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 2014 to composer HOW THEY SEE IT WELCOME Rooting for recovery s another year draws to a close, all eyes where the risks lie and who to watch. will be focused on 2014 to see if the, Emerging markets also continue to be a key A albeit shaky, signs of a return to area of interest, so we have taken a look at stability in the global economy can take root. how China’s external investment strategy is Markets weathered the recent government evolving and who stands to benefit from it. shutdown in the US while in Europe, Ireland’s Conversely, we examine Chile’s efforts to exit from its bailout programme boosted attract foreign direct investment to all areas of hopes for other eurozone nations in the its burgeoning economy. months ahead. We also bring you an insightful article And, while the debate over the tapering of from BlackRock on short duration in the quantitative easing in the US remains fixed income market, and why investors may uppermost in the minds of investors, the be concerned about future performance in the resilience of the US economy can be seen in rate cycle. the fact it didn’t fall over the fiscal cliff at the Our environmental feature in this issue start of 2013 and that it hasn’t so far defaulted looks at disruptive sustainability and the on its debts. opportunities it presents to save the world We continue to follow these events very without losing sight of the need for businesses closely here at Markit. Indeed, November saw to turn a profit. The bottom line, though, is the launch of our first US Services PMI that big change is needed. survey, which we believe will provide the most Finally, our Markit Life section features accurate take yet on the US economy in the Peter Nostrand, who, after a highly successful months ahead. career in banking, turned his hand to We have also taken the pulse of 10 leading composing music. lights of the financial world for their views on We hope you enjoy this year-end issue and what will drive the global outlook in 2014, we wish you all an enjoyable holiday.

Lance Uggla Chief executive officer, Markit

External editorial board Writers Enquiries without the written permission of Markit. Robert Barnes, Turquoise Nicholas Dunbar [email protected] Printed in England by Wyndeham Grange, Butts Tim Frost, Cairn Capital Jeffrey Kutler Road, Southwick, West Sussex BN42 4EJ. www. wyndeham.co.uk Matthew Frymier, Corrum Capital David Wiggan Opinions, estimates and projections in this The Markit Magazine ISSN: 1757-210X is published Sal Naro, Coherence Capital Partners magazine constitute the current judgement of quarterly (March, June, September & December) Editor the author at the time of writing. They do not Daniel Trinder, Deutsche Bank by Markit and distributed in the USA by Mail Right Mark Johnson necessarily reflect the opinions of Markit. International Inc, 1637 Stelton Road B4, Piscataway Markit editorial team Chief sub editor NJ 08854. Teresa Chick Although effort has been made to ensure the Karen Wheeler Periodical postage paid at Piscataway NJ and Caroline Lumley accuracy of the information contained in this additional mailing offices. POSTMASTER send Alex Paidas Design publication at the time of writing (December 2013), address changes to The Markit Magazine, Markit Markit does not have an obligation to update or c/o 1637 Stelton Road B4, Piscataway NJ 08854. Lemonbox amend information or to otherwise notify a reader Industry contributors To subscribe to the Markit Magazine, please log on thereof in the event that any matter stated herein Andrew McKeon to www.markit.com/sites/en/about/registrations/ changes or subsequently becomes inaccurate. Alice Shone Photography markit-magazine.page Karen Shenone Crown Copyright Shutterstock Markit shall not have any liability whatsoever to you, iStock photo whether in contract (including under an indemnity), in tort (including negligence), under a warranty, Total average net circulation 10,996. under statute or otherwise, in respect of any loss July 1 2012 - June 30 2013. or damage suffered by you as a result of or in connection with any opinions, recommendations, forecasts, judgments, or any other conclusions, information or materials contained herein. Markit is a registered trade mark of Markit Group Limited. Copyright © Markit Magazine. All rights reserved. Reproduction in any form is prohibited

Winter 2013 3 CONTENTS

Issue 22 | Winter 2013 16 REGULARS COVER STORY 6 News All the latest from Markit 2014 – how 8 Talking Business they see it MSCI chairman Henry Fernandez talks about turning cost into profit and creating 10 leading lights of the value for society financial world take their best shot at what may be 14 Country focus in store for 2014 Chile

FEATURES 29 Out of America The US may have had a tough year, but investors 8 14 are not ready to cash out yet 32 Yuan direction China is moving far beyond its traditional resources-led investment strategy around the world 37 Markit pages Nicholas Dunbar reviews Iain Martin’s ‘Making it happen – Fred Goodwin, RBS and the Men Who Blew up the British Economy’ 38 When rates rise Global asset manager BlackRock looks at concerns about short duration and the next

CHINA INVESTMENT 54 rate cycle 40 Disruptive world How the most urgent, eco, social and economic challenges of our age also present big opportunities for business 54 Markit life Orchestral manoeuvres - meet the bank ceo who Yuan 40 now conducts a different kind of life COMMENTARY 42 Market commentary direction Our analyst team puts the events of the last quarter into perspective Chinese foreign investment used to be concentrated on resources, but now it is broadening its horizons writes Alice Shone 58 Infograph What the numbers say about UK homebuilders ver since the Crystal Palace burned down third largest source of investment after the US and in 1936 there has been talk of rebuilding Japan. And all this in a period where global FDI the glass and steel pavilion originally built contracted by 17%. for Britain’s Great Exhibition of 1851. Last What, then, are the characteristics of Chinese month, the talk appeared to turn into a overseas investment? Since the introduction of Jiang Ereal plan – with the estimated £500million coming Zemin’s ‘Go-Out Policy’ in 1999, it has been from Shanghai Zhongrong Property Group and a dominated by SOEs and directed at acquiring energy, consortium of other Chinese developers. minerals and land in developing countries. To this Chinese money may also build the next generation day, SOEs account for roughly 75% of all Chinese of nuclear power stations in the UK. Other groups ODI and energy remains by far the most dominant $50.55bn have bought into Heathrow Airport, Manchester’s sector in terms of value. Airport City and Thames Water, while telecom However, ODI policy is no longer driven Amount China invested overseas in the first half 2013 manufacturer Huawei is establishing a vast new exclusively by resource insecurity, as reflected in a 32 corporate centre along with £1.3billion of investment survey conducted by the Economist Intelligence Unit, in the country. in which 48% of firms surveyed stated that they were This is not how things used to be – until recently planning to invest overseas, but only 26% were while money was pouring into China, it was goods motivated by natural resources. that poured out. But now China seems to be buying The regional spread of Chinese ODI is also more the world. Starting with huge investments in natural diverse than previously thought. Southeast Asia has resources by state-owned enterprises (SOEs) during seen the most investment, accounting for 30% of Winter 2013 5 the commodities boom, the private sector is now China’s total ODI since 2005, while Hong Kong pioneering massive deals around the world. remains the number one choice for mainland Of course, China continues to attract record levels investors. However, the next three regions – North of foreign direct investment (FDI) itself. According to America, Europe and Sub-Saharan Africa – received data published by the Ministry of Commerce an equal distribution of 11% each, closely followed by (Mofcom), in the first seven months of 2013, China Australia, Brazil and Canada, where investment has attracted $71.4bn in FDI, an increase of 7.1% from focused almost exclusively on energy and metals. the same period in 2012. The weight given to Europe and North America Equally as significant, though, were the levels of reflects a trend in which Chinese investors are seizing ODI policy is no longer driven outward direct investment (ODI), which totalled opportunities created by the economic downturn to $50.55bn, an increase of 19.7%. Last year, China’s compete in mature markets. According to by resource security ODI more than doubled and the country became the Organisation for Economic Co-operation and

32 Winter 2013 Winter 2013 33 MARKIT NEWS

Hong Kong firms choose Markit compliance solution Members of The Asia The rules also require customers and brokers in exchanging greatly simplifies the due diligence Securities Industry and Financial to acknowledge that they the required information. process required to comply with Markets Association have chosen understand the algorithms Buyside firms will be able to the new Hong Kong Securities Markit’s Counterparty Manager and other technologies review the answers from each and Futures Commission rules,” technology to help them comply used by their brokers. broker dealer and electronically said Mark Austen, chief executive with the Hong Kong Securities Counterparty Manager will acknowledge that they have of the Asia Securities Industry and and Futures Commission’s help financial institutions done so. This acknowledgement Financial Markets Association. new electronic trading rules. exchange the information will be transmitted directly to “Markit’s technology will replace The new rules take effect on required under the new rules their counterparties, allowing the need for a mass of bilateral January 1st 2014 and require easily and efficiently. sellside institutions to see which conversations and the management Hong Kong-licensed brokers to The solution offers an electronic customers have fulfilled their of a large volume of pages of attest that their electronic trading format of the questionnaire compliance requirements. documentation that would be systems are properly supervised, designed by a number of industry “The industry-standard required in the absence of an tested and risk managed. associations to assist the buyside questionnaire facilitates and automated solution,” he said. Messaging service set to transform markets Markit has launched an to connect to each other. platforms in this way makes it services can be embedded open messaging network that Markit Collaboration Services cost-effective for institutions in third-party applications, will enable people in all parts allows users to see availability, to offer the benefits of a workflows and other networks, of the global financial services send instant messages, use cross-industry collaboration extending the functionality of industry to communicate and video and chat rooms and network to employees. The trading, processing, research share information seamlessly. exchange documents across federation service is powered and other applications. To date, communication disparate messaging platforms. by NextPlane, the market BofA Merrill Lynch, between market participants Linking messaging leader in cloud-based unified Barclays, Citi, Credit Suisse, has been hampered by the communications (UC) federation Deutsche Bank, Goldman lack of system services for collaborative Sachs, JPMorgan Chase and interoperability. business communities. Morgan Stanley have also The new network The new network also provides joined the network and will use removes barriers the first open directory for the the federation and directory to industry financial services industry, services at the enterprise level. communication by enabling people to find, These firms employ more than allowing messaging communicate and one million people worldwide, platforms, critical collaborate with all of whom are eligible to use to price discovery one another. the new network. The banks and pre and post- The messaging will also invite their customers trade operations, and directory to join the network.

6 Winter 2013 MARKIT NEWS

BRIEFS

Hobart partners with US Services PMI survey launched Markit for commission in the world and are eagerly awaited by central banks, management services economists and the investment Hobart Capital Markets, the leading UK-based agency broker, community each month. We has partnered with Markit to are therefore very excited to provide a commission now have comparable data for management solution for buyside the US services sector, which customers who wish to direct commission sharing agreement represents over 70% of US GDP. (CSA) related trades via an “Our US surveys have been independent ‘execution-only’ providing advance indications of broker. economic growth, employment and price trends since we started More awards for Markit collecting data four years ago, Markit has won Global Custodian and will give valuable early magazine’s inaugural award for insight into official statistics such the most innovative market data The first ever SU Services “We were the first organisation as GDP, non-farm payrolls and provider. The company was recognised for the breadth of its Purchasing Managers’ Index to produce monthly service inflation,” Thompson added. data and its processing offering, was released by Markit in sector surveys back in Markit’s survey panel is which spans securities finance, November, providing the 1996,” said Luke Thompson, comprised of more than reference data, corporate actions earliest available indicator of managing director and head of 400 companies. Historical and OTC trade processing and services custodians, prime business conditions in the $9.7 economic indices at Markit. data for the new index goes brokers and administrators trillion US services sector each “Our monthly services PMI back to October 2009. around the world. month. The index will also series in the UK and eurozone are The first Markit FlashS U Markit also won Best Data complement Markit’s Flash US now among the most closely- Services PMI reading of 2014 will Management Product and Best Pricing/Valuation Service at this Manufacturing PMI data. watched economic indicators be released on January 27th. year’s Buy-Side Technology Awards. The firm was also named Best Enterprise Data Management Provider at the Banking Markit and HKEx connect for clearing Technology Readers’ Choice Awards. Markit’s global electronic Exchanges and Clearing. MarkitSERV will also trade processing service for OTC Clear started clearing connect customers to the Hong Bloomberg & Markit over-the-counter derivatives, interest rates and FX derivatives Kong Monetary Authority’s MarkitSERV, now connects on November 25th 2013 new trade repository and will sign cross-distribution customers to OTC Clearing and MarkitSERV is the provide workflows to facilitate deal for EDM services Hong Kong, the OTC first global trade processing compliance with trade reporting Bloomberg and Markit have derivatives clearing service middleware service to requirements in Hong Kong formed a non-exclusive agreement to distribute their established by Hong Kong connect to OTC Clear. from early December. pricing and reference data through Markit’s Enterprise Data Management platform and Bloomberg PolarLake, respectively. Capital markets course for New Delhi Markit’s EDM services and Bloomberg PolarLake provide Markit has set up a capital enterprise data management markets course designed to give solutions that enable the acquisition, validation, storage students at Delhi Technological and distribution of data in a University (DTU) an insight consistent, fully audited into the world of finance. environment. “RE-FINE (RE-engineer for FINancial markEts), a DTU/ Markit Initiative” Markit mag app available covers the fundamentals of You can now access and share all finance, including financial our articles via the Markit Magazine instruments such as derivatives, app, which is bonds, equities and loans. available free to download to The course will provide tablet devices. DTU’s engineering and Go digital in order MBA students with a solid course free of charge to the academia and industry and to interact with understanding of global students and the university. prepare engineering and MBA articles and let us know what capital markets and help them “Programmes such as RE-FINE students for the knowledge you think. start a career in the financial are the best way to create the economy,” said Professor PB industry. Markit provides this desired partnership between 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 o gauge the magnitude and after effects of There will always be demand for performance the 2008 market collapse, look no further analysis, attribution and benchmarking. And, as than major financial institutions’ earnings. Fernandez puts it: “The world isn’t becoming less Even as profitability has been improving, transparent.” All of that plays into MSCI’s strengths. many lament the “difficult” or “Pretty much all the things that have happened “challenging”T economic conditions that are over the last five or six years have developed into very preventing more robust growth. They cite the still strong, positive trends that propel our business,” says incomplete implementation of the Dodd-Frank Act, Fernandez. other regulatory reforms and the compliance costs Regulatory changes are not the least of those and capital requirements that will be weighing on positive factors. them for years to come. “Regulation is something we benefit from An unfavourable banking and investment climate, immensely,” Fernandez adds. “We may not agree with in turn, clouds the outlook for suppliers of data and it sometimes, but once it is done, people have to services to the financial industry. In its most recent comply. A meaningful part of our business, especially annual report, MSCI, the prominent global provider risk management, is driven by regulations.” of indices and other investment and risk analysis tools, “Once you are in the business of developing tools cited a “difficult operating environment” consisting of that enhance performance, create transparency and macroeconomic uncertainty, financial market help manage risk, a lot of good things happen,” he volatility and, specific to its day-to-day business, says. “For example, there has been an increasing outflows from actively-managed equity funds and a allocation of assets to passively-managed portfolios. lengthening of the time it takes to close sales. We have great products [indices] that provide for that. Yet, MSCI in 2012 boosted its net income 6.2%, to There has also been an incredible focus on risk $184.2million, while operating revenue increased management and transparency of performance; we 5.5%, to $950.1m. In the first nine months of 2013, offer tools for risk management and performance operating revenue was up 9.2%, to $768m and net attribution. In commercial real estate today, the income rose 35.1%, to $175.3m. A spin-off of market is clamouring for products and services that investment bank Morgan Stanley that raised $252m will institutionalise and globalise the market. We are in a November 2007 IPO, New York-based MSCI is right there with those tools.” currently valued at more than $5bn. MSCI was not always “in the business of tools” – at Those tough market conditions, it turns out, are least not as Fernandez came to define it. That is the exactly what MSCI was built for. Then again, the difference he made as a strategist and leader. company that chairman and chief executive officer Henry A. Fernandez has been running, expanding organically and by acquisition, and reinvesting in for A meaningful part of our business, more than a decade and a half – enhancing that original index business with performance and risk especially risk management, is management offerings and governance and compliance support – may just be in a position to driven by regulations thrive in any given part of the cycle.

8 Winter 2013 Winter 2013 9 MSCI timeline

1968 2007 The first Capital International MSCI completes initial public indices are published 1998 offering, listing on the New York MSCI Inc. is formed, owned and Stock Exchange; Morgan operated jointly by Morgan Stanley retains controlling Stanley and Capital International interest

2004 MSCI acquires portfolio and investment risk management 1986 systems provider Barra 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 slowed down. In 1995, Fernandez “focused a lot of after earning his MBA degree in 1983 from Stanford my efforts on understanding other parts of Morgan University Graduate School of Business. There, Stanley. I was becoming itchy. I wanted to become an Fernandez recalls, “if you were not an entrepreneur, entrepreneur again.” you were nobody”. He was no exception to that rule, Fernandez notes that Wall Street is haunted by the but for the career direction he chose. ghosts of firms that failed to adjust to changing times “I am not a technology fellow and not a venture and circumstances, in contrast to Morgan Stanley capitalist,” he remembers thinking. “I asked myself, and Goldman Sachs. That unforgiving competitive ‘What can I do that is an extension of what I am reality “generated an incredible amount of studying and of the Silicon Valley environment I am entrepreneurship within finance”, he says. “Morgan living in?’” Stanley people were most proud of its ability to As one who desired “pure-play entrepreneurship” and reinvent itself every so often.” “liked finance”, Fernandez was drawn to the boutique MSCI, the indexing operation then officially known firms of Wall Street, and he went to work for Morgan as Morgan Stanley Capital International, appeared in 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 I was becoming itchy. I wanted to than that today” – over 3,000, while become an entrepreneur again Morgan Stanley has 56,000. Over the years, Fernandez had the rare chance to be exposed to many of Morgan Stanley’s Fernandez’s entrepreneurial sights as a strong then very siloed businesses: investment banking and candidate for reinvention. It was carried on the bank’s corporate finance, fixed income, mortgage finance, books as a cost centre, with annual client revenues of mortgage trading and equities. However, he left the $9m plus $6m from Morgan Stanley, falling short of firm in 1991 and spent three years working in private its $18m in expenses. Envisioning greater possibilities, equity, financing acquisitions in Mexico at the time he began to contemplate “instead of becoming an of the North American market integration. entrepreneur, why not become an intrapreneur?” Fernandez returned to Morgan Stanley in May 1994. While his “day job” was overseeing equity “My former boss from the fixed income division, John derivatives sales and trading for Latin America, Mack, had become president and was looking for Fernandez took charge of MSCI part-time in February somebody to help open up broker-dealers in all the 1996. Two years later, the unit was turning a profit major emerging markets,” says Fernandez. Mack and Fernandez wanted to dig in deeper. He proposed a “needed a business man, almost a venture capital kind restructuring that would make him the full-time ceo; of person, who would understand the drivers of these by April 1998 he was based at the index headquarters local businesses and how to put them in place”. in Geneva, initially overseeing about 50 employees. 3,000+ A year later, as a result of market conditions such as What had been a Morgan Stanley department became Number of MSCI employees today the Mexican peso crisis, the brokerage initiative the Delaware-incorporated legal entity MSCI Inc.,

10 Winter 2013 TALKING BUSINESS

2010 MSCI acquires RiskMetrics and its corporate governance 2013 subsidiary Institutional MSCI acquires InvestorForce, a Shareholder Services and, in a leading provider of performance separate transaction, Measurisk measurement tools for pension fund consultants

2012 2009 MSCI acquires leading Morgan Stanley sells remaining commercial property data and shares and fully separates from analytics provider IPD MSCI

Source: msci.com

operating as a standalone business, 90% owned by “When I took over the business” he says, “I believed Fernandez has steered MSCI into a global Morgan Stanley and 10% by Capital International. our mission was to enhance the investment process. power brand The latter began publishing indices in 1968 and Equity indices were performance tools” but MSCI’s continued to be responsible for their creation and mission “had to be broader than equity indices to production after Morgan Stanley bought the licensing capture the full potential. rights and launched the MSCI brand in 1986. “We started with a global business – a great brand, By deeds and results, Fernandez made his case for following and reputation – a lever, so to speak; and had intrapreneurship. Before the turnaround, MSCI had the kernel of an idea that we could create a lot of the dual disadvantage of being a small operation different types of tools for the investment process, inside Morgan Stanley, while also having to answer to starting with equity performance tools in the form of a second parent organisation. That made it difficult indices. To that we kept adding over the years to build a “to get the nurturing, the resources, the right people”, larger set of tools that would complement one another.” says Fernandez. He says he was fortunate to be able to Going the acquisition route, MSCI started with follow his entrepreneurial instincts with support from portfolio risk analytics company Barra in 2004. The the senior management and directors of both Morgan pace picked up in 2010, nearly three years after the Stanley and Capital International. They gave him the IPO, when MSCI paid $1.6bn for RiskMetrics freedom to “reinvest the profits back into the Group, which brought with it other brands business, which fixed a lot of things and began our including proxy voting and governance servicer long trajectory of growth”. Institutional Shareholder Services (ISS). Also in The ceo also had a solid core business to build on. 2010, MSCI bought Measurisk, a leading provider Today, MSCI has a total of approximately 8,000 of risk transparency and measurement tools to institutional clients. An estimated $7.5trillion of hedge fund investors. assets worldwide are benchmarked to MSCI indices, In November 2012, MSCI purchased and they are the basis for around 600 exchange- IPD Group, filling a gap in traded funds, itself a significant growth segment. commercial property data and risk Operating revenues from index and ESG analytics, for $125m. Two months (environmental, social and governance) products, later it added which are reported together, jumped 18.2% year-over- Investor year in the first three quarters of 2013, to $383.2m, Force half of the companywide total. Even the loss this year Holdings, of some $25m in licensing revenue from Vanguard whose 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.

11 TALKING BUSINESS

What motivates us here at MSCI is that what we do creates value for society

Fernandez facts InvestorForce performance measurement tools serve risk tools for the real estate investment process” – the pension fund consultant market, for $23.5m. which, Fernandez adds, will be “a catalyst for the Born: Mexico City, raised Not everything is a perfect fit. Last March, MSCI acceleration of the institutionalisation and globalisation Nicaragua sold forensic accounting and research firm CFRA of the [real estate] investment process. There is no Age: 55 (Center for Financial Research and Analysis), which reason why a pension fund in Canada cannot have a Spouse: Alexia was part of RiskMetrics, to Peter de Boer, formerly of portfolio of properties in 20, 30 or 50 cities around the Children: 3 McGraw-Hill Financial and now its ceo. In October, world, just like it has equities or fixed income.” Favourite sport: Running Fernandez announced that MSCI was “exploring But there is no end to the tool-building. Fernandez Currently reading: Steve strategic alternatives” for ISS. speaks of bringing everything together for total Jobs by Walter Isaacson, The Outsiders: Eight With clients spanning the categories of asset owners portfolio analysis visibility, and there are gaps to fill Unconventional CEOs and (e.g., pension funds and sovereign wealth funds), asset along the way. Their Radically Rational managers of all types, and the traders who make “How do we combine all those asset classes into a Blueprint for Success, by markets and execute for the asset managers, MSCI total portfolio to be able to provide performance and William Thorndike claims a top market share in each of its key business risk management tools, especially for the asset owners?” lines. “We are very happy with that leadership says Fernandez. “They don’t live in a world of single position and thank our clients for it. But you have got asset classes; they want to put it all together. The biggest to earn it every day,” Fernandez says. “To earn it, you pension funds in the world use our tools to aggregate all have to innovate constantly, provide value to clients their asset classes, to understand the performance and stay ahead of the competition. If we do that well, attribution and the risk of the total portfolio. the rest will take care of itself.” “To be effective in the multi asset class setting, you The challenge is increasingly technological. In have to be effective in each asset class. It is a big October, MSCI hired Chris Corrado, most recently a endeavour for us... The holy grail is to be able to be UBS managing director who spent 11 years earlier in his good in equities, good in fixed income, in hedge career with Morgan Stanley, as its first chief information funds and private equity and real estate, and to be officer. Fernandez calls the appointment “the ultimate able to combine all of that in a seamless way on a recognition that MSCI is a technology company”. highly frequent basis for the owners of the assets.” Toward the goal of developing “mission-critical “There is still a way to go,” says Fernandez. “What tools that enhance the investment process in each of motivates us here at MSCI is that what we do creates the major asset classes and the combination of them”, value for society. If we can improve the performance as Fernandez states it, the build-out of MSCI falls of all these portfolios by a meaningful amount, then logically into place. we have helped to achieve a better living for people in “Barra added performance and risk tools and their retirement. So we get very excited by all of this portfolio construction tools for the equity investment and the innovations that we make.” process,” says Fernandez. “When we had the $7.5tn opportunity to buy RiskMetrics, it was performance and risk tools for the multi-asset class investment Jeffrey Kutler is editor-in-chief of Risk Professional Amount of assets benchmarked to and is based in New York MSCI indices globally process. When we bought IPD, it was performance and

12 Winter 2013 The road to Santiago Chile is now South America’s employment in the sector has bolstered the growth of most prosperous nation and all a new middle-class where miners are paid handsomely investors are welcome, writes for their work to the north of the country. However, Chile’s export-led economy is dependent Mark Johnson 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 ou can always tell that something is going over the past year and this may have an impact on well when the luxury brand names move shortterm growth. into town, and in South America it seems The rise in consumer spending in Chile, though, like everyone is setting up shop in the was given a boost in October when the nation’s Chilean capital of Santiago. monetary authority surprised the market by cutting YAccording to a November 2013 report from the interest rates from 5% to 4.75%. Chilean Asociación de Marcas de Lujo (or AML, the There was much speculation around the timing of luxury brands association), Santiago now trumps São the cut, which some observers noted may have been Paulo and Buenos Aires as the new hotspot for luxury to avoid any suggestion of political motives around retailers. the November 17th presidential elections in the Sales of luxury items in the country have reached country. $30 million so far this year and much of this is put However, Chile’s growth and development continue down to financial stability in this most southerly of to attract strong interest from investors. The country South American nations. has become increasingly recognised for its progressive Chile’s current consumer growth is being fuelled by approach to financial stability and its financial system one of its key industries, copper mining. The rise in is viewed as so sturdy the country is now often COUNTRY FOCUS CHILE

referred to as the Luxembourg of Latin America. the Chilean CCP and OTC derivatives settlement After decades of consistent and progressive efforts and clearing house, is estimated to save about $210m to liberalise its financial markets, Chile is rapidly a year for local Chilean banks. becoming the envy of the region. In 2010, it became Large regional players such as Suramericana and the first South American nation to join the BlackRock are establishing alliances to facilitate the Organisation for Economic Cooperation and insertion of such instruments into their investment Development. portfolios across the region. Chile’s membership of the OECD was seen as New products are also being created. At the end of recognition of its efforts to improve regulation, and August this year, Brazil’s Banco Itau launched its first the country continues to push ahead with its exchange-traded fund tracking the most liquid stocks regulatory reforms. Indeed, new rules came into play listed on the Santiago stock exchange. in 2013 aimed at creating more transparency, stronger The ETF is focused on domestic investors as it is risk management measures and improved compliance priced in the Chilean peso and is listed on the in Chilean markets. Santiago stock exchange. The Financial Times For example, in January a new rule of the supreme reported in September that the ETF was seen as an court came into force requiring bank supervisory “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 keen to attract foreign Chile is also investing in its direct investment across a range infrastructure and is keen to attract foreign direct investment across a range of projects. of projects According to a February 2013 Bloomberg news article, Chile’s foreign direct investment committee reported that FDI agents to reveal publicly all audits and reviews made grew 63% last year to $28 billion. Top: Santiago’s rising to financial institutions in Chile. Around 50% of FDI usually heads towards the cityscape. Chile’s progress in developing its markets has also nation’s mining sector, 26% to services and 10% to Inset: A Chilean copper mine, Chilean pan pipes led it to forge important alliances across the region. In utilities. However, the country is also aggressively and Easter Island a move aimed at competing with larger equity marketing investment in other areas. markets in Latin America, such as Brazil, the In October, the nation’s foreign investment Santiago stock exchange signed a deal with exchanges committee held a forum in London offering in Peru and Columbia, which led to the creation of opportunities to investors in a broad range of sectors the Latin America Integrated Market, or MILA, an in addition to those above, such as manufacturing, integrated electronic equity market system that allows financial services, biotechnology, tourism and investors to trade stocks from all three countries. infrastructure. This boosted the need for new technology and A similar event took place in Dubai in November better practices connecting issuers, investors and and the Chilean investment committee will host a brokers among the three countries. major investment forum in Santiago in mid-January Moreover, the creation in 2012 of COMDER, as 2014.

Winter 2013 15 2014 PREDICTIONSOnce 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.

The quest 1. What will 2013ions: be remembered for? 2. What was your best decision this year? 3. What should 2014 be focused on? 4. Which major changes do you foresee in the financial markets? 5. Who will have the biggest impact on the industry in 2014? 6. What will be the key focus of your business strategy next year? 7. What is your biggest worry about the year ahead? 8. Will your firm be increasing the number of women in senior roles in 2014? 9. How will environmental considerations feature in your business next year? 10. How will you personally stay on top of your game?

2014 PREDICTIONS

Capitol Hill: Eyes on the US recovery

Elizabeth Piper/Bach 6. Strategy Retirement readiness and Chair, IMCA retirement income strategies. 2014 We find many individuals still 1. View 0f 2013 of pent-up demand for don’t save enough to be able to Without a doubt, 2013 will housing. With market volatility retire. We will be focusing on be remembered as the year the continuing in the US for 2014, driving home the importance PREDICTIONS US government kicked the sectors of interest are US of early saving for a comfortable can down the road one more consumer staples and energy; retirement. For those who are time in regard to increasing commodities will provide a retired, our focus is helping the national debt ceiling and buffer for downside protection. them to find income-generating approving a new budget. It only investments. growth among women took 16 days of a government 4. Major changes within our industry. shutdown to postpone the On the macro level, the US 7. Biggest concerns inevitable decisions to the next economy will continue to We have had a 150% growth in 9. Green credentials deadlines of January 15th and recover, but ever so slowly as the market since 2009. No one Our firm will continue February 14th 2014. change must come while dealing sees the market or interest rates environmental initiatives in the with the nation’s fiscal policies. as likely to do anything rapidly workplace. We don’t currently 2. Best decision With prices high in the US and over the coming year, as the Fed use ESG (Environmental Social Initially, we were cheaper in Europe, I believe we continues to provide stimulus to and Governance) factors or contemplating changing our will see investors heading back the economy. When the Fed impact investing in our actively-managed large-cap into the developed countries begins to taper, my worry is that investment process. strategies into passive strategies overseas. Japan is still a guess, investors will fear the results and using the expense savings but it is looking brighter. and race to the sidelines, 10. Personal best to leverage into a more heavily causing even more volatility in I stay on top of my game by weighted small-cap strategy. 5. Power people both bonds and stocks. maintaining my By deciding to remain in active Janet Yellen, vice-chairman of certifications, like the CIMA large-cap management during the Board of Governors at the 8. Women in power certification, and attending this year of volatility, we added Federal Reserve and the top Our annual conference, the industry conferences, such as a meaningful amount of return contender to succeed Ben NADA Convention & Expo, the array offered by the to our portfolios. Bernanke as Fed chairman, provides an opportunity for Investment Management will have the opportunity to women to gather for a first- Consultants Association. The 3. 2014 focus have the greatest impact on class networking event content offered at these Household balance sheets have the industry. Recession designed to encourage events keeps me sharp and grown stronger and now are avoidance is the Fed’s concern, mentorship by, and meeting gives me invaluable insight comprised of lower debt and so it will continue to opportunities with, successful into the bigger picture, higher values attributed to accommodate the economy’s women in the industry. The which is paramount to stocks and housing. So, for need for stimulus activity as goal of the event is to promote helping me be the best I can

Photograph: Shutterstock Photograph: 2014, we continue to see a lot long as necessary. continued interest and career be in my role.

Winter 2013 17 2014 PREDICTIONS

David Craig regulatory divergence between President, Financial & Risk US, Europe and Asian centres. Thomson Reuters 8. Women in power Yes. We are actively identifying and developing our female 1. View 0f 2013 costs that the banking industry leaders to have a pool from 2013 should be remembered as needs to remove. This, along which to draw. Our approach the year the economy started with further regulatory is both top-down and to turn around. It is the year implications of over-the- bottom-up. the industry recognised it counter markets, swap Our top team has recently needed to change and begin to execution facilities, money been joined by two of our restore trust – and it has laundering and the like, will highest performing females: started to do so. lead to further global chief content officer, Debra structural changes. Walton, and our head of go-to- 2. Best decision market strategy and One of the most important 5. Power people operations, Emily DiMiceli. things we did this year was to Federal Reserve chair Janet focus on instant messaging Yellen. It will be interesting to 9. Green credentials collaboration. The Open see if speaking clearly Environmental, social and Messaging initiative we stimulates the economy, as governance (ESG) issues launched with Markit and recently mooted. continue to be a focus for us. eight major banks will help The environment has returned our industry vastly, especially 6. Strategy to the top of the agenda as as the community expands. Content and our partner catastrophes, such as the recent We have also done a lot of ecosystem are hugely Typhoon Haiyan in the work on messaging important and this will Philippines, demonstrate the compliance, a hot topic right include adopting linked data unpredictability and power of now, and on expanding and the cloud more widely. weather. People are at risk and connectivity to the buyside, as Data is in abundance, but it is we need a global response. Our we did through the integration about structured data and clients also want to use ESG to the FXall community. visualisation, and about being factors in their investment a filter for the industry, decisions and this is where 3. 2014 focus finding needles in the specialist data like Point As an industry, we need to get haystacks. Carbon, Asset4 and predictive back to a mindset of Our other focus will be on analytics become important. innovation and growth – pivoting from a product ideally 2014 will see a focus on business to a full enterprise 10. Personal best a more enterprise approach to business, helped by further Keeping fit helps and I plan to this. No doubt, our industry’s rollout of Eikon and Elektron continue running twice a week cost challenges around the top platforms supporting and will try to get more sleep. and bottom line still remain, transactions, connectivity, The odd bottle of good wine but this is very much the new discovery and risk. with my wife and friends also

normal. helps me relax. Photograph: Shutterstock 7. Biggest concerns Of course, staying embedded 4. Major changes Further economic or banking with our customers and Scandals resulting from the surprises – it is always what partners and tracking the sins of the past show no signs you don’t know or expect that innovators in the industry is of abating and there is still an can cause the biggest issues. something I will do even more estimated $30bn-$40bn in Other than that, further of in 2014.

18 Winter 2013 important for widening the David Wright scope of financial instruments Chairman, Iosco available for investors, market participants and the economy 1. View 0f 2013 developing standards early; as a whole. The globalisation of 2013 will be remembered strengthening the Iosco the industry will continue to perhaps primarily as the year multilateral memorandum of accelerate. when the first signs of the understanding; assisting our ending of the financial crisis emerging market securities 5. Power people emerged. Slow economic regulators; and building Iosco The behaviour of the growth began to show in the into a more effective industry itself. More OECD countries; the eurozone international institution. regulation will follow if looked far more stable and the number of scandals sustainable after the bold 3. 2014 focus does not decrease. actions by the ECB in the Delivering the key pieces of summer of 2012; and in global financial reform. 6. Strategy emerging market countries, Namely, resolving for good the Strengthening Iosco in all its banking), be growth remained reasonably too-big-to-fail problem; OTC forms. We need to start to prepared for new strong, all things considered, derivative reform in all its parts; reflect on what type of global threats (e.g. cybercrime) and even after the mid-year US shadow banking safety and financial institutions we want open to new ways to protect Federal Reserve tapering soundness; and ensuring the for the more complex, investors (e.g. behavioural signals. But in the financial new bank capital standards are interconnected world we face in economics). services world 2013 saw the applied by all. In all these areas 20 years and beyond. A world emergence of the full effects of there is a long way to go. of many more big capital 7. Biggest concerns the Libor scandal; rumours of Implementation must be markets, not just today´s simple A deterioration of global serious malpractice in other effective and international constellation of a few. If we stay economic prospects, further market segments, such as forex; regulatory arbitrage avoided. A as we are with weak, non- unsustainable rises in public record fines imposed on firms fifth priority, usually forgotten, binding global financial debt leading to more austerity for malpractice, misselling etc. is corporate governance, institutions the world faces and the danger of deflationary, The restoration of the reputation behaviour, ethics and sanctions. more fragmentation, not less. downward economic cycles. of the financial industry has a Have corporate governance We have two real institutional The earlier the capital markets very long way to go. standards genuinely improved options - either to enhance can be brought into play to in the financial industry since regulatory co-operation and address some of these 2. Best decision the crisis took hold? A vitally co-ordination in pragmatic structural problems the better. I think Iosco’s best decision important question. ways (e.g. synchronising this year has been to broaden political timetabling of 8. Women in power its scope and reach, engage 4. Major changes proposals to avoid first-mover I hope so. more widely and robustly at We hope to see more OTC regulatory advantage; agreeing the international regulatory derivatives being driven on to more granular standards to 9. Green credentials level and begin to develop a regulated exchanges, and limit implementation In our small ways we should policy to deliver a stronger cleared and reported accurately variability; converging all play a part to construct a Iosco in the years ahead. Led to trade repositories. The supervisory effectiveness and sustainable world environment by our arguments, there is a incentive structures have to be intensity etc); or, beginning to that is fair to all. growing recognition that the right for this to happen. I think cement now the foundations world is moving more towards we are also beginning to see for effective global institutions 10. Personal best market-based financing models some serious efforts being made with some global regulatory By trying to keep fit; being which means the importance by markets and regulators to get powers and binding disputes open to all views; by of the role of the securities financial markets to work better settlement. Sooner or later we recruiting the very best; and regulator is set to deepen. for SMEs, longterm financing will need the latter in the years by delivering our new Iosco is now deliberately trying etc. Reviving moribund ahead. In addition, we must emerging vision for Iosco. Plus to be more forward-looking securitisation markets and continue to deepen our the occasional game of golf to and proactive. This means deepening liquidity in corporate knowledge about how financial keep everything in

Photograph: istock identifying risks early on; bond markets are also markets function (e.g. shadow perspective. 2014 PREDICTIONS

®

Dubai: Gulf Dr Nasser Saidi, markets will be a Former chief economist, focus in 2014 DIFC Dubai

1. View 0f 2013 funding from the crowd in For deep US political divisions exchange for equity. We have and dysfunctional politics that already done cross-border threatened US and global equity raising and hope to markets by undermining the launch in Central & Latin Removing notion of US debt being the America in 2014. risk-free asset. Dysfunctional Crowdfunding can be a major US politics and divisions are source of sustainable finance leading to uncertainty about for SMEs and improve access the future course of US fiscal to finance globally. It is a uncertainty and debt policy in addition to disruptive development healthcare policy. It is telling utilising the ubiquitous that the Tea Party, a minority internet and interactive web- of Republican hardliners who based financial services. supported the shutdown due from your data to their opposition to 3. 2014 focus Obamacare, are able to dictate Recapitalising European their party’s policies. The US banks, minimising the impact political schism implies that of disruptive politics in the US Obama has become a lame- and avoiding the eruption of a supply chain duck president even before he euro sovereign debt crisis as a enters the second half of his result of ongoing weak growth second mandate. There will be in southern Europe and a growing question mark over France. We are entering 2014 his ability to deliver on major with two major sources of US issues, such as the important policy risk: an uncertain Markit Enterprise Data Management matter of US-Iran relations, a course for monetary policy and potential game changer which the onset of QE tapering and (EDM) acts as a central hub to manage is critical to the security, uncertainty on debt and fiscal political and economic policy. Both could jeopardise the more critical issue of increasingly international, war the acquisition, validation, storage and landscape of the Middle East the anaemic US economic deleveraging the Fed’s balance in Syria; and an eventual and the GCC countries. recovery and weak global sheet. Where will the savings breakdown of the budding distribution of data in a consistent, economic growth. originate to buy the assets the détente with Iran, which could 2. Best decision Fed will eventually have to sell? deteriorate into military fully-audited environment. To invest and support the 4. Major changes confrontation and war. launch of a crowd investing The internationalisation of the 6. Strategy platform, Eureeca.com. It is renminbi and the growth of Extending my advisory 8. Women in power the first equity crowdfunding the redback market, which can business into Africa and Women already occupy more marketplace offering a global become larger than the euro growing the links with than 50% of the senior roles in Contact us today for more information: solution for start-ups and debt market within the Chinese companies and my advisory business.

Photograph: Shutterstock Photograph: SMEs to raise coming decade. The world investors, who have become needs the renminbi to be the major source of funds and 9. Green credentials [email protected] the third global currency capital flows into Africa and I am a public advocate of the alongside the US dollar increasingly the Gulf and the Global Reporting Initiative markit.com and the euro. It will be Middle East. The other area and I work with stock the beginning of the of focus is financial markets exchanges, regulators and the end of the exorbitant in the Gulf with the investment management privilege the US has forthcoming reclassification industry in the Middle East enjoyed since the of the UAE and Qatar for companies to adopt GRI Second World War markets from “frontier” to and report on environmental, and the competition “emerging”. social and governance issues. will eventually impose debt 7. Biggest concerns 10. Personal best discipline on the US. High youth unemployment in I network extensively and am Europe leading to involved with a number of 5. Power people protectionism and extremism international organisations Janet Yellen will and continued deterioration of including the IMF, OECD initiate QE tapering the Arab firestorm; growing and the UN, along with the Markit makes no warranty, expressed or implied, as to accuracy, completeness or timeliness, or as to the results to be obtained by and start addressing spillover from the ongoing, WEF. use of the products and services described herein, and shall not in any way be liable for any inaccuracies, errors or omissions therein. Copyright © 2013, Markit Group Limited. All rights reserved. Any unauthorised use, reproduction or dissemination is strictly prohibited. Winter 2013 21

MKT_EDM_advert_Removing_uncertainty_from_data_supply_chain_A4_QR_code.indd 1 12/4/2013 2:35:06 PM 2014 PREDICTIONS

Jim Malgieri rapidly changing market their annual performance requirements, clients can appraisal. Executive vice president leverage BNY Mellon’s products and services to 9. Green credentials global collateral services, better manage counterparty Environmental considerations BNY Mellon and market risk in their do feature in our business and collateral transactions, engage corporate planning. We in more investment publicly and voluntarily report 1. View 0f 2013 leading services and solutions opportunities to help our environmental progress In my view, 2013 will be for clients. maximise their investment with the CDP (Carbon remembered as a period of returns and access new Disclosure Project) and through heightened awareness of 3. 2014 focus financing alternatives. our corporate social regulatory changes and how Risk identification, mitigation responsibility report. We they are reshaping business and control by all financial 7. Biggest concerns surpassed our greenhouse gas practices. institutions. It isn’t so much of a worry as emissions reduction target of an opportunity. There has been 10% by 2016, recording a 32% 2. Best decision 4. Major changes so much change to the markets reduction in greenhouse gas This is an easy one: continuing One of the major changes to over these past few years, then emissions last year across our to invest in global collateral watch for will be complete and add innovation and technology owned and controlled US services, an innovative suite of wholesale shifts in the to the mix. property portfolio. We have market- business models of some To some degree, we are in had a lot of success reducing companies to ensure the business of helping clients energy consumption with the compliance with new worry a little less. Global EPA’s Energy Star programme. regulations as they take effect. collateral services was created And, in terms of services, those The complexity and cost, both and designed to support the range from environmental, in terms of the opportunity myriad changes facing clients social and governance screening costs and the costs to comply, as a result of regulatory of assets to help assess and will inform those decisions. reforms and market changes. manage risk to socially responsible investment funds. 5. Power people 8. Women in power Regulators around the world We operate in a highly 10. Personal best will have the biggest impact on competitive landscape and we For me, I really enjoy working the industry in 2014. look to attract the best people with our clients and shaping our in the industry today and in employee culture. I continue to 6. Strategy the future. That means talk to our clients, enlisting The key focus of our business tapping into the widest talent their opinions and insights on strategy continues to be pools and ensuring diversity the market and our products. In offering value-added of thought leadership, terms of our employees, it is a services, solutions and inclusive of women. We value lot like coaching and we have collateral products to our diversity. In fact, every BNY the best people in the business. clients. As they face evolving Mellon employee has a That is good for us and even global regulations and diversity and inclusion goal in better for our clients.

22 Winter 2013 2014 PREDICTIONS

Basel, Switzerland: Capital rules now having an impact

Philip Stafford chairman of the Commodity Futures Trading Editor, FT Trading Room Commission (assuming he is sworn in). The priorities and 1. View 0f 2013 complimented us on it, which approach of the CFTC will Post-financial crisis is very satisfying. be one of the main themes regulation finally coming to early in 2014. fruition across the north 3. 2014 focus Atlantic. Mandatory Compliance with regulation 6. Strategy clearing, trading on Swap will continue to be an industry To focus on developing Execution Facilities and priority, but as that beds down, new digital initiatives for trade reporting became a I’d expect to see emphasis on the FT Trading Room reality in the US. Europe was companies trying to make a website. a little further behind, but commercial return from the the technical proposals for new world. There will be new 7. Biggest concerns the European Market products like futures contracts, That the volume of news Infrastructure Regulation outsourcing of collateral will get in the way of emerged and political management and streamlining achieving that. 23 agreement on the review of of the trading and data 8. Women in power the Markets in Financial operations of banks. There Winter 2013 Instruments Directive is should also be more focus on I have no influence in likely to come around the Asia’s response to the G20 promotions at the FT. end of the year. Progress was rules. Having said that, there made on the tricky issue of are a lot of talented extraterritoriality. The 4. Major changes women here, some in senior impact of the Basel III It is still developing, but given roles, and it would be a digital has an impact on our capital requirements for the breadth and depth of surprise if there were not business carbon footprint. banks also began to have an investigations into the foreign more in senior roles in 12 effect. exchange market, I could see a months’ time. As an aside, 10. Personal best political push for an overhaul. I’ve always been impressed The sheer weight of news 2. Best decision Moving it on to more that the market structure stories has been great, but it Much of my job relies on transparent, exchange-like world has far more women comes at a cost sometimes. I others making decisions trading venues may be far in senior and important roles have been studying aikido, a about my work. But I was harder to achieve than than other parts of the Japanese martial art, for the proud of the Exchanges, lawmakers think, though. financial services industry. past 12 years and I am a black Clearing and Transaction belt. Sadly I have missed many Services report in September. 5. Power people 9. Green credentials training sessions this year. A lot of work went into it - Two candidates: Jeff Sprecher, The FT itself has long been They help me relax a lot and I designing, commissioning, chief executive of conscious of the environment, come back to issues from a writing and editing - and IntercontinentalExchange, as from encouraging employees distance and with fresh many people in the industry I he reshapes NYSE Euronext; to recycle, to not taking perspective. My aim is to do

Photograph: Shutterstock Photograph: admire and respect have and Timothy Massad, the new unnecessary flights. Going more training.

Winter 2013 23 2014 PREDICTIONS

Award-winning global investment technology for the front, middle, and back office

Best Buy-Side EMS & Best Buy-Side OMS Professor Andrew J Oswald afraid. Every year, however, I in Water’s 2013 Buy-Side Technology Awards University of Warwick, UK worry about the City of London: interconnectedness of the May see a bull market world’s computers. One world- in 2014 says Oswald 1. View 0f 2013 4. Major changes class computer troubleshooter Best Fund Accounting and Reporting System Glimmers of sunlight in the There is a good chance that whom I know prints off hard world economy, and the 2014 will see a bull market in copies of all his bank in HFMWeek’s 2013 U.S. Hedge Fund Services Awards lighting of a blue touchpaper stocks as people shake off their statements, “For the day, on an eventual house price pessimism and herd behaviour Andrew, when all the computers boom. takes over on the upside. It is fail and I have to prove to the not a done deal yet, however. bank what cash I had.” Best EMS Provider & Best OMS Provider 2. Best decision Going public on a formal 5. Power people 8. Women in power in the 2013 Waters Rankings statistical demonstration If you mean the financial Warwick University is doing of the fact that high industry in the UK, I imagine that constantly. Plus the new home ownership rates in it will be Mark Carney at the PhDs in world economics are the world lead to high Bank of England. Much will very evenly divided between Best Fund Accounting and Reporting System unemployment rates. depend on whether he reacts men and women, so it is only a Owner-occupation strongly, one way or another, matter of time. destroys the efficiency of to house price inflation in the 2013 Hedgeweek Global Awards the labour market. probably approaching 10% per 9. Green credentials annum by the end of 2014. Still not enough, in my 3. 2014 focus judgment, but trees are

Trying to work out 6. Strategy definitely in, I am pleased to say. Photograph: Shutterstock For more information on Eze Software Group, contact: how to stop the boom- Having ideas. Trying not to [email protected] or visit www.ezesoft.com. bust cycles of the run with the herd. 10. Personal best world. We have to Your question is ten years too figure out how to stop 7. Biggest concerns late. But the older I get, the going from one We are probably due a bad more I admire the wisdom of extreme to the other. global terrorist incident, I am the old.

24 Winter 2013 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 7. Biggest concerns growth; expansion of My biggest concern moving quantitative easing in Europe into 2014 is that the US and tapering of QE in the US, economy is stronger than which should lead to originally predicted. This compression between high- could have the effect of yield, lower-rated investment- driving rates up very quickly grade and high-grade spreads causing sticker shock, and a higher dollar. Further illiquidity and an abrupt but improvement in balance sheets, temporary suspension of both corporate and personal. capital markets activity. The last time we were in a 4. Major changes protracted rate rising Final adoption of various environment was 1994. regulatory changes, ranging from bank capital to the 8. Women in power Volker rule and swaps Absolutely. We are an clearing. emerging firm and as we bring in more capital, we will be 5. Power people expanding our staff. We have Janet Yellen and Mario some key positions to fill and Draghi. are strong believers in the benefits of diversity. 6. Strategy Investing in companies that 9. Green credentials are new to the capital We are green-friendly around markets, first-time issuers to our office, but more the high-yield bond markets. importantly we always look for Investing in spread opportunities to invest in compression between lower- socially responsible businesses. grade and high-grade as balance sheets continue to 10. Personal best improve and businesses Work harder and work smarter continue to expand with the by continuing to combine new undertones of continued low cutting-edge technology with global interest rates and sound fundamental research Twitter: the most high profile IPO of 2013 Photograph: Shutterstock Photograph: default rates. and common sense.

26 Winter 2013 2014 PREDICTIONS

First class: Royal Mail 2013 IPO was the first UK privatisation of the 21st century

Tamara Box 6. Strategy My business strategy for next law firms deemed “Gold Partner, Reed Smith year rests on three legs: Standard Certified” (meaning knowledge, cooperation, and we satisfy stringent 1. View 0f 2013 addictive use of “quantitative innovation. In order to provide leadership, compensation and We will probably look back on easing” and have the markets the most creative and promotion requirements). In 2013 and say that was the year work without government innovative solutions to our addition, in 2013 we were of market schizophrenia. intervention. clients’ needs, we have to focus awarded the Euromoney Optimistic growth projections on maintaining teams of Award for being the most were countered by rumbles of a 4. Major changes people with the collective innovative law firm for looming disaster. Money in We all know that regulation experience to produce efficient women in the UK. Finally, as search of an investment found has the potential to both and effective results. Rapidly our chairman is a committed so little from which to choose correct and distort markets. changing markets create member of the 30% Club and that the deals that did come to The unintended consequences transient demands for with just over 30% of our fruition such as Twitter, and, of enacting stronger controls particular skillsets; ensuring executive comittee being in the UK, the Royal Mail, may mean that a limited few that our teams are proficient women, we are “walking the were all massively will take advantage of the and agile requires a walk”. oversubscribed, even as the distortions created by the very commitment to training and pessimists were predicting the rules designed to minimise cross-pollination of ideas, as 9. Green credentials end of the financial world. I inequities in the system. well as a belief that success Our commitment to all aspects heard one senior analyst Regulatory capital rules, for comes from cooperation. of the environment is always at describe the situation as example, mean that those in the forefront of our business “patting yourself on the back my market – structured 7. Biggest concerns considerations and 2013 has as you go over the cliff”. finance – may face entirely We constantly seek out been our best year to date, in new counterparties in the professionals who can manage terms of our recycling figures. 2. Best decision future. complex and unique client Warren Buffett is known for requirements; I worry that one 10. Personal best believing that the time to buy 5. Power people day the demand for those I am lucky to work in a truly is when everyone else is selling. We are seeing the emergence of skilled, talented and supportive professional Early in the year, as law firms new types of lenders, the non- interesting people may exceed environment that rewards were shedding people, we took banks (or shadow banks as the supply. teamwork and collaboration. that as an opportunity to invest they are more excitingly Having a talented team, rich in human capital, growing our referred to). Unconstrained by 8. Women in power in diversity of skills and financial services capabilities. the traditions and regulations Reed Smith realises that thought, means that I don’t of conventional banks, these better gender balance in always have to be on top or in 3. 2014 focus non-banks serve a variety of leadership is a key to success. front. I also work on I hope the coming year will be niches, from payday lending to For the third year in a row, important initiatives like the the year of reason, the time to vertical market lending. These the Women in Law 30% Club. Finally, I have the bring a longer term mentality nimble and diverse non-banks Empowerment Forum joy of a supportive family. to the markets. I would like to may be the trendsetters to (WILEF) has named Reed What more could a girl need

Photograph: Shutterstock Photograph: see an end to the seemingly watch in 2014. Smith to its select listing of to stay on top?

Winter 2013 27 2014 PREDICTIONS

LSE: Looking forward to a resurgence of IPOs

Xavier Rolet with customers, innovating been both inspired and and cost extraction are challenged by the fantastic Ceo, London Stock Exchange perennial strategies. people I work with, both in and outside the firm: I hope to 1. View 0f 2013 4. Major changes 7. Biggest concerns continue to be – to learn from 2013 will be remembered as We hope to see open access The outcome of the European them and to strive for success the year that confirmed the across Europe’s derivatives Parliamentary elections. and excellence in all that we emergence of the green shoots markets. In financial do. of economic recovery and the infrastructure, there will be 8. Women in power resurgence of the IPO market further consolidation and Yes. that we began to see in 2012. deeper levels of partnership between venues and 9. Green credentials 2. Best decision customers. They are important to Without doubt the acquisition us and we are focused of LCH.Clearnet – a truly 5. Power people on doing what we can transformational deal for Michel Barnier, European to be greener, such as London Stock Exchange Commissioner for financial encouraging recycling, Group and our customers. services – there are some vital running our annual decisions affecting the future ‘green week’ and playing 3. 2014 focus of European financial an active role in the Making sure SMEs in the UK marketplaces to be taken in communities in which we and across Europe have access 2014, which will in turn operate. to the right type of finance to impact us all in our pursuit of fund their development. Their economic growth. 10. Personal best success is central to the Every day since I arrived at recovery of the European job 6. Strategy London Stock Exchange

Photograph: Shutterstock Photograph: market. Continuing to work closely Group four years ago I have

Winter 2013 $$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$ US ASSETS$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$ Out$$$$$$$$$ $$of$$$$$$$$$$ $$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$ $$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$ $$$$America$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$ $$$$$$$$$$$$$$$$ $$$$$$$$$$$ $$$$$$The$$ $recent$$$ $US$ $government$$$$$$ shutdown raised $$$$$$$$$$$$$$$$$$$$$ $$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$ $$$$$$$$$questions$$$$$$ over$ the viability of US assets,$$$ but$$ $$$$$$$$$$$$$$$$ $$$$$ $$$$$$$$$$$$$$$$$ Of course, privilege has $$$$$$$$$$$$$$$$ $$$$$$$the$ $dominance$ of the dollar means investors a price,$$ and$ in$ the$ US$ $it is$ $$$ $$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$ $$$$$$$$$have$$$ few$$ alternatives,$$ writes David Wigan$$$$$a current$$$ account$$ $deficit$$ $$$$$$$ $$$ $$$$$$$$$$$$$$$$ dwarfing that of any other $$$$$$$$$$$$$$$$$ $$$$$$$$$$$ nation.$ US$ public$$ debt$$ amounts$$$ $$ $$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$hen$ the$ US$ government and Congress to slightly over$ $17$ trillion.$$$ That$$ is $just$ over$ $$52,000$$ $$$$$$$ $ reached deadlock$$$ over$ $the$ country’s$$$ $$$per$ person$$ $or, in terms of dollar bills stacked vertically, $$$$$$$$$$$$$$$$ $$$$$$$$$$ around one million miles, according to Freakonomics.$$$$$$$$$$$ $$$$$$$ budget, it prompted a$ bout$$ of $collective$$$ $$$$$$$$$$$$$$ $$$$$$$$$$$$$$$ $$$$$$$$$W$$$$head$$ scratching$$$$ around$ the world. “The US has two dominant$$ $and$ conflicting$$$$ $$$$$$$$$$$ How could it be, it was asked,$ that$ $the$ world’s$$ $$$$narratives;$$$ the$ $first$ is$ that the country has established $$$$$$$$$$$$$$$$ largest$$ $economy$$$ could$$ elect$$ leaders so debauched that itself as an economy that has huge powers of$ resilience$$$ $$$$$$$ $$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$ $$$$$$$in $pique$ $they$ push$$ their$$ nation$$ to$ the$ brink of default? and innovative capacity, which$$ make$$ US$ assets$$ $$$$$$$$$$$$ $$ Further, why does the US political$ class$ $think$ $so $little$ $$consistently$$$$ attractive$$$ to$ international investors,” said $$$$$$$$$$$$$$ of its$ creditors$$$ that$ $it plays$$ a$ game$ of dare around Ebrahim Rahbari, an economist at Citi in London.$ $$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$ $$$$$whether$$ they$$ should$$ $be $repaid?$$ $$$$ “The second is that something in $the$ US$ is$ clearly$$ $$$$$$$$$$$$$$ $$$$ The reason, not surprisingly, is because they$ $can;$ a$ $not$$ working.$$$ There$$ is$ a $growing$$ political divide $$$$$$$$$$$$$ $$$$$$$$$$ and increase in disfunctionality that has taken on $$$$$$$$$$ $$$$$$$$$fact$ neatly$$ $encapsulated in a phrase coined nearly 50$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$ $$$years$$ ago$$ by$ Valéry$$ Giscard$$$ d’Estaing,$$$ $then$ French$$ proportions which were unimaginable$ not$ so$ long$$ ago.”$$$$$$$$$$$$$$$ $$$$$ Minister of Finance. He said the reserve currency$ $$$$The$ $binary$$ nature$$ $of the$ $US$ economic$ landscape, $$$$$$$$$$$ status of the dollar$ afforded$$$ $the$ US$ an$ “exorbitant$$ with a thriving private sector offset $$$$$$$$$$ $$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$ $privilege”$$$$ that$ exempted$$$$ it from$$ the$ $normal$$ rules$$ of$ $ by a seemingly $$$$$$$$$$$$$$$$$$$ $$$$$$$ international economy. Simply put, demand for the $$hobbled$$$ political$$$ $$$$$$$$$ $$$$$$$$$$ dollar was so unequivocal$$ $that$ no$ amount$$$ of$ foolery$$ establishment, was $$$$$$$$$$$ $$$$$$$$$$$$$$$ $$$$$$$$$“The$$$ $battle$$$$ is$ $not$ to the strong, $$$$$$ would$ deter$$ the$ $world’s$$ traders$$$ from$ $acquiring$$$ it.$ $$$encapsulated by $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$The economic benefits of exorbitant privilege are the$ drama$$$ seen$ in$ $$$$nor$$ $the$$ race$ to the swift, but $$$$$$$ $$$$$$$$$$Washington in early $$$$$$$$$$ $$$$$$$$$widely$$ assumed$$$ to$ be $twofold$$ – the seigniorage created $$$$$$$$$$$$$$$$$$$$ $$$ by production of dollars$ and$ a$ useful$$ reduction$$$ in$ $$$$October.$$$$ that’s the way $to$ bet”$$$ $ $$$$$$$$$$$ $$$$$$borrowing$$$ $costs$ arising$$ from demand for Treasuries, The action started $$$$$$$$$$$$$ $$ $$$$$$$$$$$$$Damon Runyon, American author and journalist$ $$$$$$$$$$$ $amounting$$$$ to$ as$ much$$ as$ 60$ basis$ $points,$$ according$$ with the failure of $$$$$$$$$$$$$$$$ $$$$$$$ to McKinsey. There is also a third benefit, which is, as the Republican-$$$$$$$$$$$ $$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$production$ has moved abroad over the past 40 years,$ $$$controlled$$$ House$$ $of $$$$$$$$$$ $$$$$$$$$$$ $that$$ a strong$$ $dollar$ $has$ helped$$ keep$$ prices$$ under$$ control. Representatives and $$$$$$$$$$$$$$$$$ $$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$ $$$$$$$$$ Winter 2013 29$ $$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$ $$$$$$$$$$STRAP$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$ the Democrat-dominated$ Senate$$ to$ pass$$ a budget$$$ before$$ $$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$ the$ fiscal$$ $year-end$$ $on $September$$$ 30th.$$ $That$ led$ to$ the$ $$$ $$$ $$$$$$$$$$$$$$$$$$$$first partial shutdown of the US government for 17$ years,$$ $$$$$$$$$$$$$$$$ $$$$$$$$$$$$ $$and$ raised$$ the$ possibly$$$ of$ the$ first$ $default$$ in$ US$ history, $$$$ $$$$$$$$$$ with $6 billion of bonds coming due for payment at the $$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$ $$$$$$$$$$$$$$$$$end$ of$ October. Along the way, on October 17th, the $$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$ country$$$ would$$ hit$ its$ $16.7$$ trillion$$$ debt$ ceiling.$$$ $ $$$ $$$$$$$$$$ Following two weeks of brinkmanship, Congress $$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$agreed$$ to$ raise the debt ceiling, allowing hundreds $$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$ of thousands$$ of$ civil$ servants$$$ to$ go$ back$$ to $work,$$ $$ $ $$$$$$$$restoring$$$ a sense of sanity to the US political process. $$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ $$ $$$$$$$$$$$$$$The$ $government$$$ $is now funded until mid-January, the $$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$ shutdown having$$ taken$$ at$ least$$ $24bn$$ out$ of$ the$ US$ $$$$ $$ $$$$$$economy,$$$ $according to Standard & Poor’s. $$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$ $$$$$$$$$$$$While$$ the$$ budget$$ deadlock,$ shutdown and talk of $$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$ default caused widespread$$$ concern,$$$ what$$ was$ most$$ $$$$$ $$$ $$$$instructive$$$$ about$$ the period was the relatively sanguine $$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$ $$$$$$$$$$response$$ $of the$ $capital$$ markets.$$ US 10-year Treasury $$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$ yields rose a paltry nine$ basis$$ points$$ from$$ October$$$ 1st$ $$$$$$ $$$$$ $$$to$ October$$$ 14th,$$ while$ the S&P 500 equity index fell $$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$ $$$$$$$$to$ 1,655$$ from$$ 1,682,$$ giving$$$ up$ around half of the gains $$$$$$$$$$$$ $$$$$$$$$$$$$$$$$ made in the previous month. In $short,$$ while$$ investors$$$ $$$$$$$$ $$$$$$ $were$ $undoubtedly$$$$ concerned$$$ $about a potential US $$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$ $$$$$$default,$$$ few$ did$ $very$ much$$ about$$ it.$$$ $$$$$$$$$$$ $$$$$$$$$$$$$$$$ “The capital markets appeared incredibly$$$ $at ease$$ $$$$$$$$$$ $$$$$$$$$ during$$ this$ $critical$$ period,”$$$ said$ $Michael Huenseler, $$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$ $$$$$a $portfolio$$$ manager$$$ at$ Munich-based$$$$$ hedge$$ fund $$$$$$$$ $$$$$$$$$$$$$$$$ Assenagon Asset Management. “Not only$ that,$ $equity$$ $$$$$$$$$$$$ $$$$$$$$$$ indices on both$$ sides$$ of $the$ Atlantic$$$ hit$ new highs on $ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$ $$the$ heels$$ of$ the$ compromise.”$$$$$$$$$$$$ $$$$$$$ $$$$$$$$$$$$$$$$$ On closer inspection, the financial markets did$ suffer$$ $$$$$$$$$$$$$ $$$$$$$$$$ some stress. The$ so-called$$$ $TED$ spread$$ $is an$ indication$ $$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$ $of$ the$ relative$$ $security$$ of$ banks,$$ $measuring$$$ the$ $$$ $$$$$ $$$$$$$$$$$$$$$$ difference between the three-month Libor interbank $$$$$$$$$$$$$$$$ $$$$$$$$$$$ rate and government bonds$$ $of the$ $same$ $maturity.$$$ $ $$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$ The$ spread$$ $normally$$ $fluctuates$$$ $in a$ range$$ between$$ $$$$ $$$ $$$$$$$$$$$$$$$10bps$ and 30bps, with widening indicating that $$$$$$$$$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$ and perhaps more importantly to prevent the dollar $$$$$$ $$$$$$$$$$$$banks$$ are$ $slightly$$ more$$ risky$ than government bonds. $$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$ In early October,$$ $the$ spread$$ went$$ negative$$$ to$ as$ much$$ $from$$ falling$ into an inflationary decline. $ $$$$$$$$$$$$$$as 20bps,$$$ showing investors were betting that US “The US$ economy$$$ is$ structured$$$$ around$$ the$ $fact$ that$ $ $$$$$$$$$$ government debt was riskier than the$$ debt$ of$ banks.$$$ $the$$ dollar$ is the world’s reserve currency, and while $$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$ Elsewhere, haircuts$ on$ Treasuries$$$$ in$ the$ repo$$ market$$ $$the$ country$$$ benefits$ from a weaker dollar, it doesn’t $ $$$$$$$$$$rose$$ as$ banks$$ charged$ more to lend against US debt want to see its$ spending$$$ power$$ $hurt,”$$ said$ Kit$ $Juckes,$$ $$ $$$$$$$$$$$ and the Fitch rating agency put the US’s$ $AAA$ $rating$$ $a$ currency$$$ strategist at Société Générale in London. $$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$ on watch for downgrade.$$$$$$$$$$$$$“It$ is $striking$$ a$ delicate$$ balance because too much of a $$ $$$$$$$$$$Meanwhile,$$$$ the$ dollar,$ perhaps the visible indicator decline in the dollar$ would$$ mean$$ it$ would$$ have$$ to$ raise$ $$ $$$$$$$$$$ $$$$rates,$$ which$$ then$$ might create problems in terms of $$$$$$$$$$$ $$$$$$of $investor$$ $attitudes$$ $toward$$ the$ world’s$$$ largest$$ $$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ economy, languished near an eight-month$$$$ $low$ against$$ $$servicing$$$ its$ mountain$$$ of$ debt.”$ $$$$ $$$$$$$the$ euro,$$ amid$$ expectations$$$$$ that the shutdown would Still, while the US current$$ $account$$ is$ cause$$ for$ $$$$ $$$$$$$$$$ delay any decision to raise interest rates and that the$ $$concern,$$$ there$$ remain$$ compelling reasons for $$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$ $$$$$$$$$$$$$$$$$$$ resolution of the budget debate may$ be$ a$ temporary$$$ $fix$ international$$$$$ investors$$$ to$ back$$ the US. First, returns $$$$$$ $$$$$$rather$$ than$$ a $permanent$$$ solution.$$$ on US assets are relatively high compared$$$$ with$$ $$$$ $$$$$$$$$$ “The treatment of such important matters not $developed$$$ $market$$ rivals.$$ From$$ 1947 until 2003 the $$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$ $$$$$$$$$$$$$$$$$$$ only caused economic damage in the present,$$ but$$ $$US$ $GDP$ $growth$$ rate$$ averaged$$$ 3.2%$$ and$ was 2.8% $$$$$$$$ $$$significantly$$$$ $damaged$$$ the$ $US’s$ credibility$$ as a in the third quarter of this year. European$$$ growth,$$$ by$ $$ $$$$$$$$$$$ benchmark currency and refuge of stability,” said contrast,$$$ has$ exceeded$$$ 3%$$ in$ only$ one decade in the $$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$ $$$$$$$$$$$$$$$$$$$ Huenseler. “Since the financial crisis originated$$ in$ the$ $past$$ five,$ $and$ averaged$$$ just$ $2.5%$ $between$$ $1961 and $$$$$$$$$ $$US,$ any$$ further$$ indications$$$$ that$$ international$$$ lenders’ 2012, according to World Economics. $$$$$$$ $$$$$$$$$$ justified interests are being disregarded would be The US also$ $has$ some$$ outstanding$$$$ natural$ $$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$ $$$$$$$$$$$$$$$$$$devastating.”$$ $$advantages,$$$$ most$$ recently$$$ illustrated$$$ by$ the$ $extraction$$ $$$$$$$$$$$ And$$ there$$ is $the$ rub.$ While$$ $the$ impact$$ of$ the$ $budget$ of vast stores of natural gas, which led to a 60% decline$$$ $$ $$$$$$$$$$fiasco was quickly forgotten, the causes have not gone in prices and a welcome$$$ $boost$ $for$ competitiveness.$$$$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$ $$$$$$$$$$$$$$$$away$$ and$ net US debt continues to grow, recently $“The$$ $US$ has$ outperformed$$$$$ most$$ large$ $economies$$$ $ $$$$$$$$$$$$$ $17tn topping $17tn.$$$ That$ $means$$ the$ country$$$ is$ dependent$$$ $ over the past 20 or 30 years and it is likely to remain $$$ Current US net debt figure $$$$$$$ $$$$$$$$ $$$$$$$$$$$$$$$$$$ on foreign investors to keep its interest$ rates$$ in$ check$$ $an$ attractive$$$$ place$$ to $make$ $money,” said Randall $$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$ $$$$$$$$$$$$$$$$$$$$$ $$ 30 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 Concerned: China PM Li Keqiang was worried control, and a huge advantage.” about a possible US default The euro, when it was launched, was The US has outperformed most conceived as a potential alternative to the large economies over the past dollar, but the recent financial crisis and subsequent collapse in growth has put 20 or 30 years paid to that idea for now. China has made noises about diversifying away from the dollar, and Germain, a professor of political science at Carleton senior officials made no secret of their distaste in University in Ottawa. “What is more interesting is respect of the recent budget furore, with prime the ability of investors to extract profits in a way that minister Li Keqiang telling Secretary of State John does not get hit by a declining dollar, and certainly, Kerry that he was “highly concerned” about a possible internationally, there is a gathering sense that the default. current dominance of the dollar as an international However, moves to diversify have found little currency is a problem.” success, and, of China’s $3.6tn in foreign exchange Over the long term, the dollar is declining, and its reserves, about 60% remain held in dollar- purchasing power between 1970 and 2010 fell by denominated assets. some 80%. The DXY US dollar index, measuring the Longer term, a viable alternative to the dollar may be dollar’s performance against a basket of currencies the Chinese renminbi itself, and Chinese authorities including the euro, yen, sterling and Swiss franc, has have made well-publicised moves to increase the declined from a high of 165 in 1984 to 120 in 2000 role of the currency, loosening capital controls, and around 80 in recent trade. encouraging trade settlement and opening swap lines However, as the dollar has declined, foreign in London and Paris. purchases of US assets have risen and foreign However, few observers believe the renminbi will ownership of “publicly-held” federal bonds jumped offer a realistic alternative to the dollar anytime soon. from around 5% in 1970, to 46% today, according to “If you look at the well-connected people in China researchers at the London School of Economics. they still prefer to send their children to school in the Of course, behind this dynamic is the politics of self- US and to buy their houses in Palo Alto and New York interest. Until the mid-1990s the US current account and Boston,” said Tsang. deficit was in the range of around $100bn. However, “That’s because it is a safe investment. Sure, the as Asia emerged as a centre for manufacturing, the politics in the US is harmful, but what other system deficit ballooned, reaching $850bn by 2006. could survive that level of irresponsibility? I wouldn’t David Wigan is a freelance journalist based in London For producer countries the surpluses generated by write it off just yet.”

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

ver since the Crystal Palace burned down third largest source of investment after the US and in 1936 there has been talk of rebuilding Japan. And all this in a period where global FDI the glass and steel pavilion originally built contracted by 17%. for Britain’s Great Exhibition of 1851. Last What, then, are the characteristics of Chinese month, the talk appeared to turn into a overseas investment? Since the introduction of Jiang Ereal plan – with the estimated £500million coming Zemin’s ‘Go-Out Policy’ in 1999, it has been from Shanghai Zhongrong Property Group and a dominated by SOEs and directed at acquiring energy, consortium of other Chinese developers. minerals and land in developing countries. To this Chinese money may also build the next generation day, SOEs account for roughly 75% of all Chinese of nuclear power stations in the UK. Other groups ODI and energy remains by far the most dominant $50.55bn have bought into Heathrow Airport, Manchester’s sector in terms of value. Airport City and Thames Water, while telecom However, ODI policy is no longer driven Amount China invested overseas in the first half 2013 manufacturer Huawei is establishing a vast new exclusively by resource insecurity, as reflected in a corporate centre along with £1.3billion of investment survey conducted by the Economist Intelligence Unit, in the country. in which 48% of firms surveyed stated that they were This is not how things used to be – until recently planning to invest overseas, but only 26% were while money was pouring into China, it was goods motivated by natural resources. that poured out. But now China seems to be buying The regional spread of Chinese ODI is also more the world. Starting with huge investments in natural diverse than previously thought. Southeast Asia has resources by state-owned enterprises (SOEs) during seen the most investment, accounting for 30% of the commodities boom, the private sector is now China’s total ODI since 2005, while Hong Kong pioneering massive deals around the world. remains the number one choice for mainland Of course, China continues to attract record levels investors. However, the next three regions – North of foreign direct investment (FDI) itself. According to America, Europe and Sub-Saharan Africa – received data published by the Ministry of Commerce an equal distribution of 11% each, closely followed by (Mofcom), in the first seven months of 2013, China Australia, Brazil and Canada, where investment has attracted $71.4bn in FDI, an increase of 7.1% from focused almost exclusively on energy and metals. the same period in 2012. The weight given to Europe and North America Equally as significant, though, were the levels of reflects a trend in which Chinese investors are seizing outward direct investment (ODI), which totalled opportunities created by the economic downturn to $50.55bn, an increase of 19.7%. Last year, China’s compete in mature markets. According to ODI more than doubled and the country became the Organisation for Economic Co-operation and

32 Winter 2013 Yuan direction

ODI policy is no longer driven by resource security

Winter 2013 33 Development data, the share of Chinese investment competitive in international markets. These industries going to developed countries has increased from one also promise better yields than primary resources, and tenth in 2002 to two-thirds in 2012. China is the the government is therefore encouraging companies fastest growing source of FDI in the US, while in to invest in more diverse areas like infrastructure, terms of M&A the UK has received the greatest high-end property and “emerging strategic industries” proportion of Chinese investment after Hong Kong. such as next-generation IT, energy conservation, These figures come with a warning. According to a biotechnology, high-quality equipment China analyst at the European Council on Foreign manufacturing and renewable energy. Relations, data for Chinese ODI is distorted by the We can see evidence of this in the UK, where last manner in which Chinese ODI is typically channelled year China was the third largest investor by number of through offshore financial centres such as Hong Kong, projects. The UK government has framed a the Cayman Islands and the British Virgin Islands comprehensive, structured and positive approach destined for developing countries. She conceded that towards Chinese investment. Trade envoys led by there has been a marked shift towards diversification, George Osborne and David Cameron are opening the but warned against exaggeration: “From the outset, way for Chinese investment and, with the easing of investment in energy and resources in developing entry rules to the UK, major Chinese banks will soon countries has offered greater be able to establish branches in Obama and Cameron: Both US and returns and has been London for wholesale activities, UK have benefited from China’s investment machine strategically more simple than allowing them to conduct engaging heavily with Europe “There has been a business locally while remaining and North America and, regulated under Chinese law. though China’s style of ODI marked shift towards Speaking about these plans, one has begun to shift, it remains bank manager, at a large Chinese primarily targeted towards diversification” commercial bank that recently developing Latin American opened its first overseas office in and African countries.” London, commented: “The scale The shift in Chinese ODI began during the on which our clients have ‘gone global’ is really financial crisis of 2007-08, which effectively shut down amazing. We were aware of it when I was in Shanghai, western capital markets and lent a new attractiveness to but only when we came here did we realise across how Chinese investors previously priced out of the market. many different markets they are succeeding.” Chinese companies were now seen as strategic According to data published by the Heritage investors, bringing with them access to capital and a Foundation, the most significant industries for Chinese growing Chinese market. According to Huo Jianghuo, investment into the UK are energy, finance, president of the Chinese Academy of International agriculture, property and transportation. Other Trade and Economic Co-operation, Chinese investors important sectors include infrastructure, such as China were aided by debt crises and slowing domestic growth, Investment Corporation’s investments in Heathrow which “opened up great opportunities for Chinese and Thames Water. CIC, China’s sovereign wealth enterprises to invest abroad, and the appreciating yuan fund, is a state investment vehicle, but it is not directly helped the process”. run by the government. In recent years, it has been Another factor in the development of Chinese ODI diversifying and is notably branching into real assets. was the opening up of China’s economy, which has While the CIC is an important leader, private firms 9.5% created opportunities for Chinese firms to go global. are also an increasingly key source of Chinese The amount of ODI coming from Central initiatives enabled China’s railways, investment. Data from The Economist shows that, in private Chinese firms construction and renewable energy to become more 2012, private firms accounted for 9.5% of Chinese

34 Winter 2013 CHINA INVESTMENT

ODI, compared with less than 4% two years earlier. investment, which largely explains why Chinese Zhao Zhongxiu, vice president of the University of interests are taking more of the market, particularly International Business and Economics in Beijing, in services, technology and energy. According to the explains: “There are two types of firms: big state-owned ECFR analyst, European governments show very little companies that wish to acquire foreign technologies and resistance to anti-competitive practices by Chinese resources, and the more nimble small and medium- companies: “Obstacles which typically hinder sized private firms that look for business opportunities Chinese investment in developed countries are being in overseas markets.” The analyst at ECFR reiterated weakened as individual EU member states recognise that the trend towards diversification of Chinese ODI is the potential value of Chinese inflows. This was being driven by the private sector: “Chinese private indicated in the relatively swift and, in many ways, firms are generally welcomed more openly in developed weak response towards disputes over anti-dumping markets. They are able to take advantage of the greater tariffs on Chinese solar panel imports. Division across UK PM David Cameron meets returns available and the diverse range of industries in member states and desperation to maintain Chinese Chinese president Xi Jinping during a trade mission in December which they can invest.” This drive to diversify is investment meant the resolution was upheld, and beginning to impact the dominance of natural Chinese investment in the EU continues to grow.” resources: “Energy and mining are still paramount, but Despite its size, breadth and rapid expansion, then, diversification will slowly eat into the high percentage of Chinese ODI may well be considered to be in what resource-driven investment.” vice-premier Ma Kai has called a “nascent stage”. So while opportunities for Chinese companies – Aside from the challenges faced by private investors as both private and state-owned – exist, so too do latecomers to international markets and the risks of obstacles, as shown by the starkly different association with state power, even the more experiences of technology giant Huawei in the UK established model of state-led investment in natural and US. Huawei is one of the largest mainland resources was threatened by the events of the Arab Chinese investors in the UK and in 2012 it pledged to Spring, when Chinese companies and personnel in invest a further £1.3bn in its UK operations. Libya were forced to make a hurried exit, abandoning However, in the US, the company has faced public projects estimated at $7bn. North African countries, opposition due to the perceived closeness of Ren including Libya, Algeria and Morocco, now top the Zhengfei, the company’s founder, to the Ministry of list of countries perceived by Chinese companies to be State Security. This opposition culminated in October the highest-risk, and the government has 2012, when a US congressional panel warned of a implemented a programme to compile country risk national security threat posed by Huawei and profiles and devise risk management strategies and recommended barring the company from early warning systems. This exposure to the risks of participating in any US mergers and acquisitions. violence and political upheaval has created a further Huawei’s US troubles illustrate how regulatory and incentive to diversify away from higher-risk sectors political hurdles in western markets are among the into mature markets. highest risk factors perceived by Chinese companies Chinese investment, then, is more diverse, looking to invest abroad. While there is evidence of a geographically spread and dynamic than is often growing understanding between US regulators and portrayed. While state actors continue to dominate Chinese businesses – the US recently approved the strategic sectors, such as energy and natural resources, $7.1bn acquisition of Smithfield Foods, the country’s we are beginning to see an unmistakeable shift up the largest meat producer, by Shuanghui International – value chain towards advanced technology and mature political opposition and public mistrust remain markets, in which the private sector has emerged as a concerns for Chinese investors. significant force, driving many of the largest and most Alice Shone is a senior analyst at Salamanca Group

Photograph: Crown copyright Crown Photograph: The EU, meanwhile, is more open to Chinese prominent deals.

Winter 2013 35 BOOK REVIEW x Making It Happen: Fred Goodwin, RBS and the Men Who Blew up the British Economy

by Iain Martin

Book review by Nicholas Dunbar

he collapse of the Royal Bank of Scotland This empire building made the now knighted in October 2008 and its £45bn bailout by Goodwin difficult to challenge at board level. the UK government was the most Martin reveals that RBS chairman, Tom McKillop, traumatic event in British banking for over felt uneasy about Goodwin’s management style as a century and heralded the start of a steep early as 2005 and considered replacing him, but recessionT and a period of austerity, triggering a public decided to do nothing. By this point both McKillop backlash against bankers that continues today. and Goodwin were out of their depth as RBS It has taken five years for the first book-length depended increasingly on investment banking account of RBS’s rise and fall to be published, far revenues to beat earnings targets. Here, another key longer than it took for books on Lehman and the figure in RBS’s collapse makes his appearance, US banking crisis to reach print. That may reflect Johnny Cameron. Cameron ran corporate and the political context behind RBS, whose balance investment banking and, according to Martin, was Published by Simon & Schuster 2013 sheet in 2008 was 30% larger than the UK’s gross the one RBS executive who intimidated Goodwin. domestic product. Such a concentrated impact by Yet Cameron was also out of his depth, as the one institution on a single national economy means bank’s RBS Greenwich subsidiary built up a that a relatively small number of people can be held subprime CDO business unchecked and without responsible for what happened: Fred Goodwin, RBS regard for risk. chief executive, and the bank’s board members Martin documents the one honourable executive along with its senior executives, major shareholders, to raise questions at RBS, risk manager Victor advisers, regulators and politicians. Some of these Hong. Hired from JPMorgan in September 2007 to people had a vested interest in not seeing a full look at Greenwich’s CDOs, Hong resigned six reckoning come to light. weeks later when he was blocked in his attempt to Iain Martin is well qualified to write a book mark down the bank’s positions. exploring the personalities and dynamics behind Hong’s resignation came just after RBS completed RBS’s rise and fall. A former editor of The its takeover of ABN Amro, increasing its CDO Scotsman, he describes the clubby world of exposure even further. That takeover is perhaps the Edinburgh finance and politics that led a staid most terrifying part of the RBS story. Key 300-year-old institution to grow into one of the stakeholders felt compelled to go through with the world’s biggest banks. Martin believes that RBS’s deal even as the subprime meltdown began, in effect failure was largely the result of a failure to stop signing the bank’s death warrant. At the end of the Goodwin, hence the book is as much a biography of book Martin asks whether Britain’s own too-big-to- him as RBS. fail bank was also too big and complex to exist in the An ambitious accountant from Deloitte, first place. Goodwin entered banking in the 1990s on the Since its bailout, RBS has continued to reveal strength of his obsession with detail and ability to itself as a repository of everything that was wrong drive through change. This obsession with detail with finance – misselling of payment protection extended to matters like the tidiness of bank insurance, mortgage-backed securities and branches, the colour of company cars and the shape interest rate swaps and, most notably, the Libor of filing cabinets, but not issues like risk or credit. rigging scandal. As giant banks continue to His other perceived strength, driving through surprise us, Martin’s book is the best argument change and integrating large organisations, led him yet for breaking them up and curtailing the Nicholas Dunbar is a into acquisition mania, culminating in the takeover wholesale markets that allow wrongdoing to financial journalist and author of The Devil’s Derivatives of ABN Amro. flourish.

Winter 2013 37 SHORT DURATION

its purchase of US Treasuries and mortgage-backed When 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? rates 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 Portfolio portfolios since the beginning of the credit crisis. applications for rise With $2.7 trillion in money market mutual funds short duration (MMF) in the US, €477 billion in Europe and $9.5tn fixed income With global interest rates of deposits at banks in the US, investors are seeking the safety of cash equivalents. US corporate balance Reduce interest rate risk within a portfolio - Short at historic lows, many fixed sheets also collectively carry over $1.5tn of cash duration bond funds can be balances as corporate treasurers have faced an paired with other fixed- income investors have rightly uncertain investment climate. In Europe, income holdings to reduce become concerned about future approximately 50% of corporate treasurers use the overall interest rate risk of institutional money market funds to manage their a portfolio. Depending on the desired risk tolerance, performance during the next excess cash positions. investors can select funds With shortterm interest rates near zero, real rates of with an average duration of rate cycle, writes return may be negative after inflation. The average less than three years to meet Karen Schenone institutional money market mutual funds are yielding this objective. 0.01%, 0.03%, and 0.35% for US dollar, euro and Seek income relative to sterling-denominated funds, respectively. Inflation cash equivalents – For rates, as measured by the local consumer and retail investors with income goals, entral banks including the US Federal price indices, range from 1.0% to 2.6% across the short duration bond funds with credit risk can provide Reserve, Bank of England and European US, UK and eurozone. After inflation, cash investors additional income relative to Central Bank have pursued zero interest are experiencing negative real rates of return. For constant NAV money market rate policies and large scale asset investors that require principal protection, stable or funds or bank deposits. purchases (known as Quantitative constant net asset value money market mutual funds Portfolio diversifier – With CEasing) to provide stimulus to the economy. As the and bank deposits are the ideal investment options. low or negative correlations fundamentals of the economy improve, central banks However, if investors are willing to accept some to equities and core fixed will eventually change their tactics by reducing the additional risk in the form of credit, interest rate or income, short duration fixed amount of bonds on their balance sheets and even liquidity risk, they may be able to keep pace with or income can add a level of portfolio diversification and increasing shortterm interest rates. Due to deflationary even overcome the impact of inflation. The choice of can potentially help smooth pressures, the ECB cut the main refinancing rate by selecting a cash equivalent or short duration bond returns. 0.25% to 0.50% on November 7th. While the US fund will depend on the investor’s portfolio goals, Federal Reserve has not yet begun to taper or reduce income needs and liquidity considerations.

38 Winter 2013 Trading off interest rate risk for credit risk With a variety of portfolio applications, short Bond prices fall when interest rates rise. The degree duration fixed income should continue to be a theme of the price decline can be approximated by throughout 2014. With interest rates at historic lows, duration, which measures the interest rate short duration fixed income, particularly fixed and sensitivity of a fixed income security. Longer floating rate investment-grade credit, can help duration bonds experience larger losses than shorter investors mitigate the impact of increases in interest duration securities when interest rates rise. One rates and inflation on investment portfolios. 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 Karen Schenone, CFA is a fixed income strategist oversimplified since interest rates tend to not at BlackRock based in San Francisco increase uniformly across maturities. Additionally, credit spreads tend to move inversely to interest rates. If interest rates are increasing due to Central banks have pursued zero interest rate policies favourable economic conditions, credit spreads tend to tighten as corporate profitability and bond 7 ECB Main Refinancing Rate US Fed Funds Target Rate market liquidity improves. Tightening credit 6 UK Bank of England Official Bank Rate spreads cause prices to increase on corporate bonds and can offset price declines driven by increases in 5 government bond yields. Investors have sought out short duration solutions 4 to help protect against rising interest rates, while still

Rate (%) 3 seeking income. While shortening the duration of bond portfolios can help mitigate losses in a rising 2 rate environment, doing so may also impact the portfolio yield. In an upward sloping yield curve, 1 longer duration bonds offer greater yield in return for - the increased level of interest rate risk they carry. A Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec Dec duration shortening strategy may therefore result in a 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 lower portfolio yield. As the total return of a bond or Month/year a portfolio of bonds is driven by both the income generated and price changes, investors must balance Credit spreads and interest rates these two objectives when constructing a fixed income portfolio. 600 Correlation of daily Fixed vs floating rate securities 500 changes = (0.52) Allocating to short maturity or floating rate credit 400 can potentially achieve the goals of boosting yield and reducing interest rate risk. Typically, short 300 maturity bond funds will track a bond index that includes securities with maturities ranging up to 200 Spread or yield in bps three or five years. This low range of maturities 100 keeps the average duration of the index less than three years. For example, the Markit iBoxx USD - Nov Nov Nov Nov Nov Nov Nov Liquid Investment Grade 0-5 Index includes dollar- 2006 2007 2008 2009 2010 2011 2012 denominated bonds with maturities ranging up to Month/year five years and has an average duration of 2.45 and a 10 Year US Treasury yields Investment grade credit spread yield to maturity of 1.59%. Source: BlackRock, Bloomberg and Markit iBoxx from November 2006 to November 2013 Investment grade floating rate notes also offer investors direct protection against shortterm Short duration bond index interest rate increases. These securities have coupons that contractually reset, typically quarterly, against Coupon type Maturity range Index yield Index duration ETF solution a reference index such as Libor or Euribor, so the Markit iBoxx USD Fixed 0-5 Years 1.59% 2.45 SLQD (US) Liquid Investment SDIG (Dublin) duration tends to be very low (less than 0.25). The Grade 0-5 Index bonds carry a fixed credit spread that is set at Markit iBoxx GBP Fixed 1-5 Years 2.70% 2.75 IS15 (Dublin) issuance. The coupons are the sum of the shortterm Corporates 1-5 Index interest rate and the bond’s credit spread. As central Markit iBoxx GBP Both Fixed Fixed: 0-1 year 1.04% 0.22 ERNS (Dublin) banks are adjusting their target rates, such as Fed Liquid Investment and Floating Floating: 0-3 Funds or the main refinancing rate, the respective Grade Ultrashort Index Years Libor or Euribor index should also increase. The Markit iBoxx EUR Liquid Both Fixed and Fixed: 0-1 year 0.74% 0.33 ERNE (Dublin) Investment Grade Floating Floating: 0-3 bond’s coupons will reset higher and the investor Ultrashort Index Years will collect more income on their investment. Markit iBoxx USD Both Fixed and Fixed: 0-1 year 0.80% 0.32 ERND (Dublin) During rising rate environments, these bonds will Liquid Investment Floating Floating: 0-3 generally react more favourably than fixed rate Grade Ultrashort Index Years securities. 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 DisruptiveDisruptiveDisruptiveDisruptive world worldworld world ow is the time to throw a spanner in the recognition and respect – the group was awarded the works. If industrial development Nobel Peace Prize in 2007. continues along its current path, we will Perhaps the IPCC could have said it a bit find ourselves scavenging for ever scarcer differently. How about, if industrial development resources. Nothing less than a disruption continues with a business-as-usual mindset, “the ofN the thinking, policies and processes can put us on a planet’s goose is cooked”. This comment comes from more sustainable path. a 2011 letter to investors from one of the world’s top The seriousness of the issues facing us was fund managers, Jeremy Grantham, founder of GMO highlighted in September when the (Grantham, Mayo and van Oterloo) with over $100 Intergovernmental Panel on Climate Change billion in assets under management. published the Summary for Policy Makers for the Grantham, a hard-nosed money man, simply Fifth Assessment Report. The IPCC is the leading looked at reality and the basic facts. There are over international body for assessing the state of climate seven billion people living on earth, and only one change on Earth. Its work has received the highest 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 Quotes from the recently released resource depletion, damage to ecosystem carrying summary include: capacity, climate change and many other problems. “Human influence on the climate system is clear.” Without transformational change, the goose is going to get cooked. “The atmospheric concentrations of carbon dioxide, methane, Historically, sustainability has been about doing and nitrous oxide have increased to levels unprecedented in at good, with the corporation seeing sustainability as a least the last 800,000 years.” way of making up for its negative impact. More recently, business leaders have seen that sustainability “Continued emissions of greenhouse gases will cause further measures can lead to increased efficiencies and cost warming and changes in all components of the climate savings. So, more than just doing good, it can be about system. Limiting climate change will require substantial and doing well. Doing good and doing well are signs of sustained reductions of greenhouse gas emissions.” good management, but this approach to sustainability is not transformational at the scale required.

40 Winter 2013 CLIMATE CHANGE

profitable the business is, the greater the dilemma. Disruptive When sustainability was about doing good or doing sustainability is: well, it made sense. Chief executives could understand why they were doing it – it held the When a house can be 1 heated and cooled to the promise of making their companies look good and it same level of comfort as a could save them money. It was a management conventional residential “no-brainer”. building of comparable size But now that sustainability is becoming more about while using only 5% of the the hard to measure and harder to manage aspects of energy. addressing disruption, large and profitable corporations When a high-performance face a real challenge that they are ill-equipped to 2 zero-emissions car can be driven from New York to address. Michael Biddle perhaps said it best: “The Boston, with a half-hour traditional virgin (plastics) industry does NOT want to pitstop for refueling – and the see recycling happening in a big way because it is fuel is free. competitive with their existing businesses,”. He is the When the relationship founder of MBA Polymers, a company that uses 3 between a utility and its rubbish as the source for making 150 thousand metric customers is fundamentally tonnes a year of high-grade plastics that satisfy the redefined by changing roles – most exacting customer requirements. MBA Polymers customer as generator and seller of clean energy and is disrupting the plastics industry. “This kind of utility as buyer and distributor. thinking is a major roadblock to large companies who have a fear of cannibalism.” Large, established and When a small home 4 cleaning supplies startup successful companies don’t want their more profitable can capture ever growing businesses being disrupted by lower-margin operations market share from industry – even their own. Many try to fight the disruption by giants because its products sticking with old business models that today are highly don’t leave a thin film of toxins on kitchen and bathroom profitable, but in the coming years will become surfaces and actually clean outdated, burdensome and eventually a threat to their them better. existence. When new financing The choice between recognising and embracing 5 models take the capital disruptive sustainability or sticking with good and operating expenses out of management practices that have worked so far – that the cost of clean energy and is the sustainability dilemma. Disruptive provide electricity at sustainability is about fostering a different kind of competitive rates that are fixed for decades. thinking: a systems perspective of business characterised by the emerging principles of the When a 100% recyclable DisruptiveDisruptiveDisruptiveDisruptive world worldworld world industrial carpet, designed information economy: self organisation, 6 Additionally, it may be blinding ceos into thinking using a rainforest floor as they are doing what is necessary, when in fact there interdependence and diversity, which are also inspiration, becomes the best- are more significant changes taking place in the characteristics of our living planet of which the selling product in the global economy. From doing good and doing well, economy is a subsystem. company’s history and sustainability is now entering a third phase, doing Disruptive sustainability shows how the most redefines an industry. differently, and creating disruption. urgent economic, environmental and social challenges When a major property Disruption over the next 20 years will happen as of the 21st century present disruptive opportunities 7 developer announces the two to three billion more people set about trying to for business. According to the new book, Creating construction of the largest net- zero energy commercial improve their living standards. It is simply not Climate Wealth by Jigar Shah, there is a $10 trillion building in the US, and finds it possible to do this through the expansion of current opportunity in building a sustainable global economy. fully leased two years before it practices, given the Profitability is not a even opens. greater demand for bad word. When a five-year-old resources, the Disruptive 8 hospitality company that increased carbon The larger and more profitable sustainability will helps property owners emissions and other the business is, the greater show how high increase their asset utilisation environmental profits, a respect for through sharing and renting among peers, and brings in impacts. the dilemma people and a hundreds of millions of dollars To meet these sustainable planet in annual revenues without challenges, there are not trade-offs, building, owning, leasing or will have to be a complete transformation in how we but the essential and interdependent outcomes of a managing a single property. obtain and use energy, how we feed ourselves, how we well-managed, sustainable system. travel, how we make and use goods and how we work Disruptive sustainability comes down to a very and collaborate. Transformation to a sustainable simple choice: Disrupt or be disrupted. It is difficult global economic system will mean disruption. for organisations – especially large ones – to leave Sustainability, if it is to be effective and done at scale, behind practices that have brought success in order to will have to disrupt business-as-usual. This is pursue a disruptive form of sustainability, a pursuit Andrew McKeon is Director disruptive sustainability. that will require a change in management thinking. of Operations for the Markit Moreover, disruptive sustainability represents a real Yet for any business to grow and prosper in the 21st Registry and founder of the BusinessClimate Network dilemma for corporations. The larger and more century, nothing less will be sufficient.

Winter 2013 41 COMMENTARYMARKET ANDCOMMENTARY DATA Economics The pace of global lthough risks certainly economic growth is abound, there is plenty A of scope for growth to gradually reviving from surprise on the upside in 2014. the slowdown seen earlier The third quarter of 2013 saw the fastest rate of global economic in 2013, albeit taking growth since early 2012, according a bumpy route 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 PMI surveys showed that business for a second successive month of doubt can also turn around and activity in both manufacturing in November. The renewed become stronger growth drivers. and services bounced back in the downturn in the data has been First, there have been widespread US during November, having been sufficiently worrying to force concerns about the US economy, temporarily disrupted by October’s another interest rate cut out of the which is undergoing fiscal government shutdown. The US European Central Bank. tightening and heightened surveys, which now include This may be too pessimistic uncertainty arising from political Markit’s new services PMI, also a view of the single currency wrangling over the deficit and debt showed private sector job creation area’s recent growth trajectory. ceiling. However, the economy is continuing to run at a rate of The upturn in the official data looking surprisingly resilient in the around 150-200,000 per month; earlier in the year always looked face of these headwinds. Markit’s high enough to encourage the Fed too good to be true (especially to start ‘tapering’ its stimulus. an eyebrow raising growth surge It is also likely that the financial in France), contrasting with Global economic growth markets, as well as businesses, still weak survey data. That the PMI GDP annual % change have already priced in a Fed taper, official data have since fallen back 65 7% and that – communicated in is therefore no surprise. What is the correct way – a very gradual instead encouraging is that the 60 5% unwinding of policy can avoid PMI surveys signalled a consistent financial market calamities. return to growth in the five months 55 3% The second often-cited cause of to November. Although the PMI

50 1% worry for the year ahead is that has indeed fallen for two months the eurozone’s recovery appears to so far in the fourth quarter, the 45 -1% be wavering. Official GDP data decline has been only very modest showed the region pulling out and the picture remains one of 40 Global PMI Output Index -3% Global GDP of recession earlier in the year, stark contrast to the steep rate of

35 -5% but have since weakened again, decline seen in the single currency 2000 2002 2004 2006 2008 2010 2012 raising the possibility of a slide area earlier in the year. Year back into recession. The region’s Markit’s Business Outlook Source: Markit/JPMorgan PMI has also disappointed, falling Survey reinforces this message of a

42 Winter 2013 MARKET COMMENTARY

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 European-wide recovery in 2014. such as the UK, which has seen hitting record highs. However, and Japan could drive a marked Optimism about the year ahead in the monthly PMI surveys running companies’ views on their upturn in the global economy in the eurozone hit its highest since at the highest levels since the late- prospects for the year ahead 2014 and beyond. mid-2011 in October, notably 1990s. Business activity is surging remain subdued, and even Much, of course, depends improving in the ‘periphery’. in services, manufacturing and slipped compared to mid-year. on the political environment, Confidence rose in all of the four construction, and households Companies were in many cases as this will to a large extent largest eurozone nations. are feeling better off due to harbouring concerns about determine whether companies The improvement in the rising house prices, a reduced growth prospects in other Asian are comfortable boosting their eurozone economy, and the squeeze on real wages and falling countries, especially China. investment. The US needs reduced uncertainty arising from unemployment. This slower growth phase to avoid further uncertainty the calming of the region’s debt In Japan, like in the UK, the in the emerging world is the relating to its fiscal issues, crisis, has benefitted neighbours PMI surveys have also been third area of concern for the eurozone leaders need to keep global outlook. The PMI the region’s recovery on course Emerging market PMI surveys surveys deteriorated to signal with banking sector reform stagnation across the board and integration, and Japan’s PMI Output Index (manufacturing & services) among the BRICs earlier in the government – like other Asian 65 year. Markit’s global Business powerhouses such as China and Outlook Survey has since found India – needs to push through 60 companies’ optimism sliding to economic reform. Plenty of 55 new post-crisis lows in India and scope, therefore, for recoveries Russia in October, while China’s to be derailed, but there is also 50 outlook failed to plenty of upside risk to recent 45 improve on the gloomier economic forecasts.

40 China India Brazil Russia 35 Chris Williamson

30 chief economist 2009 2010 2011 2012 2013 [email protected] Year @WilliamsonChris Source: Markit/HSBC Photograph: Shutterstock Photograph:

Winter 2013 43 COMMENTARYMARKET ANDCOMMENTARY DATA Photography: Shutterstock Photography:

owever, it has not been close to their tightest levels for debatable. a steady progression up the year. The Fed’s QE taper The performance of the Hthe volume scale, which didn’t materialise as expected CDS market this year seems is a reflection of the discordant in September, giving the credit to illustrate that investors are performance of global credit markets all the incentive they going further down the ratings CDS markets. needed to embark on another rally. scale, presumably because of Talk of asset price bubbles In the middle of the year, Hence it was little surprise to the compression in spreads at spreads spiked wider when the hear the word “bubble” make investment grade level. CCC was all the rage in the first US Federal Reserve signalled a comeback. Janet Yellen, the spreads across the globe have half of 2013, and as we that it was preparing to taper its proposed new chair of the Fed, rallied by about 40% since the head into the year-end it quantitative easing programme. looks set to continue in the same beginning of the year, while single Volatility in the Chinese vein as the incumbent, Ben A spreads tightened by just 14%, seems the chattering is interbank market – sparked by the Bernanke, which is good news according to data from Markit getting louder People’s Bank of China’s refusal for risk assets, at least in the short Sector Curves. A typical CCC to provide liquidity – didn’t help term. credit now has a five-year spread matters. However, when she was of about 750bps, the tightest level Many investors now feared that questioned by senators on the since May 2011. the bursting of the bubble was issue of asset valuations, Yellen The cash market paints a similar upon us, and risk aversion was the took a stance that raised eyebrows picture. Issuance in CCC bonds order of the day. High-beta credits in the markets. She said that there has soared and yields have fallen, and emerging market names is “limited evidence of reach for leading many to posit that a bore the brunt of the sell-off, as is yield” and the Fed doesn’t see a speculative bubble has formed. usually the case. But the anxiety “broad build-up in leverage”. Yellen’s view to the contrary may proved shortlived, and spreads The reasoning behind the latter well be right, but there is little soon resumed their march tighter. statement is understandable doubt that evidence can be found By November, both the Markit – corporate and household that suggests otherwise. iTraxx Europe and Markit CDX. balance sheets are in better shape It seems unlikely that issuers NA.IG indices had not only compared with previous periods. with poor credit quality would recovered from the summer But her assertion that investors find it so easy to sell debt without malaise, they were trading at or are not grasping for yield is clearly the excess liquidity created by

44 Winter 2013 MARKET COMMENTARY

CCC spreads outperform in 2013

1300

1200

1100 'CCC' markit sector

1000 Bps 900

800

700

600 Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct 2012 2013 2013 2013 2013 2013 2013 2013 2013 2013 2013 Month/year Source: Markit the Fed and other central banks. If investors feel they are being considerable buffer, and its Ireland leads the periphery adequately compensated for risk, issuance next year is only €6bn- 900 then the valuations are justified. €10bn. 800 Ireland But the Fed has already warned Aside from its cash cushion, the Spain Italy banks to limit origination of Irish government no doubt had 700 loans to lenders with weak other reasons not to take up the 600 credit standing, and interest rate option of a backstop. A PCCL 500 exposure is considerable for many comes with considerable fiscal

Bps 400 issuers. surveillance, and Kenny may Yellen acknowledged there were have thought that the Irish people 300 risks to the current policy of QE, have endured enough austerity – 200 and said “this programme cannot particularly with a general election 100 continue forever”. In response to little more than two years away. 0 a question from a senator, Yellen Ireland’s CDS spreads are Nov Jan Mar May Jul Sep Nov Jan Mar May Jul Sep said she would have the courage now at 127bps, more than 2011 2012 2012 2012 2012 2012 2012 2013 2013 2013 2013 2013 Month/year to pop a bubble. High yield 600bps tighter than they were Source: Markit investors will be hoping that time trading two years ago. Most is some way off. of this improvement is due to China’s sovereign CDS rallies Regardless of valuations in a combination of the ECB’s the capital markets, it would be Outright Monetary Transactions 200 hard to describe the eurozone as a programme and the EU short 180 bubble economy. Growth remains selling ban on European 160 anaemic, and Markit PMI sovereigns, but Ireland has 140 surveys indicate that the picture is outperformed other names in the 120 unlikely to improve anytime soon. periphery. Greece aside, Portugal 100 Nonetheless, the markets are is in the worst position and will 80 rallying, and it isn’t all doom probably find it more difficult 60 and gloom in the currency than Ireland to exit its bailout 40 bloc. Ireland took a big step without a PCCL (or possibly 20 China Markit iTraxx Asia ex-Japan IG towards fiscal normality after it the more onerous Enhanced 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov announced that it would make a Conditions Credit Line). It will 2013 2013 2013 2013 2013 2013 2013 2013 2013 2013 2013 then be in a position to tap the clean exit from its EU bailout. Month/year Prime Minister Enda Kenny OMT, which won’t be an option Source: Markit said the country would leave the for Ireland as it won’t be under three-year rescue programme in EU supervision. plenum was greeted positively – However, China has its own December and would not request Markets in developed countries liberalisation of capital markets bubble problems, and how it a Precautionary Conditioned are being propped up by central and state-owned enterprises should deals with the intertwined issues Credit Line from the European banks, but valuations in emerging be welcomed. The sovereign’s CDS of overinvestment and bank bad Stability Mechanism. markets are also under scrutiny. spreads hit 65bps, debts will have a crucial bearing It was a momentous event for As we saw in the summer, their tightest level on spread direction in 2014 and Ireland, but the sovereign’s CDS when central banks threaten to since March. beyond. and bond spreads barely moved. withdraw liquidity, emerging On the face of it, this is somewhat market debt can be badly surprising given the country affected. The Fed clearly has a Gavan Nolan director, credit research is about to brave the capital large part to play, but China is [email protected] markets unaided. But Ireland has also an important player. @GavanNolan about €25bn in cash, giving it a The outcome of China’s third

Winter 2013 45 MARKET COMMENTARY Markit iBoxx indices Diverging monetary Markit iBoxx CVBX index, which of a euro break-up, supported by consists of 100 USD-denominated Draghi’s “all that it takes” policy to policies in the US and convertible bonds, has returned preserve the monetary union. Europe have shaped close to 20% in the year to date. Improved economic data in different fixed income In Europe, the periphery some countries also supported the significantly outperformed the higher returns. Spain officially market return profiles core over the last three months and exited recession in the third across the Atlantic in the year to date. Bond returns quarter of this year, with GDP of BBB-rated countries have growing at 0.1%. The country has skyrocketed this year, with iBoxx benefited from strong exports, a hile in the US the € Spain returning 10.8%, iBoxx € development that could sustain focus is on the pace of Ireland 10.2% and iBoxx € Italy further momentum on the back of W reducing purchases of 6.2%, while the AAAs – Germany, declining labour costs. government and mortgage related Netherlands and Austria – were In Italy, on the other hand, debt, in Europe the central bank markets have the capacity to mostly negative to flat. The main a weak coalition government is engaging in easing monetary become volatile if the next round reason for that is the reduced risk continues to cause concern and the conditions following worse than of fiscal plan renegotiations in expected inflation numbers. December turns out to be another Total return performance - corporates developed As a result, while the Markit battle. All these uncertainties Index Total return performance iBoxx $ Overall Index returned leave the Fed with few choices MTD QTD YTD 1Y 3Y just 0.15% since August, the but to continue its bond purchase USD Markit iBoxx € Overall Index programme. Corporates -1.05% 0.54% -2.02% -1.92% 13.40% rose 1.13% for the same period. The news of Janet Yellen’s Financial -0.64% 1.21% 0.70% 1.32% 16.19% In the UK, improving economic nomination as Fed chairwoman Non-Financial -1.30% 0.14% -3.65% -3.86% 12.02% conditions have brought down enforces this expectation, given GBP spreads on corporates, driving her policy convictions relating to Corporates -0.77% 1.78% 3.02% 3.49% 21.90% the iBoxx £ Corporates Index to supporting economic growth with Financial -0.39% 2.50% 5.23% 7.04% 26.27% return 1.78% since August. The monetary tools. Non-Financial -1.04% 1.26% 1.45% 0.99% 20.32% accelerating recovery in the UK Market expectations on the EUR has spurred bets that the Bank of continuation of monetary Corporates -0.08% 1.20% 2.40% 3.55% 15.93% England will start raising rates easing led to the iBoxx $ Financial 0.01% 1.46% 2.98% 4.64% 16.91% earlier rather than later. Treasuries Index delivering a flat Non-Financial -0.15% 0.99% 1.94% 2.68% 15.43% The recent debt ceiling crisis performance of 0.1% over the past in the US, which was partly three months. Total return performance - high yield

resolved by extending government The outlook for credit markets Index Total return performance funding until mid-January, will remains good, following strong MTD QTD YTD 1Y likely contribute to limiting earnings announcements over CAD 0.16% 1.56% 3.90% 4.00% the Fed’s decision agility. First, Q3. Improving credit conditions EUR 0.37% 3.25% 7.27% 10.55% brought down spreads, with GBP -0.06% 3.16% 8.11% 11.94% the economic data release will USD -0.40% 2.86% 4.77% 7.11% be delayed until Thanksgiving, the iBoxx $ Liquid High Yield making it difficult for the Fed to Index spread down 40bps since measure the economy’s robustness. September. In addition, the Total return performance - emerging markets Second, the government rally in equity markets helped shutdown might have a negative convertible bonds to deliver Index Total return performance impact on Q4 GDP. Lastly, capital strong returns this year. The MTD QTD YTD 1Y 3Y USD EM Sovereigns -1.92% 0.59% -6.71% -5.42% 12.82% Total return performance - government developed EM Corporates -1.18% 1.38% -2.18% -0.87% 15.49% Local currency in USD Index Total return performance Global -2.28% -1.12% -5.74% -2.40% 4.07% MTD QTD YTD 1Y 3Y Asia -1.60% -1.00% -5.24% -4.08% 2.49% Government EMEA -2.49% -0.29% -5.27% 0.17% 1.52% US Treasuries -0.79% -0.10% -2.62% -3.11% 6.25% Latin America -2.87% -2.63% -7.21% -4.38% 10.48% UK Gilt -1.25% -0.14% -3.29% -3.62% 14.68% Europe -0.17% 1.09% 2.32% 4.19% 14.04% Sovereigns Total return performance - others Inflation US -1.29% -1.73% -9.05% -9.53% 1.43% Index Total return performance UK -1.71% 0.08% -0.47% 2.49% 14.42% MTD QTD YTD 1Y 3Y Germany -0.73% -0.80% -3.64% -3.27% 3.65% Leveraged Loans 0.25% 1.14% 4.36% 5.30% 16.80%

Photograph: Shutterstock Photograph: France -0.99% -0.90% -3.84% -2.48% 5.22% Convertibles -0.26% 3.05% 19.65% 23.73% 38.28% Source: Markit (All data correct as of November 8th 2013)

Winter 2013 47 COMMENTARYMARKET ANDCOMMENTARY DATA

Performance of USD fixed income market Corporate spreads and PMI in the UK

65 600 25% Markit iBoxx $ Treasuries Index Markit iBoxx $ Liquid High Yield Index 60 20% Markit iBoxx USD Emerging Markets Sovereigns Index 500 Markit iBoxx $ Corporates Index 15% Markit iBoxx USD Leveraged Loans Index 55 Markit iBoxx CVBX Vintage Index 400 OAS (bps) 10% 50

PMI 300 5% 45

0% 200 40 -5% 100 -10% 35 UK Composite PMI £ Corporates OAS -15% 30 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Jan Jan Jan Jan Jan Jan Jan Oct 2013 2013 2013 2013 2013 2013 2013 2013 2013 2013 2013 2007 2008 2009 2010 2011 2012 2013 2013 Month/year Month/year Source: Markit Source: Markit

economy remains in contraction. the European Central Bank cut representatives on the ECB board. credit conditions in the UK is the Unsurprisingly, the yield on the the main refinancing rate to 0.25% In the UK, the iBoxx £ Gilts better economic data supporting iBoxx € Spain Index stood lower from 0.50% and extended the Index posted negative returns a stronger economic recovery in than that of the iBoxx € Italy unlimited liquidity until July 2015. of -0.14% since August, while the UK. Index, 3.67% vs. 3.81% as of However, the ECB has yet to the iBoxx £ Corporates Index GDP growth for Q3 stands at November 8th 2013. face a crucial test. The strong euro returned 1.78%, on the back 0.8%, higher than the 0.7% over The iBoxx € Corporates Index (up 11% against the US dollar of income and credit returns, Q2. The Markit UK Composite registered a return of 1.20% since summer 2012) adds further contributing 80bps and 135bps, PMI Index reflects the improved since August, mostly driven by disinflationary pressure to the respectively. Corporate spreads business conditions, with its income and credit return (65bps European economy. In addition, the to gilts have come down to reading for October reaching 61.6, and 54bps, respectively), with eurozone GDP barely grew at 0.1% 142bps, their lowest level since the the highest over the past five years. duration return contributing only for Q3 and the unemployment rate beginning of 2008. Bank of England guidance also 8bps. Duration return was low, as remains stubbornly high at 12.2%. The corporate sector in the UK supported the case for accelerating the eurozone spot curve twisted If the ECB is to successfully pursue has outperformed its European recovery, as it brought forward by since August, with the 1-6 year its inflation target, it has to be more counterpart, both for the last three 18 months its forecast of when the maturities shifting down and the proactive in easing monetary policy. months and in the year to date. unemployment rate will reach the long end shifting up. Thus, any The ECB has a few options at One of the reasons for improved 7% threshold. positive return from the short end its disposal, including cutting was matched by negative return the deposit rate into negative on the long end of the curve. territory, undertaking another Ivelin Angelov The main reason for the drop longterm financing operation associate, indices [email protected] in the front end of the curve was and pursuing some form of central bank action. Following quantitative easing. None of these Jun Qian the reported fall in the annual choices is easy, however, given the assistant vp, indices inflation rate of 0.7% in October, divisions between the German- [email protected] much lower than the 2% target, led North and Southern country

gains have normalised around 5% monetary policy of the Federal and volatility has fallen to its Reserve and other central banks lowest level since before the around the world, prompting both financial crisis, as measured by the a chase for yield as investors rotate Markit iBoxx USD Leveraged into risker assets and consequently Loans Loan Index (MiLLI). Despite the cheap financing availability The leveraged loan he influx of new interest fact that overall returns are muted, afforded to borrowers. This year market witnessed a return has led to an increase in given over half of the constituents has seen post-crisis record LBO T market liquidity in the asset of the MiLLI are already bid above debt issuance including a $9.5bn to form in 2013, with class, as observed by Markit’s par and effectively capped in terms loan deal to finance the takeover post-crisis record new liquidity scores and metrics data. of price return potential, inflows of HJ Heinz by Berkshire CLO structuring volume, Will the market exuberance, continue to pour into the loan Hathaway and 3G Capital, and led by extended accommodative market, both in the form of the much-proffered $9.3bn first the return of covenant- monetary policy, lead to another traditional fund inflows and via lien debt financing for Silver Lake lite deals, increased LBO bubble in leveraged loans? the rebirth of new CLO 2.0 Partners’ buyout of Dell. activity and a swath of The leveraged loan market has vehicles. Hilton Worldwide was also able begun showing off the feathers of The increase in demand for loan to secure a massive $7.6bn single- dividend recapitalisation its old self this year. After a spate of paper has been driven primarily by tranche term loan to refinance its syndications outsized returns, secondary market the extremely accommodative existing loan debt. All of these

48 Winter 2013 MARKET COMMENTARY

Leveraged loan total return and volatility, by year Loan liquidity trend by liquidity score over time

60% 55.2% 100%

50% Score 5 Score 4 40% 80% Score 3 Score 2 30% Score 1

20% 60% 11.1% 9.7% 10% 4.4% 1.5% 0.9% 0% 1.2% 10.1% 17.9% 2.8% 1.8% 2.5% 1.0% 40%

-10% % of loan market Percentage return/volatility -20% Markit iBoxx USD Leveraged Loan Index total return 20% Daily volatility ( ) -30%

-40% -30.8% 0% 2007 2008 2009 2010 2011 2012 2013 2009 2010 2011 2012 2013 Year Year Source: Markit Source: Markit deals priced cheaply at between can be observed by examining the loan market, there is a general weakening covenants, near all- L+225 and L+350 and are all the percentage of loans in each concern looming as depicted by time low default rates and cheap covenant-lite structures (not seen level of liquidity score. The the recent slowdown in CLO refinancing availability, is the to such a large extent since 2007), percentage of loans in the four issuance. The slowdown is loan market setting itself up for which, according to a senior most liquid categories has attributed to the proposed risk another failure? Has the loan research director at a large asset increased to 73% compared with retention requirements by market forgotten the lessons of manager, buyside funds have no a crisis level of 31%. This surge in regulators requiring a CLO the financial crisis that led to choice but to accept, given the liquidity is comparable to a manager to hold a 5% equity record loan defaults and a loss of few alternatives in the market. similar surge in liquidity in 2010, stake in the CLO. The rule has over 30% of market value in How have these trends affected when loan issuance started already been implemented in 2008? It is perhaps the inevitable liquidity in the loan market? accelerating post-crisis. Europe and has resulted in a consequence of continued and Loan liquidity is defined as a The upward trajectory can be measurable slowdown in CLO prolonged quantitative easing measure of a loan’s ability to be attributed in particular to the issuance. The introduction of risk and the low interest rate traded close to the market price record CLO issuance in 2013. retention laws in the US may have environment that has allowed a within a certain time period. CLO issuance in the US has been a detrimental effect on the flourishing of risk tolerance and Markit Loan Liquidity Service at $68.5bn YTD with an liquidity of loans in 2014. lenient capital markets. Whether applies a multi-dimensional additional $14bn in the forward With greater liquidity, the loan market can sustain and analysis to gauge the liquidity of a pipeline, according to S&P increasing use of structured bear the “new normal” remains loan instrument. A variety of Capital IQ. vehicles to fund investment, to be seen. factors to investigate liquidity are CLOs are the single largest used to determine a composite participant group in the liquidity score of 1 to 5, with 1 leveraged loan market, Colin Brunton, CFA vice president, loan pricing denoting high liquidity and 5 accounting for roughly over 50% and analytics denoting low liquidity. share, making the return of the [email protected] Liquidity has been on a CLO investor class extremely gradual rise since the Lehman important for the overall Hamed Ijaz Brothers collapse in 2008 and is liquidity of the market. associate, loan pricing and analytics now at its highest point since As the increased liquidity [email protected] measurement began. The trend continues to attract investors to Securities finance Capital adequacy apital adequacy regulation, cannot do this forever. So, where the one now. The period directly regulation, central central clearing and a are the opportunities and where is before the credit crisis, with very Cdesire for yield are factors the money currently being made? high equity markets and high loan clearing and a desire for offering great opportunities for volumes, were not normal times. yield are factors offering securities finance. Standing in the Contribution in a bull market We will never again see such way are the central banks whose Securities financing income, high leverage, such a proliferation great opportunities for cheap and unlimited liquidity has relative to the supply of assets of hedge funds, multiple bank securities finance drained the life out of the repo available for lending, generally proprietary trading desks and such and financing markets. But, they falls in equity bull markets such as an unfettered appetite for risk.

Winter 2013 49 COMMENTARYMARKET ANDCOMMENTARY DATA

All securities Global equities

30 20 10 35 18 9 25 30

16 Return to lendable (bps) 8

14 Return to lendable (Bp) 20 7 25 12 6 20 15 10 5 15 8 4 10 Utilisation (%) 6 3 10 4 2 Reinvestment revenue Split (%) 5 5 2 1 Revenue share from RI (%) Total return to lendable Utilisation Total return to lendable 0 0 0 0 Sep Dec Mar Jun Sep Dec Mar Jun Sep Sep Dec Mar Jun Sep Dec Mar Jun Sep 2011 2011 2012 2012 2012 2012 2013 2013 2013 2011 2011 2012 2012 2012 2012 2013 2013 2013 Month/year Month/year Source: Markit Source: Markit

in and opportunities for yield will for this, due to higher fees and abound. balances. ‘Collateral transformation’ will also only grow when the central Tools for the future clearing of credit derivatives is For our part, what we can do is expanded to include pension illuminate the collateral world with funds and more instruments. complementary data from adjacent areas for when this world erupts. Innovation Transparency into the dollar In the meantime, the custodians tri-party repo market was are sharpening their pencils. recently made available to see The adept combination of which instruments are gaining in securities lending, reverse repo popularity as well as haircut and and the use of tri-party collateral rate data. Of interest is a rise in managers will allow for (in some the use of non-US government cases) indemnified collateral debt in tri-party pools and the transformation trades where every constrained reaction to the debt counterpart wins. ceiling debate.

Rising cash reinvestment income Understanding corporate A slight fall in the intrinsic bond liquidity value of lending is being At the centre of the financing made up for with a strongly world is the corporate bond asset Rather, it is generally a find innovative ways to help the rising contribution from the class. Investment banks typically countercyclical form of risk- institutions to earn incremental cash-reinvestment income. hold lots of these, yet they need to adjusted revenue that rises when extra yield for assets that are This potentially reveals that be swapped for government bonds hedge funds are increasing their otherwise sitting idly in custody. custodians are lending cash to that can be pledged into CCPs or short book in times of volatility or tri-party agents in return for better support their core liquidity when markets are falling. Back to basics equities or corporate bonds. They ratios. It also offers good risk-adjusted Prior to the rise of the hedge are being paid a premium for this We can now offer corporate returns when the yield curve is funds, securities finance was an reverse repo activity that forms bond Z spreads and liquidity flexing, interest rates are high activity that supported market one leg of this early collateral measurements to help clients and banks need to aggressively liquidity, smooth settlement and transformation activity. better understand the risks of manage their balance sheet. allowed banks to move assets off taking these as collateral. and on to their balance sheets Falling demand to borrow Reach for yield for financing purposes. Sound This rise in the cash return is Summary High asset values don’t mask the familiar? The capital rule for masking a clear trend of lower There remain plenty of roadblocks need for yearly income. Pension banks under Basel III necessitates borrowing demand. The new to greater securities financing funds and insurance companies more of this. paradigm is one of fewer equities volumes, but all the ingredients need a yield from their assets to Standing in the way are the on loan, but with are there for when the central pay their policyholders. With central banks. Their low-cost bond lending banks feel the economy is strong near zero interest rates and central financing operations, such as gradually enough to stand on its own two bank policy leading to subdued LTRO, pre-empt the need for making up feet. repo activity, it has seldom been banks to try to finance each harder to earn money from your other. But, this can only go on money. for so long. And, when the ECB Simon Colvin vice president, securities finance So, the great opportunity is for and the Fed exit stage left, the [email protected]

Photograph: Shutterstock Photograph: the securities financing market to securities finance market will step

50 Winter 2013 MARKET COMMENTARY

Structuredgrowth in all three broad areas financeSector Spread Mid Spread Mid (bps) (bps) Oct2013 Nov2013 of activity monitored by the ALL Auto Lease AAA Float (1-4) 85 82 survey (residential, commercial ALL Auto Loan AAA Float (1-4) 39 40 and civil engineering ALL CMBS AAA Float (3-5) 110 106 ALL Credit Card AAA Float (1-4) 41 36 construction). Australia RMBS AAA Float (3-5) 110 112 In Europe, we are also seeing Italy RMBS AAA Float (1-3) 174 165 some improvement in the Netherlands RMBS AAA Float (1-3) 52 53 housing market, mainly in Spain RMBS AA Float (5-8) 265 254 United Kingdom Granite AAA Float (1-3) 80 75 France, Belgium and Sweden. United Kingdom PRMBS ex. Granite AAA Float (1-3) 41 38 The housing market has United Kingdom SPRMBS AAA Float (1-3) 149 136 deteriorated the most in the Netherlands, despite the spread of the triple-A RMBS from this AAA CLO spreads country remaining one of the bps tightest in Europe. 200.0 The European ABS market 180.0 remained very stable for senior 160.0 tranches over the past month. Most of the activity remained 140.0

around BWICs, CLOs and the 120.0 primary market. Within the BWICs, as has been the case 100.0 for the past couple of months, 80.0 1.0 2.0 Eur

the most bid names were high 60.0 beta names. Finally, most of the Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov 2013 2013 2013 2013 2013 2013 2013 2013 2013 2013 2013 dealers remained better buyers. Month/year Granite, as per the rest of Source: Markit the market, remained almost The UK property market unchanged. The A, B, M and C continued to dominate euro tranches are being traded market, bringing yearly new the non-farm payroll reports, at 99.1, 94.7, 93.9 and 90.6, issuance in CLOs to $68.5bn. an unclear timeline for the the European ABS respectively. The non-agency mortgage unwinding of QE3 and the market, while year-end market also saw some sideways uncertainty of the fate of the US ABS market movement as a result of the GSEs, lead us to believe that there trading volume slowed As a result of the Thanksgiving slowdown. Offers tended to be will be significant volatility in the in the US holiday, and going into the available for considerably longer agency market going into the first year-end, trading volumes within than they would have been a few quarter of 2014. structured products have slowed. months back, and there were Going very long duration into European ABS market In general, across asset types, even some price reductions to the New Year has more perils Once again the main news in there has been some slight spread get things moving. than in the past, as the sell-off the European ABS world in compression compared with the The market has seen increased in rates that began in the spring November was the UK housing third quarter. price movement in the STACR will likely persist throughout market, which shows no sign While spread movement in bonds issued by Freddie Mac. 2014. Investors in lower coupon of slowing down. The Halifax the US CLOs was generally They have sold off significantly pass-throughs continue to index showed a 6.2% increase flat to slightly tighter, over the compared with when they hit the compete to buy bonds and also year-on-year (+0.3%), while the last few months there has been market. ride the wave of benefits of the Nationwide index lagged slightly substantial compression in the The graph above highlights Fed’s purchases supporting that behind at 5.0% (+0.9%), but the European CLO space. some of this movement over the market. difference is decreasing. More investors are starting last few months in the CLO The implications of the Meanwhile Markit/CIPS to take advantage of perceived market, where the spread potential of unwinding the QE UK Construction PMI data relative value trades, which is compression in European AAAs programme in the wake of rising indicated another strong likely attributable to the recent is evident. rates (slower prepayments) could improvement in the overall issuance. Specifically, the Recent be perilous for the last one to exit performance of the UK mezzanine part of the capital volatility in that trade. construction sector, registering structure has come in over 64.8 in September (up from 100bps in some areas. The US Matthew Fiordaliso 61.1 in August). Increased still dominates in the area of director, US structured finance volumes of construction new CLO issuance. Deals are [email protected]

Photograph: Shutterstock Photograph: output in September reflected continually coming out to the

Winter 2013 51 COMMENTARYMARKET ANDCOMMENTARY DATA

2014 forecast dividend increase vs 2013

25% S&P 500 aggregate payout Select Sector SPDR ETF 20%

Dividends 15% Dividend growth expected expect 90% will grow dividends. Many companies have a policy 10% across all S&P 500 sectors of raising dividends in line with 5% and SPDR Select Sector earnings growth. exchange-traded funds Exposure to S&P 500 sector 0% dividend growth is accessible Energy Staples Utilities Materials S&P 500 Financials Industrials through ETFs, specifically the Technology Discretionary Health Care ividend growth is expected SPDR Select Sector ETFs, which Source: Markit across all S&P 500 sectors break down the S&P 500 into Dand SPDR Select Sector nine index funds. We project ETFs. future ETF distributions based Concentration of top 5 companies in SPDR Select Sector ETFs We expect strong growth in on the underlying stock forecasts. 100 S&P 500 dividends over 2014, We have found that these ETF 90 80 led by financials, consumer dividend distributions are 70 discretionary and technology commensurate with aggregate 60 companies. Similar dividend stock payouts in the sector. 50 40 growth is anticipated for ETFs Discrepancies between the sector 30 based on these sectors, with ETF and the aggregate S&P 20 differences explained by the ETF’s 500 sector dividend increases 10 weighting methodology. are primarily due to the ETF’s 0 Some 422 S&P 500 companies weighting methodology. XLP: Staples XLE: Energy XLU: Utilities are expected to pay dividends in XLF (Financials), XLK XLF: Financials XLI: Industrials XLB: Materials XLK: Technology XLV: Health CareXLY: Discretionary 2014, including 14 companies that (Technology) and XLE (Energy) Remaining companies Top 5 companies (%) SPY: SPDR S&P 500 initiated or reinstated dividends in lead SPDR sector ETFs with Source: Markit 2013. The result is that 84% of the 22%, 16% and 14% increases in index is expected to pay dividends, expected dividends from last year, the highest since 1997. higher than the corresponding from the top five holdings of Bank increase dividends 14% in 2014, Payout ratios have trended sector dividend increase in 2014. of America (BAC), Citigroup (C), driven by increases from Exxon higher from 27% in 2011 to a The increases expected at the JPMorgan (JPM), Wells Fargo Mobil (8%), Chevron (10%) and projected 35% in 2014. However, aggregate (un-weighted) level for (WFC) and US Bancorp (USB), Schlumberger (9%). this is flat compared with 2013 S&P 500 financials, technology in addition to State Street (STT) The S&P 500 Index SPDR and still below the historical and energy sectors are 17%, 14% in 2014 gives the fund a 22% ETF (SPY), the most widely average of 50% for the S&P 500. and 12%, respectively. increase, the highest among the traded and liquid ETF, We project total dividend payouts Index ETFs like the SPDR S&P SPDR sector ETFs. distributes dividends comparable will increase 11% in 2014. Select Sector ETFs seek to replicate The technology sector exchange to the aggregate index payout. We project financials to lead index performance through traded fund (XLK) offers Markit projects a 15% dividend all sectors with a 17% boost in market capitalisation-based exposure to large tech companies increase for the fund compared aggregate dividends followed by weightings. The ETFs allocate a and has a concentration in with 11% for the underlying the consumer discretionary and greater weight to the larger-cap Microsoft exceeding 12%. The companies at the aggregate, the technology sectors, each with companies. For example, XLF’s ETF is expected to increase unweighted level. Again, this 14% increases. Energy dividends exposure to the top five banks dividends 16% year on year, led difference is related to the fund’s are also expected to grow by exceeds 41% and XLK’s exposure by forecast increases from Apple , weighting methodology with double digits with a 12% increase. to the top five tech companies Cisco Systems, Microsoft, Oracle, a concentration in the largest Dividend growth remains strong exceeds 42% on a per share and Texas Instruments. stocks. and we expect it to be seen in all weighted basis. By focusing on the XLE covers 43 energy These ETFs are a reasonable sectors. largest companies, these SPDR companies and is composed of way to track the underlying The hike in dividends Sector ETFs tend to have higher 93% large-cap energy companies, index return performance and is a testament to stronger concentration risk. Any dividend with XOM and CVX accounting gain exposure to sector dividend balance sheets and continued changes to big names would for 19%. Markit forecasts XLE to trends. improvements in US have a significant impact to the fundamentals. Earnings are up corresponding ETF’s dividends. across all sectors and expected to XLF is composed of 81 S&P 500 rise further in the future. financial companies, offering Pan Zhang assistant vp, dividends According to consensus exposure to large financial [email protected] analyst estimates, 92% of S&P institutions. However, with the 500 companies are expected to top five holdings exceeding 41%, Daniel Victor grow earnings next year with a XLF has very high concentration associate, dividends projected median of +13%. We risk. Expected dividend increases [email protected]

52 Winter 2013 MARKET COMMENTARY Photograph: Shutterstock ETPs Costs are at the forefront of investors’ minds when executing their strategies

ithin equity derivatives there are a number W of delta 1 synthetic wrappers (such as futures and swaps) that will provide the products, pushing investors to use creation/redemption fees charged price return; however the necessary exposure, however other, easier to measure, synthetic by the ETP issuer. strongest performing emerging all with different costs and wrappers. Holding costs are determined market ETP over the last three counterparty exposures. The costs of an ETP can be by the difference between the months was the PowerShares There has been much debate broken down into three sections: index performance and that S&P Emerging Markets High about the true cost of using an entry, holding and exit. The first of the fund, most commonly Beta product with 14.26%. The ETP for a particular strategy with and last are related to trading known as tracking difference. ETP focuses on stocks that are issuers using differing metrics to costs and are measured by the These are typically comprised of extremely sensitive to emerging articulate the positive features of difference between executed price management fees and trading/ market movements over the last their product range. The reality and the net asset value of the ETP. structuring costs. 12 months, a reflection of the is that inconsistent approaches Depending on the order size, the A further consideration is strong performance within the require analyst time to accurately difference is typically made up typically how volatile the fund’s region. compare and contrast these of brokerage commissions and performance is against the Funds focused on corporate index (rather than the absolute actions, such as IPOs and spin-offs, difference), which gives a were also strong performers, with MSCI emerging market ETPs 1 year costs corridor around the historical an average return of 9.31% over holding cost, depending on when the last three months. Their AUM 200 Exit costs (bps) you enter and exit the strategy. grew to just shy of $2.8bn thanks 180 Holding costs (bps) Emerging markets can be in part to this good performance, 160 Entry cost (bps) difficult to trade, resulting in but primarily due to $1.2bn of 140 increased costs for ETP issuers inflows, which was 84.92% of the 120 that are ultimately passed on to starting AUM. 100 the end investor. Using a one-year The strongest performer was 80 investment timeframe, the HSBC the Guggenheim Spin-Off ETF, 60 product, despite not having the focusing on companies that have 40 largest AUM, has the lowest cost been spun off over the last 30 20 that, historically, was between months, achieving an 11.96% price 0 HMEM EEM LYLEM DBX1 MXFS SPYM 42bps and 64bps. return. Keeping with the emerging Over the next three months we market theme, the iShares expect to see strong performance ETP Name Ticker Tracking error Min total cost Max total cost MSCI Emerging Markets ETF by UK exposed funds, and (1Y) (1Y) (1Y) HSBC MSCI Emerging HMEM 11bps 42bps 64bps received the greatest inflows possibly significant inflows Markets UCITS ETF over the last three months with following on from recent positive iShares MSCI Emerging EEM 11bps 54bps 76bps just over $5.5bn entering PMI results. Other countries Markets ETF Lyxor ETF MSCI LYLEM 20bps 74bps 114bps the fund. This is to watch include Germany and Emerging Markets unsurprising Russia. The first quarter of 2014 db x-trackers MSCI DBX1 3bps 103bps 109bps given the 9.63% should be very interesting. Emerging Markets TRN Index UCITS ETF 1C Source MSCI Emerging MXFS 4bps 131bps 139bps Market ETF SPDR MSCI Emerging SPYM 18bps 166bps 202bps Anil Gademsetty, CFA Markets Basket vice president, equities UCITS ETF [email protected] Data as of 31st October 2013. Source: Markit

Winter 2013 53 Former bank chief executive Peter Nostrand talks to Mark Johnson about making the switch from banker to orchestral composer manoeuvres in the bank

n May 2014, Peter Nostrand will travel from his thought you were a finance guy?’” home in the US to Prague in the Czech Republic to Music and melodies, though, didn’t just start Ispend two and a half days in a studio with a arriving out of the blue after Nostrand retired. 60-piece Prague Radio Symphony Orchestra Indeed, one could argue that the banking world may recording some of his latest music scores. have been denied Nostrand’s talents and expertise had It is a far cry from his days as a top banker, during circumstances been different. which he conducted the day-to-day Washington DC As the son of a clergyman, music has been an operations at SunTrust Bank, the NYSE-listed intrinsic part of Nostrand’s life from an early age. financial group with assets of more than $175 billion. “Before my feet could touch the ground from the But, he is looking forward to what he says will be “a piano bench, my father taught me how to write music glorious experience”. and that came back to me after I retired, so the nice Nostrand rose through the ranks of SunTrust, in a thing about having musical inspiration is having the highly successful career spanning 33 years, to become ability to also write it down on paper.” chief executive of SunTrust Greater Washington, the His passion for music remained throughout his bank’s largest division. Before retiring in 2006, he teens until he graduated from Amherst College in says all he thought about were credit problems, 1969. “I was in a band and we played all the popular consumer issues, regulation and employee issues. hits of the time, from the Beatles to the Rolling “Shortly after I retired, though, I started hearing Stones and the Doors. We were very much a rock and melodies in my head which were refreshing. I would roll band,” he says. “It was a tremendous experience in tiptoe downstairs in the early hours, trying not to the late 60s because there was so much good, fresh, wake my wife, and sit down at the piano and start new music out there.” playing them out.” However, after graduating, the realities of life took Since 2006, he has composed and released four hold. Nostrand reveals that early on in his marriage albums. And in January this year Nostrand won the someone had a quiet word in his musical ear. “My BMI Songwriters’ Award for his composition “Home father-in-law said: ‘You will never make any money in Alone”, recorded by the Czech Philharmonic music and I don’t want to have to support you your Chamber Orchestra. entire life, so let me get you a real job.’” He says that his decision to return to music, and It was good advice. Nostrand went to work for composing in particular, raised some eyebrows among SunTrust and the music went dormant for 30-odd his peers on the Washington financial scene. “When years. “It certainly took a back seat; I didn’t write people on the various boards and civic activities I was anything; my piano playing stopped,” he says. “When involved in heard I was recording in Prague, they you get married, have children and have a mortgage to said: ‘What are you doing composing music, I pay on the house, you really don’t have time for other Orchestral MARKIT LIFE manoeuvres in the bank

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 I love some of those big through Nostrand’s composing. And his music from another album, The Miss Muse Collection, could screen scores that John easily work as the score for any number of quality period dramas. You can almost hear Agatha Christie’s Williams has done Miss Marple waiting in the wings.

56 Winter 2013 Nostrand, though, admits that the film score some is probably less than average, but generally market is tough to crack. “I don’t know how to speaking the average to good stuff I have out there is pursue that. It is a fairly closed fraternity,” he says. worthy, but there is a lot of worthy music out there.” The difficulty, he says, is that when the big film Thanks to his previous career in banking, though, companies need music they all go to the big Nostrand is able to focus on his composing without established names. “How do you break into that having to worry about making ends meet. “I do it group? I can imagine you are not exactly welcomed because I love it, I am compelled to do it. It has sort with open arms because that means you are taking of taken me prisoner. I am frankly exhilarated by the business away from them.” unlimited greatness that this medium provides,” he “It is a much more difficult business field than admits. “So that is a joy. If something ever happens banking is by far,” he says, adding that trying to crack with it then great, but that is not why I do it.” the film industry is made harder by the fact there is I am keen to discover how the former bank chief no set organisational structure to follow. approaches his composing. He describes his music as “In the banking industry you can start as a trainee being “for the listener” and makes a distinction between and rise up through the institution through sheer good music and good literature that is worthy of note. hard work. I know of no such training programme in “In good literature the reader often relates to one of the music business that allows you to go up through the central figures, but that figure is usually fixed in a the chain of command to where the movie houses certain time and place by the author,” he says. In want you to write for them.” orchestral music, though, he says he strives to compose And while Nostrand has had success in “adventures where the listener not only becomes the commercialising his music through sales on the central figure and protagonist, but through his or her internet – his current albums can be downloaded creativity that person determines the time and the from iTunes – he is among a populous group of place and the situation of that adventure”. musicians and composers who wince at the sheer He believes that good music is far more liberating volume of music available online. and creative than writing, because it allows the “You can go on the internet and type ‘I want to listener to create so many of the variables and the hear some music’, and you could spend the rest of circumstances. “So I think music is a better your life ploughing through music and still not get communicator than writing.” through a small percentage of what is there.” Ahead of his trip to Prague next year, Nostrand is “It is much more difficult to reach your audience due to return to Oxford for a fourth term of study and because there is so much more music out there.” Here, tutoring, or what he lightheartedly refers to as being he draws a distinction between good music and great “humiliated musically”. Despite his own obvious music. “Good music you can tap your toe to and dance musical talents, he says the university has some “really to and sing along to, but it is not something you want good music composition instructors from whom he to hear over and over again and that will be popular has learned much in the last few years”. forever,” he says. “Great music, on the contrary, is But the real fun will come when he returns to something you never get sick of and 20 years on will Prague to oversee the recording of about 30 of his still be worth listening to.” latest compositions by the Prague Despite his efforts to make Radio Symphony Orchestra. “I am something of his music in a going to be recording a different commercial sense, he is genre of music in Prague,” he says. refreshingly candid about his “It will be more Hollywood film work to date. “Some of my score style, big screen, big orchestra, music out there is very good, sometimes with big drums and a some of it is average and fast pace.” Messrs Williams and Zimmer may just want to listen in.

Nostarnd as a child with his clergyman father

Other pictures with friends from the music industry

Winter 2013 57 Key numbers Markit infograph providing a snapshot of investor reaction to UK homebuilders

All data correct at time of going to press UK Homebuilders 18.5% British Land 90 day implied volatility level, off its six month 107% high of 21.5% Projected rise in dividend payments from UK homebuilders this 64.8 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% Current average 64.8 short interest in UK homebuilders Markit/CIPS UK Residential Construction PMI Index level 51% for October - the strongest Average share price reading for 10 years increase of UK listed property firms in 2013

58 Winter 2013