money may also build the next generation
of nuclear power stations in the UK. Other groups
have bought into Heathrow Airport, Manchester’s
Airport City and Thames Water, while telecom
manufacturer Huawei is establishing a vast new
corporate centre along with £1.3billion of investment
in the country.
This is not how things used to be – until recently
while money was pouring into China, it was goods
that poured out. But now China seems to be buying
the world. Starting with huge investments in natural
resources by state-owned enterprises (SOEs) during
the commodities boom, the private sector is now
pioneering massive deals around the world.
Of course, China continues to attract record levels
of foreign direct investment (FDI) itself. According to
data published by the Ministry of Commerce
(Mofcom), in the first seven months of 2013, China
attracted $71.4bn in FDI, an increase of 7.1% from
the same period in 2012.
Equally as significant, though, were the levels of
outward direct investment (ODI), which totalled
$50.55bn, an increase of 19.7%. Last year, China’s
ODI more than doubled and the country became the
third largest source of investment after the US and
Japan. And all this in a period where global FDI
contracted by 17%.
What, then, are the characteristics of Chinese
overseas investment? Since the introduction of Jiang
Zemin’s ‘Go-Out Policy’ in 1999, it has been
dominated by SOEs and directed at acquiring energy,
minerals and land in developing countries. To this
day, SOEs account for roughly 75% of all Chinese
ODI and energy remains by far the most dominant
sector in terms of value.
However, ODI policy is no longer driven
exclusively by resource insecurity, as reflected in a
survey conducted by the Economist Intelligence Unit,
in which 48% of firms surveyed stated that they were
planning to invest overseas, but only 26% were
motivated by natural resources.
The regional spread of Chinese ODI is also more
diverse than previously thought. Southeast Asia has
seen the most investment, accounting for 30% of
China’s total ODI since 2005, while Hong Kong
remains the number one choice for mainland
investors. However, the next three regions – North
America, Europe and Sub-Saharan Africa – received
an equal distribution of 11% each, closely followed by
Australia, Brazil and Canada, where investment has
focused almost exclusively on energy and metals.
The weight given to Europe and North America
reflects a trend in which Chinese investors are seizing
opportunities created by the economic downturn to
compete in mature markets. According to
Organisation for Economic Co-operation and
ODI policy is no longer driven
by resource security
Winter 2013
33
Obama and Cameron: Both US and
UK have benefited from China’s
investment machine
9.5%
The amount of ODI coming from
private Chinese firms
34
Winter 2013
Development data, the share of Chinese investment
going to developed countries has increased from one
tenth in 2002 to two-thirds in 2012. China is the
fastest growing source of FDI in the US, while in
terms of M&A the UK has received the greatest
proportion of Chinese investment after Hong Kong.
These figures come with a warning. According to a
China analyst at the European Council on Foreign
Relations, data for Chinese ODI is distorted by the
manner in which Chinese ODI is typically channelled
through offshore financial centres such as Hong Kong,
the Cayman Islands and the British Virgin Islands
destined for developing countries. She conceded that
there has been a marked shift towards diversification,
but warned against exaggeration: “From the outset,
investment in energy and resources in developing
countries has offered greater
returns and has been
strategically more simple than
engaging heavily with Europe
and North America and,
though China’s style of ODI
has begun to shift, it remains
primarily targeted towards
developing Latin American
and African countries.”
The shift in Chinese ODI began during the
financial crisis of 2007-08, which effectively shut down
western capital markets and lent a new attractiveness to
Chinese investors previously priced out of the market.
Chinese companies were now seen as strategic
investors, bringing with them access to capital and a
growing Chinese market. According to Huo Jianghuo,
president of the Chinese Academy of International
Trade and Economic Co-operation, Chinese investors
were aided by debt crises and slowing domestic growth,
which “opened up great opportunities for Chinese
enterprises to invest abroad, and the appreciating yuan
helped the process”.
Another factor in the development of Chinese ODI
was the opening up of China’s economy, which has
created opportunities for Chinese firms to go global.
Central initiatives enabled China’s railways,
construction and renewable energy to become more
competitive in international markets. These industries
also promise better yields than primary resources, and
the government is therefore encouraging companies
to invest in more diverse areas like infrastructure,
high-end property and “emerging strategic industries”
such as next-generation IT, energy conservation,
biotechnology, high-quality equipment
manufacturing and renewable energy.
We can see evidence of this in the UK, where last
year China was the third largest investor by number of
projects. The UK government has framed a
comprehensive, structured and positive approach
towards Chinese investment. Trade envoys led by
George Osborne and David Cameron are opening the
way for Chinese investment and, with the easing of
entry rules to the UK, major Chinese banks will soon
be able to establish branches in
London for wholesale activities,
allowing them to conduct
business locally while remaining
regulated under Chinese law.
Speaking about these plans, one
bank manager, at a large Chinese
commercial bank that recently
opened its first overseas office in
London, commented: “The scale
on which our clients have ‘gone global’ is really
amazing. We were aware of it when I was in Shanghai,
but only when we came here did we realise across how
many different markets they are succeeding.”
According to data published by the Heritage
Foundation, the most significant industries for Chinese
investment into the UK are energy, finance,
agriculture, property and transportation. Other
important sectors include infrastructure, such as China
Investment Corporation’s investments in Heathrow
and Thames Water. CIC, China’s sovereign wealth
fund, is a state investment vehicle, but it is not directly
run by the government. In recent years, it has been
diversifying and is notably branching into real assets.
While the CIC is an important leader, private firms
are also an increasingly key source of Chinese
investment. Data from The Economist shows that, in
2012, private firms accounted for 9.5% of Chinese
“There has been a
marked shift towards
diversification”
Photograph: Crown copyright
CHINA INVESTMENT
ODI, compared with less than 4% two years earlier.
Zhao Zhongxiu, vice president of the University of
International Business and Economics in Beijing,
explains: “There are two types of firms: big state-owned
companies that wish to acquire foreign technologies and
resources, and the more nimble small and mediumsized private firms that look for business opportunities
in overseas markets.” The analyst at ECFR reiterated
that the trend towards diversification of Chinese ODI is
being driven by the private sector: “Chinese private
firms are generally welcomed more openly in developed
markets. They are able to take advantage of the greater
returns available and the diverse range of industries in
which they can invest.” This drive to diversify is
beginning to impact the dominance of natural
resources: “Energy and mining are still paramount, but
diversification will slowly eat into the high percentage of
resource-driven investment.”
So while opportunities for Chinese companies –
both private and state-owned – exist, so too do
obstacles, as shown by the starkly different
experiences of technology giant Huawei in the UK
and US. Huawei is one of the largest mainland
Chinese investors in the UK and in 2012 it pledged to
invest a further £1.3bn in its UK operations.
However, in the US, the company has faced public
opposition due to the perceived closeness of Ren
Zhengfei, the company’s founder, to the Ministry of
State Security. This opposition culminated in October
2012, when a US congressional panel warned of a
national security threat posed by Huawei and
recommended barring the company from
participating in any US mergers and acquisitions.
Huawei’s US troubles illustrate how regulatory and
political hurdles in western markets are among the
highest risk factors perceived by Chinese companies
looking to invest abroad. While there is evidence of a
growing understanding between US regulators and
Chinese businesses – the US recently approved the
$7.1bn acquisition of Smithfield Foods, the country’s
largest meat producer, by Shuanghui International –
political opposition and public mistrust remain
concerns for Chinese investors.
The EU, meanwhile, is more open to Chinese
investment, which largely explains why Chinese
interests are taking more of the market, particularly
in services, technology and energy. According to the
ECFR analyst, European governments show very little
resistance to anti-competitive practices by Chinese
companies: “Obstacles which typically hinder
Chinese investment in developed countries are being
weakened as individual EU member states recognise
the potential value of Chinese inflows. This was
indicated in the relatively swift and, in many ways,
weak response towards disputes over anti-dumping
tariffs on Chinese solar panel imports. Division across
member states and desperation to maintain Chinese
investment meant the resolution was upheld, and
Chinese investment in the EU continues to grow.”
Despite its size, breadth and rapid expansion, then,
Chinese ODI may well be considered to be in what
vice-premier Ma Kai has called a “nascent stage”.
Aside from the challenges faced by private investors as
latecomers to international markets and the risks of
association with state power, even the more
established model of state-led investment in natural
resources was threatened by the events of the Arab
Spring, when Chinese companies and personnel in
Libya were forced to make a hurried exit, abandoning
projects estimated at $7bn. North African countries,
including Libya, Algeria and Morocco, now top the
list of countries perceived by Chinese companies to be
the highest-risk, and the government has
implemented a programme to compile country risk
profiles and devise risk management strategies and
early warning systems. This exposure to the risks of
violence and political upheaval has created a further
incentive to diversify away from higher-risk sectors
into mature markets.
Chinese investment, then, is more diverse,
geographically spread and dynamic than is often
portrayed. While state actors continue to dominate
strategic sectors, such as energy and natural resources,
we are beginning to see an unmistakeable shift up the
value chain towards advanced technology and mature
markets, in which the private sector has emerged as a
significant force, driving many of the largest and most
prominent deals.
UK PM David Cameron meets
Chinese president Xi Jinping during a
trade mission in December
Alice Shone is a senior
analyst at Salamanca Group
Winter 2013
35
BOOK REVIEW
Making It Happen:
Fred Goodwin, RBS
and the Men Who Blew up
the British Economy
by Iain Martin
Book review by Nicholas Dunbar
T
he collapse of the Royal Bank of Scotland
in October 2008 and its £45bn bailout by
the UK government was the most
traumatic event in British banking for over
a century and heralded the start of a steep
recession and a period of austerity, triggering a public
backlash against bankers that continues today.
It has taken five years for the first book-length
account of RBS’s rise and fall to be published, far
longer than it took for books on Lehman and the
US banking crisis to reach print. That may reflect
the political context behind RBS, whose balance
sheet in 2008 was 30% larger than the UK’s gross
domestic product. Such a concentrated impact by
one institution on a single national economy means
that a relatively small number of people can be held
responsible for what happened: Fred Goodwin, RBS
chief executive, and the bank’s board members
along with its senior executives, major shareholders,
advisers, regulators and politicians. Some of these
people had a vested interest in not seeing a full
reckoning come to light.
Iain Martin is well qualified to write a book
exploring the personalities and dynamics behind
RBS’s rise and fall. A former editor of The
Scotsman, he describes the clubby world of
Edinburgh finance and politics that led a staid
300-year-old institution to grow into one of the
world’s biggest banks. Martin believes that RBS’s
failure was largely the result of a failure to stop
Goodwin, hence the book is as much a biography of
him as RBS.
An ambitious accountant from Deloitte,
Goodwin entered banking in the 1990s on the
strength of his obsession with detail and ability to
drive through change. This obsession with detail
extended to matters like the tidiness of bank
branches, the colour of company cars and the shape
of filing cabinets, but not issues like risk or credit.
His other perceived strength, driving through
change and integrating large organisations, led him
into acquisition mania, culminating in the takeover
of ABN Amro.
This empire building made the now knighted
Goodwin difficult to challenge at board level.
Martin reveals that RBS chairman, Tom McKillop,
felt uneasy about Goodwin’s management style as
early as 2005 and considered replacing him, but
decided to do nothing. By this point both McKillop
and Goodwin were out of their depth as RBS
depended increasingly on investment banking
revenues to beat earnings targets. Here, another key
figure in RBS’s collapse makes his appearance,
Johnny Cameron. Cameron ran corporate and
investment banking and, according to Martin, was
the one RBS executive who intimidated Goodwin.
Yet Cameron was also out of his depth, as the
bank’s RBS Greenwich subsidiary built up a
subprime CDO business unchecked and without
regard for risk.
Martin documents the one honourable executive
to raise questions at RBS, risk manager Victor
Hong. Hired from JPMorgan in September 2007 to
look at Greenwich’s CDOs, Hong resigned six
weeks later when he was blocked in his attempt to
mark down the bank’s positions.
Hong’s resignation came just after RBS completed
its takeover of ABN Amro, increasing its CDO
exposure even further. That takeover is perhaps the
most terrifying part of the RBS story. Key
stakeholders felt compelled to go through with the
deal even as the subprime meltdown began, in effect
signing the bank’s death warrant. At the end of the
book Martin asks whether Britain’s own too-big-tofail bank was also too big and complex to exist in the
first place.
Since its bailout, RBS has continued to reveal
itself as a repository of everything that was wrong
with finance – misselling of payment protection
insurance, mortgage-backed securities and
interest rate swaps and, most notably, the Libor
rigging scandal. As giant banks continue to
surprise us, Martin’s book is the best argument
yet for breaking them up and curtailing the
wholesale markets that allow wrongdoing to
flourish.
Published by Simon & Schuster 2013
Nicholas Dunbar is a
financial journalist and author
of The Devil’s Derivatives
Winter 2013
37
SHORT DURATION
Portfolio
applications for
short duration
fixed income
Reduce interest rate risk
within a portfolio - Short
duration bond funds can be
paired with other fixedincome holdings to reduce
the overall interest rate risk of
a portfolio. Depending on the
desired risk tolerance,
investors can select funds
with an average duration of
less than three years to meet
this objective.
Seek income relative to
cash equivalents – For
investors with income goals,
short duration bond funds
with credit risk can provide
additional income relative to
constant NAV money market
funds or bank deposits.
Portfolio diversifier – With
low or negative correlations
to equities and core fixed
income, short duration fixed
income can add a level of
portfolio diversification and
can potentially help smooth
returns.
38
Winter 2013
When
rates
rise
With global interest rates
at historic lows, many fixed
income investors have rightly
become concerned about future
performance during the next
rate cycle, writes
Karen Schenone
C
entral banks including the US Federal
Reserve, Bank of England and European
Central Bank have pursued zero interest
rate policies and large scale asset
purchases (known as Quantitative
Easing) to provide stimulus to the economy. As the
fundamentals of the economy improve, central banks
will eventually change their tactics by reducing the
amount of bonds on their balance sheets and even
increasing shortterm interest rates. Due to deflationary
pressures, the ECB cut the main refinancing rate by
0.25% to 0.50% on November 7th. While the US
Federal Reserve has not yet begun to taper or reduce
its purchase of US Treasuries and mortgage-backed
securities, market participants anticipating these
actions have put upward pressure on longterm interest
rates. So while we are not yet in a tightening cycle,
investors are looking towards rising rates in 2014 and
adjusting portfolios accordingly.
Cash as an investment: how short is too short?
During periods of market volatility or uncertainty,
investors seek the safety of cash equivalents for
principal protection. This flight to quality or flight to
safety trade has been reflected in falling government
bond yields and increasing cash balances in investment
portfolios since the beginning of the credit crisis.
With $2.7 trillion in money market mutual funds
(MMF) in the US, €477 billion in Europe and $9.5tn
of deposits at banks in the US, investors are seeking
the safety of cash equivalents. US corporate balance
sheets also collectively carry over $1.5tn of cash
balances as corporate treasurers have faced an
uncertain investment climate. In Europe,
approximately 50% of corporate treasurers use
institutional money market funds to manage their
excess cash positions.
With shortterm interest rates near zero, real rates of
return may be negative after inflation. The average
institutional money market mutual funds are yielding
0.01%, 0.03%, and 0.35% for US dollar, euro and
sterling-denominated funds, respectively. Inflation
rates, as measured by the local consumer and retail
price indices, range from 1.0% to 2.6% across the
US, UK and eurozone. After inflation, cash investors
are experiencing negative real rates of return. For
investors that require principal protection, stable or
constant net asset value money market mutual funds
and bank deposits are the ideal investment options.
However, if investors are willing to accept some
additional risk in the form of credit, interest rate or
liquidity risk, they may be able to keep pace with or
even overcome the impact of inflation. The choice of
selecting a cash equivalent or short duration bond
fund will depend on the investor’s portfolio goals,
income needs and liquidity considerations.
Bond prices fall when interest rates rise. The degree
of the price decline can be approximated by
duration, which measures the interest rate
sensitivity of a fixed income security. Longer
duration bonds experience larger losses than shorter
duration securities when interest rates rise. One
strategy to mitigate losses of bond portfolios during
a period of rising interest rates is to adjust the
portfolio duration downward. This concept is often
oversimplified since interest rates tend to not
increase uniformly across maturities. Additionally,
credit spreads tend to move inversely to interest
rates. If interest rates are increasing due to
favourable economic conditions, credit spreads tend
to tighten as corporate profitability and bond
market liquidity improves. Tightening credit
spreads cause prices to increase on corporate bonds
and can offset price declines driven by increases in
government bond yields.
Investors have sought out short duration solutions
to help protect against rising interest rates, while still
seeking income. While shortening the duration of
bond portfolios can help mitigate losses in a rising
rate environment, doing so may also impact the
portfolio yield. In an upward sloping yield curve,
longer duration bonds offer greater yield in return for
the increased level of interest rate risk they carry. A
duration shortening strategy may therefore result in a
lower portfolio yield. As the total return of a bond or
a portfolio of bonds is driven by both the income
generated and price changes, investors must balance
these two objectives when constructing a fixed
income portfolio.
With a variety of portfolio applications, short
duration fixed income should continue to be a theme
throughout 2014. With interest rates at historic lows,
short duration fixed income, particularly fixed and
floating rate investment-grade credit, can help
investors mitigate the impact of increases in interest
rates and inflation on investment portfolios.
Karen Schenone, CFA is a fixed income strategist
at BlackRock based in San Francisco
Central banks have pursued zero interest rate policies
7
5
4
3
2
1
Dec
1998
Dec
1999
Dec
2000
Dec
2001
Dec
2002
Dec
2003
Dec
Dec
Dec
2004 2005 2006
Month/year
Dec
2007
Dec
2008
Dec
2009
Dec
2010
Dec
2011
Dec
2012
Credit spreads and interest rates
600
Fixed vs floating rate securities
Correlation of daily
changes = (0.52)
500
Spread or yield in bps
Allocating to short maturity or floating rate credit
can potentially achieve the goals of boosting yield
and reducing interest rate risk. Typically, short
maturity bond funds will track a bond index that
includes securities with maturities ranging up to
three or five years. This low range of maturities
keeps the average duration of the index less than
three years. For example, the Markit iBoxx USD
Liquid Investment Grade 0-5 Index includes dollardenominated bonds with maturities ranging up to
five years and has an average duration of 2.45 and a
yield to maturity of 1.59%.
Investment grade floating rate notes also offer
investors direct protection against shortterm
interest rate increases. These securities have coupons
that contractually reset, typically quarterly, against
a reference index such as Libor or Euribor, so the
duration tends to be very low (less than 0.25). The
bonds carry a fixed credit spread that is set at
issuance. The coupons are the sum of the shortterm
interest rate and the bond’s credit spread. As central
banks are adjusting their target rates, such as Fed
Funds or the main refinancing rate, the respective
Libor or Euribor index should also increase. The
bond’s coupons will reset higher and the investor
will collect more income on their investment.
During rising rate environments, these bonds will
generally react more favourably than fixed rate
securities.
ECB Main Refinancing Rate
US Fed Funds Target Rate
UK Bank of England Official Bank Rate
6
Rate (%)
Trading off interest rate risk for credit risk
400
300
200
100
Nov
2006
Nov
2007
Nov
2008
Nov
Nov
2009
2010
Month/year
10 Year US Treasury yields
Nov
2011
Nov
2012
Investment grade credit spread
Source: BlackRock, Bloomberg and Markit iBoxx from November 2006 to November 2013
Short duration bond index
Coupon type Maturity range Index yield Index duration ETF solution
Markit iBoxx USD
Liquid Investment
Grade 0-5 Index
Fixed
0-5 Years
1.59%
2.45
SLQD (US)
SDIG (Dublin)
Markit iBoxx GBP
Corporates 1-5 Index
Fixed
1-5 Years
2.70%
2.75
IS15 (Dublin)
Both Fixed
and Floating
Fixed: 0-1 year
Floating: 0-3
Years
1.04%
0.22
ERNS (Dublin)
Markit iBoxx EUR Liquid Both Fixed and Fixed: 0-1 year
Floating
Floating: 0-3
Investment Grade
Years
Ultrashort Index
0.74%
0.33
ERNE (Dublin)
Both Fixed and Fixed: 0-1 year
Floating
Floating: 0-3
Years
0.80%
0.32
ERND (Dublin)
Markit iBoxx GBP
Liquid Investment
Grade Ultrashort Index
Markit iBoxx USD
Liquid Investment
Grade Ultrashort Index
Source: Markit as of 14/11/13
Winter 2013
39
The most urgent economic, environmental
and social challenges of the 21st century
could mean big opportunities for business,
writes Andrew McKeon
Disruptive
Disruptive
Disruptive
Disruptivewo
wo
ww
N
ow is the time to throw a spanner in the
works. If industrial development
continues along its current path, we will
find ourselves scavenging for ever scarcer
resources. Nothing less than a disruption
of the thinking, policies and processes can put us on a
more sustainable path.
The seriousness of the issues facing us was
highlighted in September when the
Intergovernmental Panel on Climate Change
published the Summary for Policy Makers for the
Fifth Assessment Report. The IPCC is the leading
international body for assessing the state of climate
change on Earth. Its work has received the highest
Quotes from the recently released
summary include:
“Human influence on the climate system is clear.”
“The atmospheric concentrations of carbon dioxide, methane,
and nitrous oxide have increased to levels unprecedented in at
least the last 800,000 years.”
“Continued emissions of greenhouse gases will cause further
warming and changes in all components of the climate
system. Limiting climate change will require substantial and
sustained reductions of greenhouse gas emissions.”
40
Winter 2013
recognition and respect – the group was awarded the
Nobel Peace Prize in 2007.
Perhaps the IPCC could have said it a bit
differently. How about, if industrial development
continues with a business-as-usual mindset, “the
planet’s goose is cooked”. This comment comes from
a 2011 letter to investors from one of the world’s top
fund managers, Jeremy Grantham, founder of GMO
(Grantham, Mayo and van Oterloo) with over $100
billion in assets under management.
Grantham, a hard-nosed money man, simply
looked at reality and the basic facts. There are over
seven billion people living on earth, and only one
billion of us have access to a middle-class standard of
living, yet we are already using the resources of one
and a half earths, just to keep it up. This has led to
resource depletion, damage to ecosystem carrying
capacity, climate change and many other problems.
Without transformational change, the goose is going
to get cooked.
Historically, sustainability has been about doing
good, with the corporation seeing sustainability as a
way of making up for its negative impact. More
recently, business leaders have seen that sustainability
measures can lead to increased efficiencies and cost
savings. So, more than just doing good, it can be about
doing well. Doing good and doing well are signs of
good management, but this approach to sustainability
is not transformational at the scale required.
CLIMATE CHANGE
world
world
orld
orld
Additionally, it may be blinding ceos into thinking
they are doing what is necessary, when in fact there
are more significant changes taking place in the
global economy. From doing good and doing well,
sustainability is now entering a third phase, doing
differently, and creating disruption.
Disruption over the next 20 years will happen as
two to three billion more people set about trying to
improve their living standards. It is simply not
possible to do this through the expansion of current
practices, given the
greater demand for
resources, the
increased carbon
emissions and other
environmental
impacts.
To meet these
challenges, there
will have to be a complete transformation in how we
obtain and use energy, how we feed ourselves, how we
travel, how we make and use goods and how we work
and collaborate. Transformation to a sustainable
global economic system will mean disruption.
Sustainability, if it is to be effective and done at scale,
will have to disrupt business-as-usual. This is
disruptive sustainability.
Moreover, disruptive sustainability represents a real
dilemma for corporations. The larger and more
profitable the business is, the greater the dilemma.
When sustainability was about doing good or doing
well, it made sense. Chief executives could
understand why they were doing it – it held the
promise of making their companies look good and it
could save them money. It was a management
“no-brainer”.
But now that sustainability is becoming more about
the hard to measure and harder to manage aspects of
addressing disruption, large and profitable corporations
face a real challenge that they are ill-equipped to
address. Michael Biddle perhaps said it best: “The
traditional virgin (plastics) industry does NOT want to
see recycling happening in a big way because it is
competitive with their existing businesses,”. He is the
founder of MBA Polymers, a company that uses
rubbish as the source for making 150 thousand metric
tonnes a year of high-grade plastics that satisfy the
most exacting customer requirements. MBA Polymers
is disrupting the plastics industry. “This kind of
thinking is a major roadblock to large companies who
have a fear of cannibalism.” Large, established and
successful companies don’t want their more profitable
businesses being disrupted by lower-margin operations
– even their own. Many try to fight the disruption by
sticking with old business models that today are highly
profitable, but in the coming years will become
outdated, burdensome and eventually a threat to their
existence.
The choice between recognising and embracing
disruptive sustainability or sticking with good
management practices that have worked so far – that
is the sustainability dilemma. Disruptive
sustainability is about fostering a different kind of
thinking: a systems perspective of business
characterised by the emerging principles of the
information economy: self organisation,
interdependence and diversity, which are also
characteristics of our living planet of which the
economy is a subsystem.
Disruptive sustainability shows how the most
urgent economic, environmental and social challenges
of the 21st century present disruptive opportunities
for business. According to the new book, Creating
Climate Wealth by Jigar Shah, there is a $10 trillion
opportunity in building a sustainable global economy.
Profitability is not a
bad word.
Disruptive
sustainability will
show how high
profits, a respect for
people and a
sustainable planet
are not trade-offs,
but the essential and interdependent outcomes of a
well-managed, sustainable system.
Disruptive sustainability comes down to a very
simple choice: Disrupt or be disrupted. It is difficult
for organisations – especially large ones – to leave
behind practices that have brought success in order to
pursue a disruptive form of sustainability, a pursuit
that will require a change in management thinking.
Yet for any business to grow and prosper in the 21st
century, nothing less will be sufficient.
The larger and more profitable
the business is, the greater
the dilemma
Disruptive
sustainability is:
1
When a house can be
heated and cooled to the
same level of comfort as a
conventional residential
building of comparable size
while using only 5% of the
energy.
2
When a high-performance
zero-emissions car can be
driven from New York to
Boston, with a half-hour
pitstop for refueling – and the
fuel is free.
3
When the relationship
between a utility and its
customers is fundamentally
redefined by changing roles –
customer as generator and
seller of clean energy and
utility as buyer and distributor.
4
When a small home
cleaning supplies startup
can capture ever growing
market share from industry
giants because its products
don’t leave a thin film of toxins
on kitchen and bathroom
surfaces and actually clean
them better.
5
When new financing
models take the capital
and operating expenses out of
the cost of clean energy and
provide electricity at
competitive rates that are fixed
for decades.
6
When a 100% recyclable
industrial carpet, designed
using a rainforest floor as
inspiration, becomes the bestselling product in the
company’s history and
redefines an industry.
7
When a major property
developer announces the
construction of the largest netzero energy commercial
building in the US, and finds it
fully leased two years before it
even opens.
8
When a five-year-old
hospitality company that
helps property owners
increase their asset utilisation
through sharing and renting
among peers, and brings in
hundreds of millions of dollars
in annual revenues without
building, owning, leasing or
managing a single property.
Andrew McKeon is Director
of Operations for the Markit
Registry and founder of the
BusinessClimate Network
Winter 2013
41
MARKET
COMMENTARY
COMMENTARY
AND DATA
Economics
A
The pace of global
economic growth is
gradually reviving from
the slowdown seen earlier
in 2013, albeit taking
a bumpy route
lthough risks certainly
abound, there is plenty
of scope for growth to
surprise on the upside in 2014.
The third quarter of 2013 saw
the fastest rate of global economic
growth since early 2012, according
to Markit’s global Purchasing
Managers’ Index (PMI) surveys,
and a similar pace has been
maintained into the fourth quarter.
This is clearly encouraging: the
PMI surveys are based on factual
information, not sentiment,
provided by some 20,000
companies around the world,
making them particularly accurate
indicators of economic growth.
The picture is not sufficiently
encouraging, however, for the
Organistaion for Economic
Co-operation and Development,
which revised down its prediction
for global economic growth
in 2014 to 2.7%, almost half a
percentage point lower than it was
predicting back in the summer.
There appear to be several
key factors behind the drop in
optimism for 2014, but all sources
of doubt can also turn around and
become stronger growth drivers.
First, there have been widespread
concerns about the US economy,
which is undergoing fiscal
tightening and heightened
uncertainty arising from political
wrangling over the deficit and debt
ceiling. However, the economy is
looking surprisingly resilient in the
face of these headwinds. Markit’s
Global economic growth
PMI
GDP annual % change
65
7%
60
5%
55
3%
50
1%
45
-1%
40
-3%
Global PMI Output Index
Global GDP
35
-5%
2000
2002
2004
2006
2008
2010
2012
Year
Source: Markit/JPMorgan
42
Winter 2013
PMI surveys showed that business
activity in both manufacturing
and services bounced back in the
US during November, having been
temporarily disrupted by October’s
government shutdown. The US
surveys, which now include
Markit’s new services PMI, also
showed private sector job creation
continuing to run at a rate of
around 150-200,000 per month;
high enough to encourage the Fed
to start ‘tapering’ its stimulus.
It is also likely that the financial
markets, as well as businesses,
have already priced in a Fed taper,
and that – communicated in
the correct way – a very gradual
unwinding of policy can avoid
financial market calamities.
The second often-cited cause of
worry for the year ahead is that
the eurozone’s recovery appears to
be wavering. Official GDP data
showed the region pulling out
of recession earlier in the year,
but have since weakened again,
raising the possibility of a slide
back into recession. The region’s
PMI has also disappointed, falling
for a second successive month
in November. The renewed
downturn in the data has been
sufficiently worrying to force
another interest rate cut out of the
European Central Bank.
This may be too pessimistic
a view of the single currency
area’s recent growth trajectory.
The upturn in the official data
earlier in the year always looked
too good to be true (especially
an eyebrow raising growth surge
in France), contrasting with
still weak survey data. That the
official data have since fallen back
is therefore no surprise. What is
instead encouraging is that the
PMI surveys signalled a consistent
return to growth in the five months
to November. Although the PMI
has indeed fallen for two months
so far in the fourth quarter, the
decline has been only very modest
and the picture remains one of
stark contrast to the steep rate of
decline seen in the single currency
area earlier in the year.
Markit’s Business Outlook
Survey reinforces this message of a
MARKET
COMMENTARY
European-wide recovery in 2014.
Optimism about the year ahead in
the eurozone hit its highest since
mid-2011 in October, notably
improving in the ‘periphery’.
Confidence rose in all of the four
largest eurozone nations.
The improvement in the
eurozone economy, and the
reduced uncertainty arising from
the calming of the region’s debt
crisis, has benefitted neighbours
such as the UK, which has seen
the monthly PMI surveys running
at the highest levels since the late1990s. Business activity is surging
in services, manufacturing and
construction, and households
are feeling better off due to
rising house prices, a reduced
squeeze on real wages and falling
unemployment.
In Japan, like in the UK, the
PMI surveys have also been
Emerging market PMI surveys
PMI Output Index (manufacturing & services)
65
60
55
50
Photograph: Shutterstock
45
hitting record highs. However,
companies’ views on their
prospects for the year ahead
remain subdued, and even
slipped compared to mid-year.
Companies were in many cases
harbouring concerns about
growth prospects in other Asian
countries, especially China.
This slower growth phase
in the emerging world is the
third area of concern for the
global outlook. The PMI
surveys deteriorated to signal
stagnation across the board
among the BRICs earlier in the
year. Markit’s global Business
Outlook Survey has since found
companies’ optimism sliding to
new post-crisis lows in India and
Russia in October, while China’s
outlook failed to
improve on the
low seen at mid-year. Only Brazil
saw business sentiment improve,
reaching a new post-crisis high,
buoyed by optimism about the
positive impact of the Olympics
and Fifa World Cup.
However, the monthly PMI
surveys have improved again
in the BRIC economies since
the lows seen at mid-year and,
perhaps more importantly,
growth is also picking up in
other key emerging markets.
Manufacturing PMI surveys
for Taiwan, South Korea,
Indonesia, Vietnam and Mexico,
for instance, were all in growth
territory during October and
November. The government in
China is pushing ahead with
reform and many emerging
economies are reviving. This
provides added potential for
the developing world to gather
further momentum into
2014, assuming the economic
environment in the rich world
remains favourable.
Many of the concerns about
the global economy may be being
overplayed, and could even turn
around into positives in 2014.
In particular, rising business
investment in the US, Europe
and Japan could drive a marked
upturn in the global economy in
2014 and beyond.
Much, of course, depends
on the political environment,
as this will to a large extent
determine whether companies
are comfortable boosting their
investment. The US needs
to avoid further uncertainty
relating to its fiscal issues,
eurozone leaders need to keep
the region’s recovery on course
with banking sector reform
and integration, and Japan’s
government – like other Asian
powerhouses such as China and
India – needs to push through
economic reform. Plenty of
scope, therefore, for recoveries
to be derailed, but there is also
plenty of upside risk to recent
gloomier economic forecasts.
40
China
India
Brazil
Russia
35
30
2009
2010
2011
2012
Year
2013
Source: Markit/HSBC
Chris Williamson
chief economist
chris.williamson@markit.com
@WilliamsonChris
Winter 2013
43
Photography: Shutterstock
MARKET
COMMENTARY
COMMENTARY
AND DATA
CDS
Talk of asset price bubbles
was all the rage in the first
half of 2013, and as we
head into the year-end it
seems the chattering is
getting louder
44
Winter 2013
H
owever, it has not been
a steady progression up
the volume scale, which
is a reflection of the discordant
performance of global credit
markets.
In the middle of the year,
spreads spiked wider when the
US Federal Reserve signalled
that it was preparing to taper its
quantitative easing programme.
Volatility in the Chinese
interbank market – sparked by the
People’s Bank of China’s refusal
to provide liquidity – didn’t help
matters.
Many investors now feared that
the bursting of the bubble was
upon us, and risk aversion was the
order of the day. High-beta credits
and emerging market names
bore the brunt of the sell-off, as is
usually the case. But the anxiety
proved shortlived, and spreads
soon resumed their march tighter.
By November, both the Markit
iTraxx Europe and Markit CDX.
NA.IG indices had not only
recovered from the summer
malaise, they were trading at or
close to their tightest levels for
the year. The Fed’s QE taper
didn’t materialise as expected
in September, giving the credit
markets all the incentive they
needed to embark on another rally.
Hence it was little surprise to
hear the word “bubble” make
a comeback. Janet Yellen, the
proposed new chair of the Fed,
looks set to continue in the same
vein as the incumbent, Ben
Bernanke, which is good news
for risk assets, at least in the short
term.
However, when she was
questioned by senators on the
issue of asset valuations, Yellen
took a stance that raised eyebrows
in the markets. She said that there
is “limited evidence of reach for
yield” and the Fed doesn’t see a
“broad build-up in leverage”.
The reasoning behind the latter
statement is understandable
– corporate and household
balance sheets are in better shape
compared with previous periods.
But her assertion that investors
are not grasping for yield is clearly
debatable.
The performance of the
CDS market this year seems
to illustrate that investors are
going further down the ratings
scale, presumably because of
the compression in spreads at
investment grade level. CCC
spreads across the globe have
rallied by about 40% since the
beginning of the year, while single
A spreads tightened by just 14%,
according to data from Markit
Sector Curves. A typical CCC
credit now has a five-year spread
of about 750bps, the tightest level
since May 2011.
The cash market paints a similar
picture. Issuance in CCC bonds
has soared and yields have fallen,
leading many to posit that a
speculative bubble has formed.
Yellen’s view to the contrary may
well be right, but there is little
doubt that evidence can be found
that suggests otherwise.
It seems unlikely that issuers
with poor credit quality would
find it so easy to sell debt without
the excess liquidity created by
MARKET
COMMENTARY
CCC spreads outperform in 2013
1300
1200
'CCC' markit sector
Bps
1100
1000
900
800
700
600
Dec
2012
Jan
2013
Feb
2013
Mar
2013
Apr
2013
May
2013
Jun
2013
Jul
2013
Aug
2013
Sep
2013
Month/year
considerable buffer, and its
issuance next year is only €6bn€10bn.
Aside from its cash cushion, the
Irish government no doubt had
other reasons not to take up the
option of a backstop. A PCCL
comes with considerable fiscal
surveillance, and Kenny may
have thought that the Irish people
have endured enough austerity –
particularly with a general election
little more than two years away.
Ireland’s CDS spreads are
now at 127bps, more than
600bps tighter than they were
trading two years ago. Most
of this improvement is due to
a combination of the ECB’s
Outright Monetary Transactions
programme and the EU short
selling ban on European
sovereigns, but Ireland has
outperformed other names in the
periphery. Greece aside, Portugal
is in the worst position and will
probably find it more difficult
than Ireland to exit its bailout
without a PCCL (or possibly
the more onerous Enhanced
Conditions Credit Line). It will
then be in a position to tap the
OMT, which won’t be an option
for Ireland as it won’t be under
EU supervision.
Markets in developed countries
are being propped up by central
banks, but valuations in emerging
markets are also under scrutiny.
As we saw in the summer,
when central banks threaten to
withdraw liquidity, emerging
market debt can be badly
affected. The Fed clearly has a
large part to play, but China is
also an important player.
The outcome of China’s third
Source: Markit
Ireland leads the periphery
900
Ireland
Spain
Italy
800
700
600
500
Bps
the Fed and other central banks.
If investors feel they are being
adequately compensated for risk,
then the valuations are justified.
But the Fed has already warned
banks to limit origination of
loans to lenders with weak
credit standing, and interest rate
exposure is considerable for many
issuers.
Yellen acknowledged there were
risks to the current policy of QE,
and said “this programme cannot
continue forever”. In response to
a question from a senator, Yellen
said she would have the courage
to pop a bubble. High yield
investors will be hoping that time
is some way off.
Regardless of valuations in
the capital markets, it would be
hard to describe the eurozone as a
bubble economy. Growth remains
anaemic, and Markit PMI
surveys indicate that the picture is
unlikely to improve anytime soon.
Nonetheless, the markets are
rallying, and it isn’t all doom
and gloom in the currency
bloc. Ireland took a big step
towards fiscal normality after it
announced that it would make a
clean exit from its EU bailout.
Prime Minister Enda Kenny
said the country would leave the
three-year rescue programme in
December and would not request
a Precautionary Conditioned
Credit Line from the European
Stability Mechanism.
It was a momentous event for
Ireland, but the sovereign’s CDS
and bond spreads barely moved.
On the face of it, this is somewhat
surprising given the country
is about to brave the capital
markets unaided. But Ireland has
about €25bn in cash, giving it a
Oct
2013
400
300
200
100
0
Nov
2011
Jan
2012
Mar
2012
May
2012
Jul
2012
Sep
2012
Nov
2012
Jan
2013
Mar
2013
May
2013
Jul
2013
Month/year
Sep
2013
Source: Markit
China’s sovereign CDS rallies
200
180
160
140
120
100
80
60
40
20
China
Markit iTraxx Asia ex-Japan IG
0
Jan
2013
Feb
2013
Mar
2013
Apr
2013
May
2013
Jun
2013
Jul
2013
Aug
2013
Sep
2013
Month/year
plenum was greeted positively –
liberalisation of capital markets
and state-owned enterprises should
be welcomed. The sovereign’s CDS
spreads hit 65bps,
their tightest level
since March.
Oct
2013
Nov
2013
Source: Markit
However, China has its own
bubble problems, and how it
deals with the intertwined issues
of overinvestment and bank bad
debts will have a crucial bearing
on spread direction in 2014 and
beyond.
Gavan Nolan
director, credit research
gavan.nolan@markit.com
@GavanNolan
Winter 2013
45
MARKET
COMMENTARY
Markit iBoxx indices
Diverging monetary
policies in the US and
Europe have shaped
different fixed income
market return profiles
across the Atlantic
W
hile in the US the
focus is on the pace of
reducing purchases of
government and mortgage related
debt, in Europe the central bank
is engaging in easing monetary
conditions following worse than
expected inflation numbers.
As a result, while the Markit
iBoxx $ Overall Index returned
just 0.15% since August, the
Markit iBoxx € Overall Index
rose 1.13% for the same period.
In the UK, improving economic
conditions have brought down
spreads on corporates, driving
the iBoxx £ Corporates Index to
return 1.78% since August. The
accelerating recovery in the UK
has spurred bets that the Bank of
England will start raising rates
earlier rather than later.
The recent debt ceiling crisis
in the US, which was partly
resolved by extending government
funding until mid-January, will
likely contribute to limiting
the Fed’s decision agility. First,
the economic data release will
be delayed until Thanksgiving,
making it difficult for the Fed to
measure the economy’s robustness.
Second, the government
shutdown might have a negative
impact on Q4 GDP. Lastly, capital
markets have the capacity to
become volatile if the next round
of fiscal plan renegotiations in
December turns out to be another
battle. All these uncertainties
leave the Fed with few choices
but to continue its bond purchase
programme.
The news of Janet Yellen’s
nomination as Fed chairwoman
enforces this expectation, given
her policy convictions relating to
supporting economic growth with
monetary tools.
Market expectations on the
continuation of monetary
easing led to the iBoxx $
Treasuries Index delivering a flat
performance of 0.1% over the past
three months.
The outlook for credit markets
remains good, following strong
earnings announcements over
Q3. Improving credit conditions
brought down spreads, with
the iBoxx $ Liquid High Yield
Index spread down 40bps since
September. In addition, the
rally in equity markets helped
convertible bonds to deliver
strong returns this year. The
Total return performance - government developed
Index
Photograph: Shutterstock
MTD
Government
US Treasuries
UK Gilt
Europe
Sovereigns
Inflation
US
UK
Germany
France
-0.79%
-1.25%
-0.17%
Total return performance
QTD
YTD
1Y
-0.10%
-0.14%
1.09%
-2.62%
-3.29%
2.32%
-3.11%
-3.62%
4.19%
3Y
6.25%
14.68%
14.04%
Markit iBoxx CVBX index, which
consists of 100 USD-denominated
convertible bonds, has returned
close to 20% in the year to date.
In Europe, the periphery
significantly outperformed the
core over the last three months and
in the year to date. Bond returns
of BBB-rated countries have
skyrocketed this year, with iBoxx
€ Spain returning 10.8%, iBoxx €
Ireland 10.2% and iBoxx € Italy
6.2%, while the AAAs – Germany,
Netherlands and Austria – were
mostly negative to flat. The main
reason for that is the reduced risk
of a euro break-up, supported by
Draghi’s “all that it takes” policy to
preserve the monetary union.
Improved economic data in
some countries also supported the
higher returns. Spain officially
exited recession in the third
quarter of this year, with GDP
growing at 0.1%. The country has
benefited from strong exports, a
development that could sustain
further momentum on the back of
declining labour costs.
In Italy, on the other hand,
a weak coalition government
continues to cause concern and the
Total return performance - corporates developed
Index
Total return performance
QTD
YTD
1Y
MTD
3Y
USD
Corporates
Financial
Non-Financial
-1.05%
-0.64%
-1.30%
0.54%
1.21%
0.14%
-2.02%
0.70%
-3.65%
-1.92%
1.32%
-3.86%
13.40%
16.19%
12.02%
GBP
Corporates
Financial
Non-Financial
-0.77%
-0.39%
-1.04%
1.78%
2.50%
1.26%
3.02%
5.23%
1.45%
3.49%
7.04%
0.99%
21.90%
26.27%
20.32%
EUR
Corporates
Financial
Non-Financial
-0.08%
0.01%
-0.15%
1.20%
1.46%
0.99%
2.40%
2.98%
1.94%
3.55%
4.64%
2.68%
15.93%
16.91%
15.43%
Total return performance - high yield
Index
CAD
EUR
GBP
USD
Total return performance
QTD
YTD
1.56%
3.90%
3.25%
7.27%
3.16%
8.11%
2.86%
4.77%
MTD
0.16%
0.37%
-0.06%
-0.40%
1Y
4.00%
10.55%
11.94%
7.11%
Total return performance - emerging markets
Index
MTD
Total return performance
QTD
YTD
1Y
3Y
USD
EM Sovereigns
EM Corporates
-1.92%
-1.18%
0.59%
1.38%
-6.71%
-2.18%
-5.42%
-0.87%
12.82%
15.49%
Local currency in USD
Global
Asia
EMEA
Latin America
-2.28%
-1.60%
-2.49%
-2.87%
-1.12%
-1.00%
-0.29%
-2.63%
-5.74%
-5.24%
-5.27%
-7.21%
-2.40%
-4.08%
0.17%
-4.38%
4.07%
2.49%
1.52%
10.48%
Total return performance
QTD
YTD
1Y
1.14%
4.36%
5.30%
3.05%
19.65%
23.73%
3Y
16.80%
38.28%
Total return performance - others
-1.29%
-1.71%
-0.73%
-0.99%
-1.73%
0.08%
-0.80%
-0.90%
-9.05%
-0.47%
-3.64%
-3.84%
-9.53%
2.49%
-3.27%
-2.48%
1.43%
14.42%
3.65%
5.22%
Index
Leveraged Loans
Convertibles
MTD
0.25%
-0.26%
Source: Markit (All data correct as of November 8th 2013)
Winter 2013
47
MARKET
COMMENTARY
COMMENTARY
AND DATA
Performance of USD fixed income market
Corporate spreads and PMI in the UK
65
Markit iBoxx $ Treasuries Index
Markit iBoxx $ Liquid High Yield Index
Markit iBoxx USD Emerging Markets Sovereigns Index
Markit iBoxx $ Corporates Index
Markit iBoxx USD Leveraged Loans Index
Markit iBoxx CVBX Vintage Index
25%
20%
15%
600
60
500
55
PMI
5%
400
50
300
45
0%
200
40
-5%
100
35
-10%
UK Composite PMI
-15%
Feb
2013
Mar
2013
Apr
2013
May
2013
Jun
2013
Jul
2013
Month/year
economy remains in contraction.
Unsurprisingly, the yield on the
iBoxx € Spain Index stood lower
than that of the iBoxx € Italy
Index, 3.67% vs. 3.81% as of
November 8th 2013.
The iBoxx € Corporates Index
registered a return of 1.20%
since August, mostly driven by
income and credit return (65bps
and 54bps, respectively), with
duration return contributing only
8bps. Duration return was low, as
the eurozone spot curve twisted
since August, with the 1-6 year
maturities shifting down and the
long end shifting up. Thus, any
positive return from the short end
was matched by negative return
on the long end of the curve.
The main reason for the drop
in the front end of the curve was
central bank action. Following
the reported fall in the annual
inflation rate of 0.7% in October,
much lower than the 2% target,
The leveraged loan
market witnessed a return
to form in 2013, with
post-crisis record new
CLO structuring volume,
the return of covenantlite deals, increased LBO
activity and a swath of
dividend recapitalisation
syndications
Winter 2013
Aug
2013
Sep
2013
Oct
2013
Nov
2013
Source: Markit
the European Central Bank cut
the main refinancing rate to 0.25%
from 0.50% and extended the
unlimited liquidity until July 2015.
However, the ECB has yet to
face a crucial test. The strong euro
(up 11% against the US dollar
since summer 2012) adds further
disinflationary pressure to the
European economy. In addition, the
eurozone GDP barely grew at 0.1%
for Q3 and the unemployment rate
remains stubbornly high at 12.2%.
If the ECB is to successfully pursue
its inflation target, it has to be more
proactive in easing monetary policy.
The ECB has a few options at
its disposal, including cutting
the deposit rate into negative
territory, undertaking another
longterm financing operation
and pursuing some form of
quantitative easing. None of these
choices is easy, however, given the
divisions between the Germanled North and Southern country
Loans
48
£ Corporates OAS
0
Oct
2013
30
Jan
2013
T
he influx of new interest
has led to an increase in
market liquidity in the asset
class, as observed by Markit’s
liquidity scores and metrics data.
Will the market exuberance,
led by extended accommodative
monetary policy, lead to another
bubble in leveraged loans?
The leveraged loan market has
begun showing off the feathers of
its old self this year. After a spate of
outsized returns, secondary market
Jan
2007
OAS (bps)
10%
Jan
2008
Jan
2009
Jan
2010
Jan
2011
Jan
2012
Jan
2013
Month/year
representatives on the ECB board.
In the UK, the iBoxx £ Gilts
Index posted negative returns
of -0.14% since August, while
the iBoxx £ Corporates Index
returned 1.78%, on the back
of income and credit returns,
contributing 80bps and 135bps,
respectively. Corporate spreads
to gilts have come down to
142bps, their lowest level since the
beginning of 2008.
The corporate sector in the UK
has outperformed its European
counterpart, both for the last three
months and in the year to date.
One of the reasons for improved
Source: Markit
credit conditions in the UK is the
better economic data supporting
a stronger economic recovery in
the UK.
GDP growth for Q3 stands at
0.8%, higher than the 0.7% over
Q2. The Markit UK Composite
PMI Index reflects the improved
business conditions, with its
reading for October reaching 61.6,
the highest over the past five years.
Bank of England guidance also
supported the case for accelerating
recovery, as it brought forward by
18 months its forecast of when the
unemployment rate will reach the
7% threshold.
Ivelin Angelov
associate, indices
ivelin.angelov@markit.com
Jun Qian
assistant vp, indices
jun.qian@markit.com
gains have normalised around 5%
and volatility has fallen to its
lowest level since before the
financial crisis, as measured by the
Markit iBoxx USD Leveraged
Loan Index (MiLLI). Despite the
fact that overall returns are muted,
given over half of the constituents
of the MiLLI are already bid above
par and effectively capped in terms
of price return potential, inflows
continue to pour into the loan
market, both in the form of
traditional fund inflows and via
the rebirth of new CLO 2.0
vehicles.
The increase in demand for loan
paper has been driven primarily by
the extremely accommodative
monetary policy of the Federal
Reserve and other central banks
around the world, prompting both
a chase for yield as investors rotate
into risker assets and consequently
cheap financing availability
afforded to borrowers. This year
has seen post-crisis record LBO
debt issuance including a $9.5bn
loan deal to finance the takeover
of HJ Heinz by Berkshire
Hathaway and 3G Capital, and
the much-proffered $9.3bn first
lien debt financing for Silver Lake
Partners’ buyout of Dell.
Hilton Worldwide was also able
to secure a massive $7.6bn singletranche term loan to refinance its
existing loan debt. All of these
MARKET
COMMENTARY
Leveraged loan total return and volatility, by year
60%
Loan liquidity trend by liquidity score over time
55.2%
100%
40%
80%
30%
20%
10%
0%
11.1%
1.5%
1.2%
9.7%
0.9%
10.1%
17.9%
2.8%
1.8%
2.5%
4.4%
1.0%
-10%
-20%
Markit iBoxx USD Leveraged Loan Index total return
Daily volatility ( )
-30%
2007
2008
Score
Score
Score
Score
Score
5
4
3
2
1
60%
40%
20%
-30.8%
-40%
% of loan market
Percentage return/volatility
50%
0%
2009
2010
2011
Year
deals priced cheaply at between
L+225 and L+350 and are all
covenant-lite structures (not seen
to such a large extent since 2007),
which, according to a senior
research director at a large asset
manager, buyside funds have no
choice but to accept, given the
few alternatives in the market.
How have these trends affected
liquidity in the loan market?
Loan liquidity is defined as a
measure of a loan’s ability to be
traded close to the market price
within a certain time period.
Markit Loan Liquidity Service
applies a multi-dimensional
analysis to gauge the liquidity of a
loan instrument. A variety of
factors to investigate liquidity are
used to determine a composite
liquidity score of 1 to 5, with 1
denoting high liquidity and 5
denoting low liquidity.
Liquidity has been on a
gradual rise since the Lehman
Brothers collapse in 2008 and is
now at its highest point since
measurement began. The trend
2012
2013
2009
2010
2011
can be observed by examining
the percentage of loans in each
level of liquidity score. The
percentage of loans in the four
most liquid categories has
increased to 73% compared with
a crisis level of 31%. This surge in
liquidity is comparable to a
similar surge in liquidity in 2010,
when loan issuance started
accelerating post-crisis.
The upward trajectory can be
attributed in particular to the
record CLO issuance in 2013.
CLO issuance in the US has been
at $68.5bn YTD with an
additional $14bn in the forward
pipeline, according to S&P
Capital IQ.
CLOs are the single largest
participant group in the
leveraged loan market,
accounting for roughly over 50%
share, making the return of the
CLO investor class extremely
important for the overall
liquidity of the market.
As the increased liquidity
continues to attract investors to
2012
Year
Source: Markit
the loan market, there is a general
concern looming as depicted by
the recent slowdown in CLO
issuance. The slowdown is
attributed to the proposed risk
retention requirements by
regulators requiring a CLO
manager to hold a 5% equity
stake in the CLO. The rule has
already been implemented in
Europe and has resulted in a
measurable slowdown in CLO
issuance. The introduction of risk
retention laws in the US may have
a detrimental effect on the
liquidity of loans in 2014.
With greater liquidity,
increasing use of structured
vehicles to fund investment,
2013
Source: Markit
weakening covenants, near alltime low default rates and cheap
refinancing availability, is the
loan market setting itself up for
another failure? Has the loan
market forgotten the lessons of
the financial crisis that led to
record loan defaults and a loss of
over 30% of market value in
2008? It is perhaps the inevitable
consequence of continued and
prolonged quantitative easing
and the low interest rate
environment that has allowed a
flourishing of risk tolerance and
lenient capital markets. Whether
the loan market can sustain and
bear the “new normal” remains
to be seen.
Colin Brunton, CFA
vice president, loan pricing
and analytics
colin.brunton@markit.com
Hamed Ijaz
associate, loan pricing
and analytics
hamed.ijaz@markit.com
Securities finance
Capital adequacy
regulation, central
clearing and a desire for
yield are factors offering
great opportunities for
securities finance
C
apital adequacy regulation,
central clearing and a
desire for yield are factors
offering great opportunities for
securities finance. Standing in the
way are the central banks whose
cheap and unlimited liquidity has
drained the life out of the repo
and financing markets. But, they
cannot do this forever. So, where
are the opportunities and where is
the money currently being made?
Contribution in a bull market
Securities financing income,
relative to the supply of assets
available for lending, generally
falls in equity bull markets such as
the one now. The period directly
before the credit crisis, with very
high equity markets and high loan
volumes, were not normal times.
We will never again see such
high leverage, such a proliferation
of hedge funds, multiple bank
proprietary trading desks and such
an unfettered appetite for risk.
Winter 2013
49
MARKET
COMMENTARY
COMMENTARY
AND DATA
All securities
Global equities
20
30
10
16
20
12
10
15
8
10
6
5
0
Sep
2011
Revenue share from RI (%)
Dec
2011
Mar
2012
Jun
2012
Sep
Dec
2012
2012
Month/year
Total return to lendable
Mar
2013
Jun
2013
Sep
2013
30
8
25
7
6
20
5
15
4
3
4
2
2
1
0
0
Sep
2011
10
5
Utilisation
Dec
2011
Mar
2012
Jun
2012
Source: Markit
Innovation
In the meantime, the custodians
are sharpening their pencils.
The adept combination of
securities lending, reverse repo
and the use of tri-party collateral
managers will allow for (in some
cases) indemnified collateral
transformation trades where every
counterpart wins.
Rising cash reinvestment income
Rather, it is generally a
countercyclical form of riskadjusted revenue that rises when
hedge funds are increasing their
short book in times of volatility or
when markets are falling.
It also offers good risk-adjusted
returns when the yield curve is
flexing, interest rates are high
and banks need to aggressively
manage their balance sheet.
Photograph: Shutterstock
Reach for yield
50
High asset values don’t mask the
need for yearly income. Pension
funds and insurance companies
need a yield from their assets to
pay their policyholders. With
near zero interest rates and central
bank policy leading to subdued
repo activity, it has seldom been
harder to earn money from your
money.
So, the great opportunity is for
the securities financing market to
Winter 2013
find innovative ways to help the
institutions to earn incremental
extra yield for assets that are
otherwise sitting idly in custody.
Back to basics
Prior to the rise of the hedge
funds, securities finance was an
activity that supported market
liquidity, smooth settlement and
allowed banks to move assets off
and on to their balance sheets
for financing purposes. Sound
familiar? The capital rule for
banks under Basel III necessitates
more of this.
Standing in the way are the
central banks. Their low-cost
financing operations, such as
LTRO, pre-empt the need for
banks to try to finance each
other. But, this can only go on
for so long. And, when the ECB
and the Fed exit stage left, the
securities finance market will step
Total return to lendable
Sep
Dec
2012
2012
Month/year
in and opportunities for yield will
abound.
‘Collateral transformation’ will
also only grow when the central
clearing of credit derivatives is
expanded to include pension
funds and more instruments.
A slight fall in the intrinsic
value of lending is being
made up for with a strongly
rising contribution from the
cash-reinvestment income.
This potentially reveals that
custodians are lending cash to
tri-party agents in return for
equities or corporate bonds. They
are being paid a premium for this
reverse repo activity that forms
one leg of this early collateral
transformation activity.
Falling demand to borrow
This rise in the cash return is
masking a clear trend of lower
borrowing demand. The new
paradigm is one of fewer equities
on loan, but with
bond lending
gradually
making up
Return to lendable (Bp)
14
35
9
Utilisation (%)
25
Return to lendable (bps)
Reinvestment revenue Split (%)
18
Mar
2013
Jun
2013
Sep
2013
0
Source: Markit
for this, due to higher fees and
balances.
Tools for the future
For our part, what we can do is
illuminate the collateral world with
complementary data from adjacent
areas for when this world erupts.
Transparency into the dollar
tri-party repo market was
recently made available to see
which instruments are gaining in
popularity as well as haircut and
rate data. Of interest is a rise in
the use of non-US government
debt in tri-party pools and the
constrained reaction to the debt
ceiling debate.
Understanding corporate
bond liquidity
At the centre of the financing
world is the corporate bond asset
class. Investment banks typically
hold lots of these, yet they need to
be swapped for government bonds
that can be pledged into CCPs or
better support their core liquidity
ratios.
We can now offer corporate
bond Z spreads and liquidity
measurements to help clients
better understand the risks of
taking these as collateral.
Summary
There remain plenty of roadblocks
to greater securities financing
volumes, but all the ingredients
are there for when the central
banks feel the economy is strong
enough to stand on its own two
feet.
Simon Colvin
vice president, securities finance
simon.colvin@markit.com
MARKET
COMMENTARY
Structured finance
The UK property market
continued to dominate
the European ABS
market, while year-end
trading volume slowed
in the US
Photograph: Shutterstock
European ABS market
Once again the main news in
the European ABS world in
November was the UK housing
market, which shows no sign
of slowing down. The Halifax
index showed a 6.2% increase
year-on-year (+0.3%), while the
Nationwide index lagged slightly
behind at 5.0% (+0.9%), but the
difference is decreasing.
Meanwhile Markit/CIPS
UK Construction PMI data
indicated another strong
improvement in the overall
performance of the UK
construction sector, registering
64.8 in September (up from
61.1 in August). Increased
volumes of construction
output in September ref lected
growth in all three broad areas
of activity monitored by the
survey (residential, commercial
and civil engineering
construction).
In Europe, we are also seeing
some improvement in the
housing market, mainly in
France, Belgium and Sweden.
The housing market has
deteriorated the most in the
Netherlands, despite the spread
of the triple-A RMBS from this
country remaining one of the
tightest in Europe.
The European ABS market
remained very stable for senior
tranches over the past month.
Most of the activity remained
around BWICs, CLOs and the
primary market. Within the
BWICs, as has been the case
for the past couple of months,
the most bid names were high
beta names. Finally, most of the
dealers remained better buyers.
Granite, as per the rest of
the market, remained almost
unchanged. The A, B, M and C
euro tranches are being traded
at 99.1, 94.7, 93.9 and 90.6,
respectively.
US ABS market
As a result of the Thanksgiving
holiday, and going into the
year-end, trading volumes within
structured products have slowed.
In general, across asset types,
there has been some slight spread
compression compared with the
third quarter.
While spread movement in
the US CLOs was generally
flat to slightly tighter, over the
last few months there has been
substantial compression in the
European CLO space.
More investors are starting
to take advantage of perceived
relative value trades, which is
likely attributable to the recent
issuance. Specifically, the
mezzanine part of the capital
structure has come in over
100bps in some areas. The US
still dominates in the area of
new CLO issuance. Deals are
continually coming out to the
Sector
ALL Auto Lease AAA Float (1-4)
ALL Auto Loan AAA Float (1-4)
ALL CMBS AAA Float (3-5)
ALL Credit Card AAA Float (1-4)
Australia RMBS AAA Float (3-5)
Italy RMBS AAA Float (1-3)
Netherlands RMBS AAA Float (1-3)
Spain RMBS AA Float (5-8)
United Kingdom Granite AAA Float (1-3)
United Kingdom PRMBS ex. Granite AAA Float (1-3)
United Kingdom SPRMBS AAA Float (1-3)
Spread Mid
(bps) Oct2013
85
39
110
41
110
174
52
265
80
41
149
Spread Mid (bps)
Nov2013
82
40
106
36
112
165
53
254
75
38
136
AAA CLO spreads
bps
200.0
180.0
160.0
140.0
120.0
100.0
80.0
60.0
Jan
2013
1.0
Feb
2013
Mar
2013
Apr
2013
May
2013
Jun
2013
Jul
2013
Aug
2013
2.0
Sep
2013
Eur
Oct
2013
Nov
2013
Month/year
Source: Markit
market, bringing yearly new
issuance in CLOs to $68.5bn.
The non-agency mortgage
market also saw some sideways
movement as a result of the
slowdown. Offers tended to be
available for considerably longer
than they would have been a few
months back, and there were
even some price reductions to
get things moving.
The market has seen increased
price movement in the STACR
bonds issued by Freddie Mac.
They have sold off significantly
compared with when they hit the
market.
The graph above highlights
some of this movement over the
last few months in the CLO
market, where the spread
compression in European AAAs
is evident.
Recent
volatility in
the non-farm payroll reports,
an unclear timeline for the
unwinding of QE3 and the
uncertainty of the fate of the
GSEs, lead us to believe that there
will be significant volatility in the
agency market going into the first
quarter of 2014.
Going very long duration into
the New Year has more perils
than in the past, as the sell-off
in rates that began in the spring
will likely persist throughout
2014. Investors in lower coupon
pass-throughs continue to
compete to buy bonds and also
ride the wave of benefits of the
Fed’s purchases supporting that
market.
The implications of the
potential of unwinding the QE
programme in the wake of rising
rates (slower prepayments) could
be perilous for the last one to exit
that trade.
Matthew Fiordaliso
director, US structured finance
matthew.fiordaliso@markit.com
Winter 2013
51
MARKET
COMMENTARY
COMMENTARY
AND DATA
52
Winter 2013
10%
5%
0
s
50
P
S&
M
at
St
lth
U
til
iti
e
er
ia
ls
le
s
ap
C
ar
e
ria
ls
In
H
ea
du
En
no
st
er
gy
y
lo
g
ar
y
Te
D
is
c
ch
re
t
Fi
na
nc
io
n
ia
ls
0%
Source: Markit
Concentration of top 5 companies in SPDR Select Sector ETFs
100
90
80
70
60
50
40
30
20
10
from the top five holdings of Bank
of America (BAC), Citigroup (C),
JPMorgan (JPM), Wells Fargo
(WFC) and US Bancorp (USB),
in addition to State Street (STT)
in 2014 gives the fund a 22%
increase, the highest among the
SPDR sector ETFs.
The technology sector exchange
traded fund (XLK) offers
exposure to large tech companies
and has a concentration in
Microsoft exceeding 12%. The
ETF is expected to increase
dividends 16% year on year, led
by forecast increases from Apple ,
Cisco Systems, Microsoft, Oracle,
and Texas Instruments.
XLE covers 43 energy
companies and is composed of
93% large-cap energy companies,
with XOM and CVX accounting
for 19%. Markit forecasts XLE to
50
ia
SP
Y:
SP
XL
D
R
B:
M
S&
at
P
er
iti
til
Top 5 companies (%)
0
ls
es
ry
:U
U
et
cr
is
D
XL
Y:
H
V:
XL
Remaining companies
XL
io
C
lth
ea
du
In
I:
XL
na
ar
e
ls
ria
st
er
En
E:
XL
ap
St
nc
gy
s
le
ls
P:
na
Fi
ch
no
F:
XL
lo
ia
gy
0
Te
ETFs.
We expect strong growth in
S&P 500 dividends over 2014,
led by financials, consumer
discretionary and technology
companies. Similar dividend
growth is anticipated for ETFs
based on these sectors, with
differences explained by the ETF’s
weighting methodology.
Some 422 S&P 500 companies
are expected to pay dividends in
2014, including 14 companies that
initiated or reinstated dividends in
2013. The result is that 84% of the
index is expected to pay dividends,
the highest since 1997.
Payout ratios have trended
higher from 27% in 2011 to a
projected 35% in 2014. However,
this is flat compared with 2013
and still below the historical
average of 50% for the S&P 500.
We project total dividend payouts
will increase 11% in 2014.
We project financials to lead
all sectors with a 17% boost in
aggregate dividends followed by
the consumer discretionary and
the technology sectors, each with
14% increases. Energy dividends
are also expected to grow by
double digits with a 12% increase.
Dividend growth remains strong
and we expect it to be seen in all
sectors.
The hike in dividends
is a testament to stronger
balance sheets and continued
improvements in US
fundamentals. Earnings are up
across all sectors and expected to
rise further in the future.
According to consensus
analyst estimates, 92% of S&P
500 companies are expected to
grow earnings next year with a
projected median of +13%. We
15%
XL
D
ividend growth is expected
across all S&P 500 sectors
and SPDR Select Sector
S&P 500 aggregate payout
Select Sector SPDR ETF
20%
K:
Dividend growth expected
across all S&P 500 sectors
and SPDR Select Sector
exchange-traded funds
expect 90% will grow dividends.
Many companies have a policy
of raising dividends in line with
earnings growth.
Exposure to S&P 500 sector
dividend growth is accessible
through ETFs, specifically the
SPDR Select Sector ETFs, which
break down the S&P 500 into
nine index funds. We project
future ETF distributions based
on the underlying stock forecasts.
We have found that these ETF
dividend distributions are
commensurate with aggregate
stock payouts in the sector.
Discrepancies between the sector
ETF and the aggregate S&P
500 sector dividend increases
are primarily due to the ETF’s
weighting methodology.
XLF (Financials), XLK
(Technology) and XLE (Energy)
lead SPDR sector ETFs with
22%, 16% and 14% increases in
expected dividends from last year,
higher than the corresponding
sector dividend increase in 2014.
The increases expected at the
aggregate (un-weighted) level for
S&P 500 financials, technology
and energy sectors are 17%, 14%
and 12%, respectively.
Index ETFs like the SPDR S&P
Select Sector ETFs seek to replicate
index performance through
market capitalisation-based
weightings. The ETFs allocate a
greater weight to the larger-cap
companies. For example, XLF’s
exposure to the top five banks
exceeds 41% and XLK’s exposure
to the top five tech companies
exceeds 42% on a per share
weighted basis. By focusing on the
largest companies, these SPDR
Sector ETFs tend to have higher
concentration risk. Any dividend
changes to big names would
have a significant impact to the
corresponding ETF’s dividends.
XLF is composed of 81 S&P 500
financial companies, offering
exposure to large financial
institutions. However, with the
top five holdings exceeding 41%,
XLF has very high concentration
risk. Expected dividend increases
25%
XL
Dividends
2014 forecast dividend increase vs 2013
Source: Markit
increase dividends 14% in 2014,
driven by increases from Exxon
Mobil (8%), Chevron (10%) and
Schlumberger (9%).
The S&P 500 Index SPDR
ETF (SPY), the most widely
traded and liquid ETF,
distributes dividends comparable
to the aggregate index payout.
Markit projects a 15% dividend
increase for the fund compared
with 11% for the underlying
companies at the aggregate,
unweighted level. Again, this
difference is related to the fund’s
weighting methodology with
a concentration in the largest
stocks.
These ETFs are a reasonable
way to track the underlying
index return performance and
gain exposure to sector dividend
trends.
Pan Zhang
assistant vp, dividends
pan.zhang@markit.com
Daniel Victor
associate, dividends
daniel.victor@markit.com
MARKET
COMMENTARY
Photograph: Shutterstock
ETPs
Costs are at the forefront
of investors’ minds when
executing their strategies
W
ithin equity derivatives
there are a number
of delta 1 synthetic
wrappers (such as futures and
swaps) that will provide the
necessary exposure, however
all with different costs and
counterparty exposures.
There has been much debate
about the true cost of using an
ETP for a particular strategy with
issuers using differing metrics to
articulate the positive features of
their product range. The reality
is that inconsistent approaches
require analyst time to accurately
compare and contrast these
products, pushing investors to use
other, easier to measure, synthetic
wrappers.
The costs of an ETP can be
broken down into three sections:
entry, holding and exit. The first
and last are related to trading
costs and are measured by the
difference between executed price
and the net asset value of the ETP.
Depending on the order size, the
difference is typically made up
of brokerage commissions and
MSCI emerging market ETPs 1 year costs
200
180
160
Exit costs (bps)
Holding costs (bps)
Entry cost (bps)
140
120
100
80
60
40
20
0
HMEM
EEM
ETP Name
Ticker
HSBC MSCI Emerging
Markets UCITS ETF
iShares MSCI Emerging
Markets ETF
Lyxor ETF MSCI
Emerging Markets
db x-trackers MSCI
Emerging Markets TRN
Index UCITS ETF 1C
Source MSCI Emerging
Market ETF
SPDR MSCI Emerging
Markets Basket
UCITS ETF
HMEM
LYLEM
DBX1
MXFS
Tracking error
(1Y)
11bps
Min total cost
(1Y)
42bps
SPYM
Max total cost
(1Y)
64bps
EEM
11bps
54bps
76bps
LYLEM
20bps
74bps
114bps
DBX1
3bps
103bps
109bps
MXFS
4bps
131bps
139bps
SPYM
18bps
166bps
202bps
creation/redemption fees charged
by the ETP issuer.
Holding costs are determined
by the difference between the
index performance and that
of the fund, most commonly
known as tracking difference.
These are typically comprised of
management fees and trading/
structuring costs.
A further consideration is
typically how volatile the fund’s
performance is against the
index (rather than the absolute
difference), which gives a
corridor around the historical
holding cost, depending on when
you enter and exit the strategy.
Emerging markets can be
difficult to trade, resulting in
increased costs for ETP issuers
that are ultimately passed on to
the end investor. Using a one-year
investment timeframe, the HSBC
product, despite not having the
largest AUM, has the lowest cost
that, historically, was between
42bps and 64bps.
Keeping with the emerging
market theme, the iShares
MSCI Emerging Markets ETF
received the greatest inflows
over the last three months with
just over $5.5bn entering
the fund. This is
unsurprising
given the 9.63%
price return; however the
strongest performing emerging
market ETP over the last three
months was the PowerShares
S&P Emerging Markets High
Beta product with 14.26%. The
ETP focuses on stocks that are
extremely sensitive to emerging
market movements over the last
12 months, a reflection of the
strong performance within the
region.
Funds focused on corporate
actions, such as IPOs and spin-offs,
were also strong performers, with
an average return of 9.31% over
the last three months. Their AUM
grew to just shy of $2.8bn thanks
in part to this good performance,
but primarily due to $1.2bn of
inflows, which was 84.92% of the
starting AUM.
The strongest performer was
the Guggenheim Spin-Off ETF,
focusing on companies that have
been spun off over the last 30
months, achieving an 11.96% price
return.
Over the next three months we
expect to see strong performance
by UK exposed funds, and
possibly significant inflows
following on from recent positive
PMI results. Other countries
to watch include Germany and
Russia. The first quarter of 2014
should be very interesting.
Anil Gademsetty, CFA
vice president, equities
anil.gademsetty@markit.com
Data as of 31st October 2013. Source: Markit
Winter 2013
53
Orchestral
Former bank chief executive Peter
Nostrand talks to Mark Johnson
about making the switch from banker
to orchestral composer
manoeuvres
in the bank
I
n May 2014, Peter Nostrand will travel from his
home in the US to Prague in the Czech Republic to
spend two and a half days in a studio with a
60-piece Prague Radio Symphony Orchestra
recording some of his latest music scores.
It is a far cry from his days as a top banker, during
which he conducted the day-to-day Washington DC
operations at SunTrust Bank, the NYSE-listed
financial group with assets of more than $175 billion.
But, he is looking forward to what he says will be “a
glorious experience”.
Nostrand rose through the ranks of SunTrust, in a
highly successful career spanning 33 years, to become
chief executive of SunTrust Greater Washington, the
bank’s largest division. Before retiring in 2006, he
says all he thought about were credit problems,
consumer issues, regulation and employee issues.
“Shortly after I retired, though, I started hearing
melodies in my head which were refreshing. I would
tiptoe downstairs in the early hours, trying not to
wake my wife, and sit down at the piano and start
playing them out.”
Since 2006, he has composed and released four
albums. And in January this year Nostrand won the
BMI Songwriters’ Award for his composition “Home
Alone”, recorded by the Czech Philharmonic
Chamber Orchestra.
He says that his decision to return to music, and
composing in particular, raised some eyebrows among
his peers on the Washington financial scene. “When
people on the various boards and civic activities I was
involved in heard I was recording in Prague, they
said: ‘What are you doing composing music, I
thought you were a finance guy?’”
Music and melodies, though, didn’t just start
arriving out of the blue after Nostrand retired.
Indeed, one could argue that the banking world may
have been denied Nostrand’s talents and expertise had
circumstances been different.
As the son of a clergyman, music has been an
intrinsic part of Nostrand’s life from an early age.
“Before my feet could touch the ground from the
piano bench, my father taught me how to write music
and that came back to me after I retired, so the nice
thing about having musical inspiration is having the
ability to also write it down on paper.”
His passion for music remained throughout his
teens until he graduated from Amherst College in
1969. “I was in a band and we played all the popular
hits of the time, from the Beatles to the Rolling
Stones and the Doors. We were very much a rock and
roll band,” he says. “It was a tremendous experience in
the late 60s because there was so much good, fresh,
new music out there.”
However, after graduating, the realities of life took
hold. Nostrand reveals that early on in his marriage
someone had a quiet word in his musical ear. “My
father-in-law said: ‘You will never make any money in
music and I don’t want to have to support you your
entire life, so let me get you a real job.’”
It was good advice. Nostrand went to work for
SunTrust and the music went dormant for 30-odd
years. “It certainly took a back seat; I didn’t write
anything; my piano playing stopped,” he says. “When
you get married, have children and have a mortgage to
pay on the house, you really don’t have time for other
MARKIT LIFE
Winter 2013
55
MARKIT LIFE
things, so the music got put in the closet for a while.”
So, music was his first passion, Nostrand threw
himself into his financial career and has no regrets.
He started on the bank’s graduate training
programme and worked his way through the
company, gaining experience in every division. He
retired after running the largest banking division in
the group and is proud of his achievements.
“I was especially proud of the fact that not only did
we have the highest revenues and earnings, but we
had the highest return on capital of any of the 20
banks within the group.
It wasn’t just the quantity of earnings but also the
quality of earnings. I worked very hard on that.”
He says the highlight of his career, though, was
watching those who worked for him go on to achieve
greater success in the business. “I think one measure of
someone’s success in whatever job they do is the success
of the people that used to work for them and whether
they are sought after for other positions or not.”
Despite having left the bank, Nostrand has
opinions about the crises that befell the industry in
the years following his departure. “The banking
world has gone through a severe punishment and has
been blamed for about every economic woe in the
world,” he says. “I think that, to a certain extent,
some of it is justified, particularly on the investment
banking side, but some of it is simply scapegoatism.
“Some of the obscene compensation packages we’ve
seen on Wall Street and elsewhere are absolutely
ridiculous,” he adds. “But most banks behaved properly.
There were a handful that didn’t and unfortunately the
whole industry has been thrown under a bus.”
So, was he relieved to be out of the markets when
the crisis hit? “It may sound strange, but when the
financial markets were really in trouble about five
years ago I wished I hadn’t retired. I left when the
seas were calm and smooth, and everything was easy
and it was just a question of what percentage the EPS
would go up next year and so on. Frankly, I was
bored and retired at 57.”
He insists that, if he had known the world was
headed for a financial crisis and meltdown, he would
have stayed. “I think I would have really enjoyed
those rough seas of the financial crisis because that is
when it is fun to be the captain. There is no point in
being a leader when you don’t need one.”
His focus now, though, is firmly on his composing.
Nostrand says that, aside from the classical greats of
the composing world, such as Beethoven and Mozart,
he is hugely inspired by composers like John
Williams, Hans Zimmer and their contemporaries.
“I love some of those big screen scores that John
Williams has done. He has a lot of good technology
that an orchestra doesn’t have. I wish I had access to
some of that.” Williams and Zimmer are of course
legends of the cinematic world and it is a market
Nostrand dreams of breaking into.
Indeed, in his album The Duchess you can clearly
hear and feel the cinematic elements spilling out
through Nostrand’s composing. And his music from
another album, The Miss Muse Collection, could
easily work as the score for any number of quality
period dramas. You can almost hear Agatha Christie’s
Miss Marple waiting in the wings.
56
Winter 2013
I love some of those big
screen scores that John
Williams has done
Nostrand, though, admits that the film score
market is tough to crack. “I don’t know how to
pursue that. It is a fairly closed fraternity,” he says.
The difficulty, he says, is that when the big film
companies need music they all go to the big
established names. “How do you break into that
group? I can imagine you are not exactly welcomed
with open arms because that means you are taking
business away from them.”
“It is a much more difficult business field than
banking is by far,” he says, adding that trying to crack
the film industry is made harder by the fact there is
no set organisational structure to follow.
“In the banking industry you can start as a trainee
and rise up through the institution through sheer
hard work. I know of no such training programme in
the music business that allows you to go up through
the chain of command to where the movie houses
want you to write for them.”
And while Nostrand has had success in
commercialising his music through sales on the
internet – his current albums can be downloaded
from iTunes – he is among a populous group of
musicians and composers who wince at the sheer
volume of music available online.
“You can go on the internet and type ‘I want to
hear some music’, and you could spend the rest of
your life ploughing through music and still not get
through a small percentage of what is there.”
“It is much more difficult to reach your audience
because there is so much more music out there.” Here,
he draws a distinction between good music and great
music. “Good music you can tap your toe to and dance
to and sing along to, but it is not something you want
to hear over and over again and that will be popular
forever,” he says. “Great music, on the contrary, is
something you never get sick of and 20 years on will
still be worth listening to.”
Despite his efforts to make
something of his music in a
commercial sense, he is
refreshingly candid about his
work to date. “Some of my
music out there is very good,
some of it is average and
some is probably less than average, but generally
speaking the average to good stuff I have out there is
worthy, but there is a lot of worthy music out there.”
Thanks to his previous career in banking, though,
Nostrand is able to focus on his composing without
having to worry about making ends meet. “I do it
because I love it, I am compelled to do it. It has sort
of taken me prisoner. I am frankly exhilarated by the
unlimited greatness that this medium provides,” he
admits. “So that is a joy. If something ever happens
with it then great, but that is not why I do it.”
I am keen to discover how the former bank chief
approaches his composing. He describes his music as
being “for the listener” and makes a distinction between
good music and good literature that is worthy of note.
“In good literature the reader often relates to one of
the central figures, but that figure is usually fixed in a
certain time and place by the author,” he says. In
orchestral music, though, he says he strives to compose
“adventures where the listener not only becomes the
central figure and protagonist, but through his or her
creativity that person determines the time and the
place and the situation of that adventure”.
He believes that good music is far more liberating
and creative than writing, because it allows the
listener to create so many of the variables and the
circumstances. “So I think music is a better
communicator than writing.”
Ahead of his trip to Prague next year, Nostrand is
due to return to Oxford for a fourth term of study and
tutoring, or what he lightheartedly refers to as being
“humiliated musically”. Despite his own obvious
musical talents, he says the university has some “really
good music composition instructors from whom he
has learned much in the last few years”.
But the real fun will come when he returns to
Prague to oversee the recording of about 30 of his
latest compositions by the Prague
Radio Symphony Orchestra. “I am
going to be recording a different
genre of music in Prague,” he says.
“It will be more Hollywood film
score style, big screen, big orchestra,
sometimes with big drums and a
fast pace.”
Messrs Williams and Zimmer
may just want to listen in.
Nostarnd as a ch
ild
with his clergyma
n
father
Other pictures wit
h
friends from the
music industry
Winter 2013
57
Key numbers
providing
a snapshot
of investor
reaction to UK
homebuilders
Markit infograph
All data correct at time of
going to press
s
r
e
d
l
i
u
b
e
m
o
UK H
18.5%
British Land 90 day implied
volatility level, off its six month
high of 21.5%
64.8
107%
Projected rise in dividend
payments from UK
homebuilders this
fiscal year
Level that UK
construction housing
activity was up
to in September 2013
(50 being neutral)
10,000
Number of additional
UK housing starts implied
by the Markit/CIPS
UK Construction PMI in
Q3 2013
0.4%
64.8
Markit/CIPS UK Residential
Construction PMI Index level
for October - the strongest
reading for 10 years
58
Winter 2013
51%
Average share price
increase of UK listed
property firms in 2013
Current average
short interest in UK
homebuilders