Fundamentals

Securities Services & Securities Lending for Funds, Managers and Investors

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 Welcome to the first edition of Fundamentals.
FundFront

W e hope you enjoy the magazine as much as we have enjoyed putting it together. We feel
that the magazine sets a new standard in financial journalism, covering all that is relevant to funds
of all forms.
The financial services industry has fundamentally changed in the last few years and continues to
do so. Fundamentals will tell you how.
Fund Front addresses the key, front office topics that fund managers, trustees/plan sponsors
and investors need to know, from regulation to investment opportunities.
Investor Services provides in-depth and comprehensive analysis on custody and associated
back-office functions, providing readers with the stories that do not always make the
headlines elsewhere.
Securities Lending takes our leading position in the securities financing space to raise and
address the vital topics in an industry that is perhaps going through more changes than any other
in the financial services sphere.
Back Office provides the reference point for finding contacts within all the businesses covered.
I would like to introduce our editorial team below...

Mark Latham, Publisher

Meet the editorial team

Clive Gande – Editorial
advisory board
chairman, Clive gained
his experience in asset
servicing over 30 years
in the Banking Sector
and over 12 years
as Deputy General
Manager at The Bank of
New York.
Craig McGlashan -
Fundamentals editor,
with a background in
software engineering,
Craig has an in-depth
understanding of the
systems which support
the back-office functions
of the funds business.
Craig’s career in financial
journalism began in
newswire reporting in
the City and he has
since specialised in World, Newsdesk as to a wide range of
the investor services well as ING Bank, publications. He
and securities lending Citigroup, Aegis Group, authors a leading
spaces. REL Consultancy securities lending blog,
Group, Global Asset while his consulting
Brian Bollen – Investor Management, and State business advises firms
Services editor, Brian Street, amongst others. on strategic planning,
worked at the Financial business structuring
Times for more than Roy Zimmerhansl and marketing for
eight years covering – Securities Lending the securities finance
international capital editor, During almost 30 business, and has
markets and mergers years in the securities developed a specific
and acquisitions as industry, Roy has held niche in the growing ETF
a writer and editor. senior positions across a financing area.
Brian combined editing variety of market leading
Investor Services organisations including Stephanie Baxter
Journal with specialist proprietary trading firms, - Fundamentals
writing for the Financial prime brokers, custodian correspondent,
Times, Financial News, banks and a central Stephanie worked on
Global Pensions, depository. several international
Investment & Pensions A recognised securities financial news websites
Europe, European lending industry before joining the
Fund Manager, Private commentator, Roy is Fundamentals editorial
Equity News, Financial a regular contributor team.

2 | Fundamentals Magazine | Fall 2010

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3
 Contents
FundFront

New colour coordinated sections, making it easier to find what you want to read
Editorial Advisory
P.6 P.34 P.70 Chairman
Mandates Basel III: The low down Clive Gande
People Moves

P.8 P.37 Editor

P.72 Craig McGlashan
News Round Prime Services: The Join the central craig.mcglashan@eFunds.tv
new SEB package counter party (CCP)
P.10 Investor Services Editor
NAPF on Pension P.38 P.74 Brian Bollen
funds The Russian Evolution US economic study brian.bollen@eFunds.tv
InvestorServices

Reality v. regulation
P.12 P.42 Securities Lending
Goldman Sachs Looking East for Editor
P.78 Roy Zimmerhansl
Derisking pensions custody: Deutsche Staying on track? ETF roy.zimmerhansl@eFunds.tv
Bank tracking errors
P.14 Correspondent
UK Pension funds: P.44 P.80 Stephanie Baxter
A summary Clearstream 40th Italy: Feeling the Stephanie.Baxter@eFunds.tv
Anniversary Review pressure from
P.16 regulators Contributors
Dodd-Frank Wall P.48 James Clunie
Street Reform Euroclear: The Next Norbert Boon
P.82
step Repo - ERC FIgures Design & Cover
P.20
Luke Merryweather
P.50
SecuritiesLending

Malta: The next P.84

offshore success? Corporate actions Account Manager
Securities Lending
special: The danger of Eradat Munshi
Directory
P.22 data errors
Profile: Sam Hocking - Chief Technology Officer
BNP Paribas P.52 Peter Ainsworth
Asia Focus
P.24 Commercial Director
P.54 Jon Hewson
Short Selling
Syncing the front and
back office Publisher
P.26
Mark Latham
High Frequency
Trading P.56
Big Brother: New call
2

Media
P.29 recording regulation
AIFMD: The big Five
P.57
BackOffice

2i UK, One Angel Wharf,

P.31 Data Management: 59 Eagle Wharf Road,
Profile: Peter De Proft Unlocking its potential London, N1 7ER, UK
T: +44 (0) 20 7183 8470
- EFAMA
F: +44 (0) 20 7250 0350
P.60
Reporting regulation: P.87 2i USA, 410 Park Avenue,
Comply or Compete Brazil: Succession 15th Floor, New York, NY 10022
T: +1 212 231 8421
P.62 F: +1 212 231 8121
P.88
Payment processing: STP: Slow to Progress © 2010 2i Media
How to source it All rights reserved.
No part of this publication may be
P.64 reproduced, in whole or in part,
Investor Services without prior written permission from
the publishers.
Directory
ISSN 2045-421X Printed in the UK

4 | Fundamentals Magazine | Fall 2010

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 BNY Mellon Asset Servicing
and Investor Analytics have been
selected by OneAmerica Funds to
provide stress tests that model the
FundFront
impact of shocks in interest-rate,
credit risk and liquidity risk on its
money market funds. The duo say
the service will help money market
funds comply with Rule 2a-7 issued
by the US Securities and Exchange
Commission, which requires
money market funds to examine
combinations of
potential stresses.
In another announcement, BNY
Mellon Asset Servicing declared
a new mandate to provide back-
office services for ARGA Investment
Management. OnCoreSM – the new
name of BNY Mellon’s outsourcing
service - will provide ARGA with
a range of outsourcing services,
including trade support, accounting,
reconciliations, performance
measurement, client statements and
client billing.
Scipion Capital has appointed
alternative investment specialist
Centaur Fund Services to take over
the fund administration requirements
of its funds. Scipion claimed the
package - which includes fund
accounting as well as investor and
corporate services – will offer its
investors a more accurate and up to
date account of its
funds’ activities.
J.P. Morgan has been chosen
as depositary bank for the French
food company Danone for its
American Depository Receipt (ADR)
programme. The firm reminded
readers that it pioneered the
depositary receipts market with its
introduction of the first-ever DR
in 1927. J.P. Morgan added that it
manages more than 70 blue-chip ADR
programmes across Europe, including
for other French companies such as
Lafarge, BNP Paribas and Peugeot.
Northern Trust has won a
mandate worth to provide Babcock
International Group with a range of
services to GBP 2bn worth of pension
fund assets in the group’s pension
schemes. The specialised service
6 | Fundamentals Magazine | Fall 2010
package will include global custody,
transition management, investment
accounting and performance
measurement services. Douglas Gee,
business development manager
at Northern Trust, said a growing
number of clients are looking for
advanced asset reporting as well as
core global core services.
Another winner for Northern
Trust as it wins a mandate to
service pension fund assets worth
USD 1.2bn for the London Borough
of Wandsworth, demonstrating its
commitment to servicing UK local
government pension schemes. This
mandate follows Northern Trust’s
appointment earlier this year to
service $2.61bn in pension fund assets
for West Sussex Pension Fund.
Northern Trust has also been
named global custodian for private
health insurer Western Provident
Association (WPA). Working with
WPA’s investment manager in
Hong Kong, Northern Trust will
service the insurer’s Asian equities
mandate using its global custody
and investment accounting services.
With the addition of 16 new insurance
mandates since January 2009, the
custodian bank said it now services
more than 230 insurance
relationships worldwide.
Dalton Strategic Partnership
has chosen Northern Trust
to provide custody and fund
administration services – including
fund accounting and transfer agency
– for its GBP 350 million Melchior
investment funds. Melchior is the
brand name of DSP’s range of funds,
of which it manages long-only hedge
funds, one investment trust and
segregated portfolios. The global
investment manager has a total of
$1.8bn in assets under management.
RBC Dexia Investor Services
has been appointed by Aubrey
Capital Management to provide a
full range of services to its Australia-
domiciled funds. The Sydney-based
company has been charged with
providing global custody, investment
accounting, transfer agency, mandate
compliance and performance and
attribution functions across Aubrey.
This latest win adds to RBC Dexia's
growing client base in the region,
including Treasury Group which
acquired an equity stake in Aubrey
Capital in 2009.
SEI has won a mandate to provide
Aviva Investors North America
with full-service fund operations
outsourcing for the firm’s recently
created mutual fund offering. SEI
will provide the services through
its Advisors’ Inner Circle series
trust, which it claimed allows
investment managers to reduce time
to market and quickly gain scale and
efficiencies. The company said that its
distribution support model will give
Aviva faster access to a broad range of
intermediary firms and platforms.
Societe Generale Securities
Services (SGSS) has been
mandated by Santander Asset
Management to provide a range of
asset servicing for its Luxembourg-
domiciled funds which are
administered and deposited with
SGSS. The offer includes value
added services such as management
of collateral requirements, OTC
pricing, daily portfolio valuation,
margin calls calculation and control,
tripartite reconciliation and disputes
management.
In a separate move, Societe
Generale Securities Services
(SGSS) and Credit Suisse Asset
Management in Germany have
signed an agreement on a partnership
where the SGSS will provide the
asset manager with comprehensive
fund administration services.
The services will include a broad
range of administrative and
technological solutions to Credit
Suisse (Deutschland) AG, including
front-office services (ASP), funds
administration and reporting services.
As part of the agreement, SGSS will
acquire the legal structure of Credit
Suisse’s Kapitalanlagegesellschaft
mbH which it will incorporate into
its existing local structure, SGSS
Deutschland
KAG mbH.
 The financial information
you need when you need
it. Because there’s no
pause button in business.

Considering the current economic environment, staying on top of your securities lending programme and
managing risk has never been more important. So Northern Trust has launched a specialised securities
lending technology and reporting platform designed to provide you with transparent, targeted and timely
information. Just one of the reasons Global Custodian named us Best in Class for reporting.* For more
information, visit northerntrust.com/securitieslending or call Chris Doell at +1 312 444 7177 or
Sunil Daswani at +44 (0)20 7982 3850.
*Securities lending survey 2010

Asset Servicing | Asset Management | Wealth Management

© 2010 Northern Trust Corporation, 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Incorporated with limited liability in the United States. Northern Trust operates in Canada as The Northern Trust Canada, Branch which is an authorized foreign
bank branch under the Bank Act (Canada) and as The Northern Trust Company, Canada which is an authorized trust company under the Trust & Loans Companies Act (Canada). Deposits with Northern Trust and its affiliates are not insured by the Canada
Deposit Insurance Corporation. Northern Trust, London Branch (reg. no. BR001960) registered in England & Wales each with their registered office at 50 Bank Street, Canary Wharf, London, E14 5NT. Where Northern Trust’s UK entities undertake
regulated business, they are authorised and regulated in the United Kingdom by the Financial Services Authority. Northern Trust (Guernsey) Limited, Northern Trust Fiduciary Services (Guernsey) Limited, Northern Trust Fiduciary Company (Guernsey) Limited and
Northern Trust International Fund Administration Services (Guernsey) Limited are licensed by the Guernsey Financial Services Commission. Northern Trust International Fund Administrators (Jersey) Limited and Northern Trust Fiduciary Services (Jersey) Limited are
regulated by the Jersey Financial Services Commission. Northern Trust International Fund Administration Services (Ireland) Limited and Northern Trust Fiduciary Services (Ireland) Limited are regulated by the Financial Regulator. Northern Trust Global Services
is authorised and regulated in the Netherlands by De Nederlandsche Bank. Northern Trust Global Services Limited Luxembourg Branch and Northern Trust Luxembourg Management Company S.A. are authorised and regulated in Luxembourg by the
Commission de Surveillance du Secteur Financier. Northern Trust Global Services Ltd (UK) Sweden Filial is authorised by the Financial Services Authority and subject to regulation by the Finansinspektionen.

7
 News summary
FundFront
Securities Lending
Broadridge Financial
Solutions and Euroclear
have formed an alliance
through a memorandum
of understanding (MoU)
to jointly strengthen
shareholders’ governance
rights. The two firms aim to
meet the EU shareholders’
rights directive by offering
an end-to-end voting
solution for issuers and
their agents, financial
intermediaries and
investors. Broadridge and
Euroclear claimed that
investors will find it easier
to vote electronically at
general meetings.
The International Securities
Lending Association
(ISLA) has dismissed the
proposed short selling
disclosure regulations
announced by the European
Commission (EC) as too
stringent and a threat to
market efficiency. ISLA is
concerned that a number
of the EC’s proposals
for naked short selling,
flagging of short sales and
for automated settlement
buy-ins are excessive. It
also criticised the proposed
public disclosure threshold
of 0.5% for short sales as
too low.
BlackRock’s exchange-
traded funds (ETFs)
platform iShares has
launched a new swap-
based ETF offering, which
provides multiple swap
counterparties to investors
on collateral holdings, swap
costs and fund exposures.
8 | Fundamentals Magazine | Fall 2010
The firm said that the
drive behind the new
products was in response
to an investor demand
for exposure to hard-to-
access markets, more
transparency, minimised
counterparty risk and
disclosure.
Asian securities lending is
forecast to grow by 20-25%
in 2011, according to a
survey carried out by Data
Explorers following the
Asian Securities Financing
Forum. Over 50% of
respondents believed Asia
will drive global growth
in securities lending. The
survey also showed that
Hong Kong has taken over
Japan in securities lending
income for the first time.
Fund Administration
UK-domiciled emerging
market funds are facing
tough competition from
offshore counterparts
following their inclusion in
the performance league
tables from the first
quarter of this year. Amid
China equity funds, the
top 10 best performing
are domiciled in Ireland
or Luxembourg rather
than the UK, according
to an analysis of Lipper
performance data by HSBC
Global Asset Management
(GAM) and Baring Asset
Management.
A new survey by EDHEC
Risk Institute Survey
suggests a majority
of European pension
funds have a blinkered
view of their risks.
The results showed
that accounting risk
(the volatility from the
pension fund in the
sponsor’s books) is
managed by only 33%
of respondents, and
more than 50% ignore
sponsor risk (the risk of a
bankrupt sponsor leaving a
pension fund with deficits).
Also, pension funds
generally do not assess
the adequacy of their ALM,
which may lead to sub-
optimal decisions being
taken again and again.
BNP Paribas Securities
Services (BNP2S)
has launched what
it describes as an
enhanced administration
service for onshore and
offshore private equity
and real estate funds.
The firm said that its
operational teams provide
transfer agency, fund
administration and custody
monitoring, together with
a comprehensive suite of
accounting, investor and
regulatory reports.
Technology
Wealth managers will face
increasing pressures from
clients and regulators in the
coming years, according to
a report by the IT solutions
provider, 3i Infotech. The
report identified four future
trends that firms need to
address early on to keep
business flowing, including:
a demand for faster
information; more accurate
data; regulation; greater
transparency.
Citi has launched a global
technology platform which
it says is specifically
designed for servicing
funds of hedge funds.
The new service provides
a suite of fund of hedge
fund solutions through a
single, seamless front-to-
back online service which
gives greater efficiency and
accuracy, Citi says.
Misys, the global
application software and
services company, says
it has enhanced its trade
finance solution, Misys
Trade Portal (MTP) for
Multi-Bank. Misys said
that instead of managing
trade finance business
with each bank separately,
corporate organisations can
access a consolidated view
of all their trade finance
transactions online. By
enabling SWIFTNet access
through its SWIFTNet
Service Bureau, Misys
says it provides corporate
companies with a more
effective solution to manage
their trade finance business.
Trade settlement
Chi-East has obtained
approval from the Monetary
Authority of Singapore
to become a recognised
market operator. Chi-East
describes itself as an
independent, non-displayed
trading venue for select
securities listed in Australia,
Hong Kong, Japan and
Singapore. The market
operator said it expects that
participants will be able to
provide their clients with
better execution options,
including reduced market
impact and tighter spreads.
Chi-East is a joint venture of
Chi-X Global and Singapore
Exchange (SGX).
BNP Paribas Securities
Services has launched
a suite of settlement
and custody services
for Chinese, RMB-
denominated bonds in
Hong Kong as part of the
bank’s focus on driving
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 News/ UK Pensions
FundFront
innovation in the Asia Pacific
region. The bank says the
development immediately
opens up Chinese currency
investments to BNP Paribas'
current and future clientele,
both in Hong Kong and
internationally.
The European Fund and Asset
Management Association
(EFAMA) has said it welcomes
the European Commission’s
regulation on OTC derivatives,
central counterparties and
trade repositories, which
represents an important
further step towards
strengthening the financial
system and fulfilling the G20
commitments. EFAMA says
it applauds the European
Commission’s aims to
increase transparency of the
derivatives market, reduce
risk, and enhance market
integrity and oversight.
General
The disgraced Moscow
mayor Yury Luzhkov has
been sacked after criticizing
the Kremlin and President
Medvedev. Luzhkov, who
is a strong supporter of
Vladimir Putin, had ruled
the capital since 1992 but
angered Medvedev in a state
newspaper article where
he criticised the President’s
administration and suggested
Russia needed a stronger
leader. The ex-mayor’s
comments brought on a
foray of media bashing this
summer with numerous
reports of corruption. A
Kremlin spokesperson said
that Medvedev’s reason
for sacking Luzhkov was
“because he has lost the trust
of the president of the Russian
Federation.”
10 | Fundamentals Magazine | Fall 2010
Lend some advice
As a new securities lending guide for pension fund trustees is launched,
Fundamentals talks to one of the organisations behind the publication.
UK pension fund
trustees now have a new source
of information about securities
lending, after a number of
organisations clubbed together
to produce a series of documents
and checklists for funds that
want to lend out their shares.
In September, organisations
including the National Association
of Pension Funds (NAPF), the
International Securities Lending
Association (ISLA) and the Bank of
England’s Securities Lending and
Repo Committee (SLRC) released
the guide, which can be found at the
SLRC’s website.
According to Julian Le Fanu, a policy
adviser on investment regulation
and funding at the NAPF, the guide
was created because of a Financial
Services Authority (FSA) review of
securities lending after the Lehman
Brothers collapse.
“We were asked to do it by the SLRC,
after the original request came from
the FSA which had been doing an
informal review of securities lending
for Lord Myners, who was then
financial services secretary to the
Treasury,” explains Le Fanu.
“At his request, the regulator looked
at securities lending post-Lehman
Brothers and identified certain areas
of weakness. One of those was the
area of knowledge on the part of
trustees and other beneficial owners.
It was felt that a bit more help was
needed in that regard.”
However, more generally, the FSA
found that securities lending among
UK pension funds stood up well
during the crisis, a position with
which the NAPF agrees.
“Encouragingly, most UK schemes
were quite well placed and did
not lose out. I think what that
showed was that securities
lending documentation proved to
be robust and the high levels of
collateralisation that UK schemes
insist on did provide that when there
were problems they could just move
on the collateral and get their money
back that way.”
Indeed, Le Fanu cites an additional
reason behind educating trustees
about the potential pitfalls of
securities lending – encouraging
those that do not lend their shares to
consider doing so.
“There may be trustees who are not
engaging in securities lending when
they perhaps should be, mainly
because it is a useful additional
source of revenue for schemes and
trustees should not turn down
additional sources of revenue,” he
explains.
“Also, securities lending plays a very
important part in the markets, first of
all in assisting the settlement process
and then providing liquidity and
assisting price formation.”
Since launching the guide, Le Fanu
says that there has been a “trickle” of
queries, from trustees, the press and
legal firms that advise pension funds.
However, the NAPF will now be
hosting a breakfast seminar for
trustees on 20th October to outline
some of the key points made in the
new documentation – an event which
already has a “good number” of
trustees signed up, according to Le
Fanu.
 BNP Paribas Securities Services
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BNP Paribas Securities Services is incorporated in France with Limited Liability and authorised by the French Regulators (CECEI and AMF). BNP Paribas Trust Corporation UK
Limited and Investment Fund Services Limited are authorised and regulated by the Financial Services Authority. BNP Paribas Securities Services London Branch is authorised by the
CECEI and supervised by the AMF and subject to limited regulation by the Financial Services Authority. Details on the extent of our regulation by the Financial Services Authority
are available from us on request. BNP Paribas Securities Services is also a member of the London Stock Exchange. 11
Fall 2010 | Fundamentals Magazine |
 Pensions risk
Capital ‘G’ & Capital ‘S’
Goldman subsidiary Rothesay Life is helping the British Airways pension fund derisk.
FundFront
Will it take off?
A ny deal struck by a pension fund with an
insurance company to reduce its risk levels merits
attention. When the parties involved are the British
Airways pension and Rothesay Life, a subsidiary
of Goldman Sachs, eyebrows shoot up slightly
more than usual. ‘Cui bono?’, the Roman orator and
lawyer is often reputed to have asked when trying
to determine the likely culprits in any individual
case. Who benefits? Cynics will suggest that there
is only one likely significant beneficiary in any
transaction involving Goldman Sachs or any of
its manifestations on earth. And that beneficiary’s
initials are certain to be a big capital ‘G’ and a big
capital ‘S’.
The practice of selling inherently flawed products to
clients who naively think they can trust the institution
doing the selling has become so embedded in the DNA of
the financial services industry that the sellers look upon
unhappy customers with genuine confusion and even
disbelief. “We are the masters of the universe,“ seems to be
the default setting. “We have told you this is a product of
our genius that will work for you. Why are you complaining?
You should be honoured that you are losing money hand
over fist while we make profits by the barrowload.”
This is not, of course, to suggest that there is anything
remotely improper or untoward about the BA pension fund/
Rothesay/Goldman Sachs threesome (the pension fund and
Goldman Sachs were all invited to discuss their ménage-
a-trois with Investor Services Journal, but declined to even
respond to the invitation). But if those who choose to dine
with the devil should learn how to sup with a long spoon,
those who choose to transact with major international
investment banks should learn to count their fingers
instinctively after shaking hands. Some would say.
Any pension fund that is taking steps to derisk itself is only
following the fashion of the times. There has to be some
concern, however, that the industry that is helping them to
do this is still very much in the embryonic stage. Indeed,
in some respects it is almost a frontier market, and frontier
markets are characterised by a shortage of participants, low
levels of activity (some estimates say the market might be
worth anything from £4bn a year to £8bn a year, in terms of
new transactions undertaken), and extremely high margins.
Industry specialists, though, reject any suggestion that the
pension side of the industry might be overpaying or that the
insurance side might be overcharging, while acknowledging
12 | Fundamentals Magazine | Fall 2010
that the insurers are not charities, they are intent on
making money.
David Ellis, head of longevity risk management at Mercer,
the consultants, declines to comment on other institutions’
transactions as a matter of policy, other than to make the
most inoffensive observations. “it sounds like an innovative
deal,” he says, for example. “The overall trend is for pension
funds to transfer risk out to third parties. This is very much
in that line. It is quite a large deal in the broader context of
the industry, but then, the pension fund is large.”
Don’t think of it as a pension scheme, though, he advises.
In terms of these trades, it is a pure set of cash flows. And
those cash flows are uncertain, dependent upon the lifeline
of the beneficiaries. Insurers, pension schemes and their
advisers will have to work out discounted cash flows, and
calculate inflation risk. They will build prudence into the
process and charge accordingly. Over time, as experience
unfolds, as people die and inflation evolves, and if the
pricing is right, insurers will make a small profit each year.
“Each contract is bespoke,” Ellis explains. “Some risk will
be reinsured. Some common factors will be extracted and
will be sold, while some core elements will be packaged up
and sold.” At the end of the process, the insurer is on the
hook for future risk, rather than the pension scheme, which
is the whole point of the exercise.
Only a handful of insurers are currently willing to bid, but
Mercer prides itself on being able to arrange a competitive
auction for any buyout, or buy-in, regardless of the
proposed size. “Five, six or seven insurers will be willing to
bid, enough to ensure a fair auction. Negotiations take place
not just on price but also on execution. What is the right
timeframe? What is the right product? The way we do them
is constantly evolving, but often the sponsoring employer is
the main driver behind any attempt to derisk, as it is their
responsibility to fund the pension scheme. If they keep
putting money in the plan but assets keep shrinking and
liabilities keep rising, a bulk annuity might be a good idea.
Derisking the pension plan can allow an employer to get
back to concentrating on its core business.”
Which all sounds fine. But cynics would surely argue
that the risk is only being moved around, away from the
employer and onto an insurance company. No-one will
know, until decades after this article has seen the light of
day, who will win, and who will lose. History suggests, show,
that it will be Goldman Sachs and its insurance subsidiary
 Pensions risk

counting healthy profits, and finding innovative ways to
accelerate them and transmute them into short-term rewards
and bonuses.
In the meantime, a lack of personnel is also hindering
growth. “This is a real opportunity for growth, but there are
not enough skilled people in the industry in the shorter term
to do it,” says Ellis.
John Whitworth, a partner in the insurance practice at
Oliver Wyman, a sister company to Mercer, operates on
the other side of the business to Ellis. Rather than advising
pension funds and trustees, he advises banks and insurers on
how to extract profit from corporate pensions. He surmises
that Rothesay is probably able to charge an ample margin
because of the lack of competition in the market, and will
likely be able to access profits regularly by warehousing the
risk and selling it down gradually when it deems the price to
be right.
All pension fund buyouts are different from one another,
he says, echoing Ellis. “Benefit structures are linked to age
profiles. In some funds, all members will be old, and/or
retired, and these are very easy to take into the insurance
market. In some, members will all be young, and these are
very difficult to take to market.
Generally speaking, the transfer of risk from the pensions
regulatory environment to the insurance regulatory
environment is viewed as a good thing. The BA situation,
muses Whitworth, is interesting from a financial perspective.
It has a very large deficit, especially in relation to the size of
BA itself, and it is not very difficult to imagine a world in
which BA no longer exists to make up the deficit. We now
know for certain that governments will tend not to let banks
collapse, but can the same be said of an airline, at a time
when pension liabilities can not only be quantified more
easily than five to 10 years ago, but are also becoming ever
harder in their impact on the sponsor’s balance sheet? Only
time, of course, will tell, but the advice from the industry
(which does of course have a huge vested interest) is: if a
company can afford to offload its pension risk, it should, but
don’t start crying ‘foul’ if markets triple the following year
and it looks like a very bad deal. Pension funds, in the end,
are damned if they do, and damned if they don’t.

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Fall 2010 | Fundamentals Magazine | 13

 Pensions hutton report
The Changing Face of Pension Funds
In the light of the other Hutton Report into public sector pensions Stephanie Baxter looks at
FundFront
the UK pension sector.
UK pension funds have been the subject
of recent media attacks with reports of high
investment costs to pension savers and news that
the sector was in deficit again. A documentary
on the BBC pushed the dagger in deeper this
month with a raid on the sector, claiming that
some companies had been taking out fees and
commissions equivalent to 80% of money paid into
pension plans.
Yet in the midst of the drama, reports suggest a
growing demand for private pension schemes as
cash-strapped employers fail to provide pension
schemes and Britons take on more individual
financial responsibility.
Hedge funds: In the spotlight
Word is spreading that hedge funds are an increasingly
popular choice in UK pension fund management. The
economic crisis may have pulled down the hedging sector,
but things are definitely looking rosier and the future
is predicted to be even better. The news is surprising
considering hedges were previously only used as
alternative investments and struggled to compete with
equity and commodities.
Yariv Itah of investment management consultant Casey
Quirk made a prediction in June that interest from pension
funds will peak hedge fund assets at USD 3 trillion (GBP
2 trillion) by 2013, far above the USD 2 trillion (GBP 1.5
trillion) pre-recession figure.
Private equity has been blamed for pension fund debt
with claims that it strips assets, has little transparency and
charges high fees. A recent report from the Centre for the
Study of Financial Innovation by former Morgan Stanley
banker Peter Morris claims that private equity returns are
not as high as the industry declares.
“High debt levels are the biggest component of private
equity returns. The IRR (internal rate of return) used to
calculate returns, includes the debt. By using debt you
make a bigger return and this has nothing to do with
manager skill,” Morris says.
A similar trend is emerging in the States where many
institutional investors are picking credit hedge funds
over equities. Patrick Adelsbach, a partner at Aksia LLC,
explained the reason behind the shift is “nervousness
about equities.” There is even talk of a ‘hybrid fund’ at
investment consultant NEPC in Massachusetts, which says
it is recommending clients to invest in credit funds that are
a cross between hedge and equity funds.
14 | Fundamentals Magazine | Fall 2010
Back in the red
Equity’s instability could be linked to the deficit hole
which private pension funds keep tumbling down.
The sector was put on red alert again this August as debt
swung from GBP 7 billion to GBP 54 billion in just one
month.
Although the figures are nowhere near the mountainous
GBP 192 billion deficit of March 2009, it is clear pension
schemes are still in an extremely volatile position. The
Pension Protection Fund said in August that the sharp
rise in surplus was due to rising costs of paying for
pensions which it claimed were linked to lower returns on
government bonds.
EU reform debate
The European Commission wants to spring-clean EU
pensions and its consultancy period for reform is open
until November. Its green paper, ‘Towards adequate,
sustainable and safe European pension systems’, received
a mixed response from the pensions industry this summer
with its aims to create portable and cross-border pensions
and increase transparency across the sector. The challenge
is developing a pension policy that will support economic
growth and at the same time allow the sector to cope with
a rapidly ageing population. There were, and still are,
concerns the Commission will adopt a ‘one-size-fits-all’
approach to reform.
2012: A fresh outlook
The future of UK pensions is uncertain as the coalition
government introduces reform to the system. A brand new
low-cost pension scheme is on the cards for the year of
the London Olympics where employers with no existing
workplace pension scheme will be able to automatically
enrol workers in the National Employment Savings Trust
(NEST). However pensions minister Steve Webb has
announced that NEST’s auto-enrolment factor is still being
reviewed and that a decision will be made shortly.
The basic state pension is also set for major reform as part
of public sector cuts, causing a backlash among savers
who will gradually have to pay higher contributions.
Back to basics: Three fund facts
• About 85% of public sector employees have some
form of employer-sponsored pension compared with
about 35% in the private sector.
• The life expectancy of a 60-year-old is 28 years,
compared with 18 years in the early 1970s.
• Only one in five Britons are active, deferred, or
pensioner members of public sector schemes.
Fund fact source: Lord Hutton’s interim report on pensions
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 US Focus regulation
Financial regulatory
Reform legislation:
FundFront
Ernst & Young explain the impact of the Dodd-Frank Act for Fundamentals.
W hat is the status of the Dodd-Frank bill?
The Dodd-Frank Wall Street Reform and Consumer
Protection Act (HR 4173) has now been signed by
President Obama. This legislation, considered the most
significant overhaul of financial regulation in the US
since the 1930s, passed the US House 30 June by a vote
of 237-192 passed in the US Senate 15 July by 60-39.
Why is the financial regulatory reform legislation
significant?
In response to the financial crisis, Congress moved to
address a number of identified weaknesses and gaps in the US
financial regulatory framework. Reform efforts quickly focused
on the abuses by a few on Wall Street and the perceived lack
of strong oversight and foresight of problems by regulators.
The result of nearly 18 months of Congressional deliberations
is an over 2,300-page bill that provides the federal regulators
with a mechanism to resolve failing nonbank financial
institutions, the authority to address regulatory gaps, increases
transparency in the OTC derivatives market, imposes risk
retention standards in the securitisation process and provides
new levels of consumer protection for financial products.
While central elements of the bill are focused on the
regulation of the financial services sector, it also includes
provisions affecting every public company, including enhanced
Securities and Exchange Commission (SEC) enforcement
authority and additional corporate governance requirements.
Although the regulation of the accounting provision remains
largely unchanged, a number of provisions will have a
particular impact.
This document provides high-level observations on provisions
within the financial regulatory reform bill that affect the
financial services sector, the broader corporate community and
the accounting profession.
What is the expected impact of the legislation on
the financial services sector, capital markets and the
economy?
Although the provisions of greatest concern to the financial
services industry ultimately were somewhat relaxed (e.g., strict
interpretations of the Volcker Rule, derivatives
restrictions), the final legislation can be expected to have
significant impact on business and funding models, products
and services, and governance and risk management practices
of financial institutions. Substantial uncertainty remains as to
capital, leverage and liquidity requirements to be imposed on
16 | Fundamentals Magazine | Fall 2010
large, complex firms, on OTC derivatives dealers and on
significant swaps participants, with attendant implications
for profitability.
Large, complex institutions and newly regulated ones, such as
hedge funds and private equity, will face new and enhanced
regulatory reporting requirements. This will challenge systems
and data infrastructures at many firms.
Finally, expectations that the largest nonbank and bank
holding companies supervised by the Federal Reserve will
have to develop recovery and resolution plans (so-called living
wills) will mean renewed focus on legal entity-level financial
and operational concerns in what are often very complex global
legal structures.
More broadly, there remain questions as to what these
substantial new requirements will mean for the capital markets
and for credit availability. Some aspects of the legislation are
directed at strengthening transparency and accountability
for issuers of financial instruments, which is a constructive
development. However, the impact of more stringent capital,
leverage, liquidity and compliance requirements on credit
availability in what remains a fragile economic recovery
is unclear. The legislation includes somewhat extended
transition periods for some of its more far-reaching provisions.
Additionally, although much of the US legislation remains
consistent with the global goals set out by G20 leaders, the
extent and pace of US reforms as compared to initiatives
in other jurisdictions could pose appreciable challenges to
multinational financial firms as they respond to different
regulatory demands around the world and could raise
competitive concerns.
What key provisions impact the financial
services sector?
Financial Stability Oversight Council (FSOC) (Sec. 111) –
The new 10-member FSOC, composed of existing regulators,
is charged with monitoring and addressing system-wide risks.
Among its duties, the FSOC may recommend stricter liquidity,
capital and leverage requirements. It may develop rules for
large, complex financial firms that are judged to threaten the
financial system, including firms that have not heretofore been
supervised and regulated as bank holding companies.
In extreme cases, it has the power to break up financial firms.
Liquidation authority (Sec. 165) – Requires large, complex
financial companies to periodically submit ‘living wills’
outlining how they would wind down operations in a quick and
orderly manner in the event of material financial distress or
an economic failure. The bill also creates a process allowing

the FDIC, at the direction of the Treasury Secretary, to orderly
liquidate nonbank financial firms on the verge of collapse.
Before such a company could be placed into the liquidation
process though, the FDIC, Treasury Department and Federal
Reserve must agree that such action is necessary to protect the
financial system.
Risk committees (Sec.165 (h)) – Requires publicly traded
nonbank financial institutions supervised by the Federal Reserve
and large publicly traded bank holding companies to establish a
board-level risk committee. This only applies to certain financial
institutions, not public companies generally.
Consumer Financial Protection Bureau (CFPB) (Sec. 1011)
– The new independent bureau, housed within the Federal
Reserve, will have authority over all credit, savings and payment
products provided to consumers, including credit cards and
mortgage lending but not products subject to securities or
insurance regulations. The CFPB has rule-making authority
over a host of entities, but its enforcement and examination
reach will generally be limited to banks, thrifts and credit unions
with more than $10bn in assets. Bank regulators will continue
examining consumer practices at smaller financial institutions.
While some services offered by the accounting profession are
referenced in the list of activities to be regulated by the CFPB,
the bill includes an exemption for CPAs and accounting firms in
recognition of existing profession regulatory structures.
Volcker Rule (Sec. 619) – While the Volcker Rule as initially
proposed would have prohibited banks from engaging in
proprietary trading and owning hedge funds or private equity
operations, the final legislation allows banks to make de
minimis investments in hedge funds and private equity, using
no more than 3% of their tangible common equity in all such
funds combined. Also, a bank's investment in a private fund
may not exceed 3% of the fund’s total ownership interest.
Transactions and relationships among a fund advised by a
banking company, or any affiliate of the company and any entity
within the group, would be significantly constrained. Under a
separate provision modifying the Volcker rule, underwriters or
sponsors of asset backed securities would be prohibited from
engaging in any transaction, such as shorting the securities,
which would result in a material conflict of interest with
investors in that security for one year, although hedging would
be permitted.
Derivatives reform (Sec. 721) – Most derivatives will now
have to be cleared and traded on exchanges. Banks may
continue engaging in principal transactions involving interest-
rate, foreign-exchange, gold, silver and investment-grade credit
default swaps, subject to Volcker Rule limitations on proprietary
trading. However, with respect to commodities, most other
metals, energy and equities, banks will have to shift their swaps
operations to a separately capitalized affiliate within the
holding company.
Credit rating agencies (CRA) (Sec. 931) – The credit rating
agencies were subject to increased scrutiny given their role in
the subprime mortgage crisis. In order to reduce corporate and
consumer reliance on them, most references to CRAs will be
US Focus regulation
removed from federal rules. Rating agencies will not only be
subject to increased liability, but claims can be brought against
them for "recklessly" failing to review “key information” in Q&A
on the Dodd-Frank Wall Street Reform and Consumer Protection
Act developing a rating (including external information). With
the nullification of Section 436(g) of the 1933 Act, CRAs will
now be subject to liability under the Act. The SEC will have the
right to ‘deregister’ a CRA firm, require ratings analysts to pass
qualifying exams and prevent issuers of structured products
from shopping for the best rating. The SEC must also study
the CRA ‘issuer pays’ business model over the next two years.
Should it determine that a change in business model would be
in the best interest of investors, the SEC is directed to establish
a system to assign issuers of debt products to a randomly
selected CRA, unless an alternate approach is identified.
Interchange restrictions (Sec. 1075) – While initially much
broader in scope, the final legislation directs the Federal
Reserve to ensure that debit-swipe fees are “reasonable and
proportional” to the cost of processing transactions. The
provision exempts lenders with less than $10bn in assets.
Private pools of capital (Sec. 401) – Advisers to hedge
funds and private equity funds with more than $150m in assets
will be required to register with the SEC and be subject to SEC
regulatory oversight; venture capital funds will be exempt.
The bill raises the asset threshold for federal regulation of
investment advisers from $30m to $100m, which means that a
greater number of smaller investment advisers will be subject
exclusively to state supervision.
What are the key corporate governance and SEC
provisions that impact public companies?
Proxy access (Sec. 971) – Gives the SEC authority to issue
proxy access rules to enable shareholder nomination of
directors and allows the SEC to exempt small businesses from
this requirement. The SEC issued a proposed proxy access rule
last year but has been awaiting the clear legal authority that this
bill provides prior to moving ahead with a final rule. The SEC is
already in the process of writing proxy access rules for
public comment.
Independent compensation committees
(Sec. 952) – Requires members of a listed company’s
compensation committee be independent under a definition
established by its exchange. The section also requires the
committee to select consultants, legal counsel or other advisors
only after taking into account independence factors established
by the SEC. These provisions build on existing New York Stock
Exchange listing requirements and SEC rules issued in
December 2009.
Executive compensation/’say-on-pay’ (Sec. 951) – Every
six years, a shareholder resolution will determine whether a
non-binding, say-on-pay vote occurs every one, two or three
years. The bill also gives shareholders a non-binding vote
on golden parachutes in connection with a shareholder vote
on an acquisition, merger or proposed sale of the company.
Additionally, the bill requires institutional investment managers
to disclose, at least annually, how they voted on both items.
Fall 2010 | Fundamentals Magazine | 17
 US Focus: regulation
Enhanced compensation disclosures (Sec. 953) –
Provides the SEC with statutory authority to clarify disclosure
rules relating to compensation, including a chart that
compares executive compensation to stock performance over a
FundFront
five-year period. Requires companies to disclose the following
in their annual proxy statement: (1) median of annual total
compensation of all employees other than the CEO; (2) annual
total compensation of the CEO; and (3) the ratio of these two
amounts.
Clawback (Sec. 954) – Requires issuers to adopt and
implement a “clawback” policy to recover incentive-based
compensation from current or former executives during a
three- year ‘look back’ period. The policy must be applied if
the company has to issue an accounting restatement based
on erroneous data due to material non-compliance with any
financial reporting requirement under the securities laws,
regardless of whether the executive was involved in the
misconduct that led to the restatement. Companies will also
be required to disclose their incentive-based compensation
policies. These requirements expand on a previously existing
clawback provision included in the Sarbanes-Oxley Act.
Broker voting (Sec. 957) – Provides the SEC with statutory
authority to prohibit a broker that is not the beneficial owner
of a company’s shares (i.e., shares held on behalf of retail
investors) from voting on the election of board members,
executive compensation or other significant matters (as
determined by the SEC), unless the beneficial owner has
provided the broker with voting instructions.
Disclosure of board leadership structure
(Sec. 972) – Provides the SEC with statutory authority to
issue rules requiring companies to disclose the reasons why
they chose the same person, or different people, to serve as
their chairman and chief executive officer in the annual proxy.
Because the SEC issued disclosure requirements in this area in
Dec, further rule-making is not anticipated in the near-term.
Section 404(b) (Sec. 989G) – Non-accelerated issuers (those
with $75m or less in market capitalisation) are permanently
exempted from Section 404(b) of the Sarbanes- Oxley Act that
requires an auditor to attest to management’s disclosures
regarding the effectiveness of an issuer’s internal controls
over financial reporting. Additional provisions require the
General Accountability Office (GAO) and SEC to study whether
additional changes to, or a broader exemption from, Section
404(b) should be instituted.
Whistleblower financial rewards (Sec. 922) – Creates an
SEC program to encourage reporting of securities violations.
Provides rewards of up to 30% of funds recovered for
information leading to a successful SEC enforcement action
resulting in over $1m in sanctions. Individuals working at
regulatory and enforcement agencies, those who obtain
information through the performance of a financial audit,
or anyone convicted of a criminal violation related to the
underlying act are ineligible for the reward. Employers are
prohibited from retaliating against whistleblowers.
Source: Ernst & Young Financial Regulatory Reform Legislation: Q&A on the Dodd-Frank Wall Street Reform and Consumer Protection Act. July 2010
18 | Fundamentals Magazine | Fall 2010
Aiding and abetting for recklessness (Sec. 929O) –
Allows the SEC to bring enforcement cases against persons
who ‘recklessly’ aid and abet violations of the securities laws
(current law requires ‘knowing’ violations).
Aiding and abetting study (Sec. 929Z) – Requires the
GAO to study the impact of authorizing private rights of action
against persons who aid or abet others in violations of the
federal securities laws.
Extraterritorial reach of US courts for anti-fraud cases
brought by the SEC or DOJ (Sec. 929P (b))
– Defines the jurisdiction of US courts over anti-fraud cases
brought by the SEC or the US Department of Justice (DOJ)
where much of the activity occurs outside the US. This
previously had been a matter of case law. The legislation sets
the standard so that US jurisdiction in these types of cases
exists if "significant steps in furtherance of the violation" are
taken in the US.
Collateral bars (Sec. 925) – The SEC is given the authority
to bar an individual who has violated the federal securities law
from becoming associated with any regulated financial services
entity, regardless of the area in which the violation occurred
(e.g., a person associated with an investment adviser could be
barred from becoming associated with a broker-dealer).
Nationwide service of subpoenas (Sec. 929E) – Allows
the SEC to serve a subpoena for the attendance of a witness
or production of documents anywhere in the US in civil SEC
actions filed in federal courts.
SEC funding (Sec. 991) – SEC is permitted to use fee
collections to establish a reserve fund of up to $100m, which
can be used to fund special projects. In addition, the SEC may
submit its annual budget directly to Congress without requiring
the prior approval of the White House.
What comes next?
Now that the President signs the financial reform bill into
law, much of the debate shifts from the halls of Congress to
the offices of federal regulatory agencies (e.g., the Federal
Reserve Board, SEC, CFTC, FDIC and the new CFPB).
Congress delegated many of the implementation details to the
regulators, and that process will take place over the next six to
18 months. The impact will be staggered, as rule-making will be
spread over a two-year period, if not longer. While the effective
date for final rules varies, many of the provisions, such as the
Volcker Rule, provide for a transition period to allow affected
companies time to meet new requirements. The extended time
frame in which much of this bill is implemented allows for
renewed efforts by affected parties to influence the shape and
scope of the rules being written.
As part of the legislation, Congress included requirements for
over 60 different studies and reports by the various oversight
agencies. As these studies are likely to produce legislative
recommendations and potentially new regulations, financial
regulatory reform will remain an ongoing process for the next
few years, even after the bill’s passage.
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 Malta focus: offshoring
FundFront
Is Malta the
new Dubl-embourg?
Fundamentals considers whether the island will make a big splash
in global financial waters.
M alta has seen significant expansion
as an offshore centre since joining the EU in
2004. It has worked hard to shake off its more
free-wheeling reputation to brand itself as a
domicile of choice for fund companies seeking
a pan-European distribution platform for their
funds. But can it genuinely rival the established
offshore centres of Dublin and Luxembourg?
Dublin has faced some problems in recent years.
Ireland’s financial weakness has raised the question
for fund promoters of what would happen to their
money if the country were to fail. Equally, it had
become extremely expensive to do business there,
though costs have moved to more realistic levels post-
crisis. Luxembourg has also faced some criticism. Ash
Costello, a solicitor in the funds team at Withers law
firm, says: “It is simply more difficult to get things done
in Luxembourg and the other Benelux countries. It is
very administrative and slow.”
AIFMD-driven expansion
The AIFMD (Alternative Investment Fund Managers
Directive) is creating some overall expansion in the
market. Clara Dunne, senior country officer for CACEIS
Bank, in Dublin says: “There is a strong move to
regulated jurisdictions. They are re-domiciling from
offshore jurisdictions to Dublin and Luxembourg in
20 | Fundamentals Magazine | Fall 2010
anticipation of the AIFM directive. Malta is a beneficiary
of this trend as well.”
Malta has won plaudits for its attitude. Costello says:
“They are quick, on the ball and want to help. It is
much the same attitude that characterises the Irish
system.” Ross Whitehill, head of offshore management
at BNY Mellon Asset Services agrees that the country
is building a creditable proposition: “It has a number
of double-taxation treaties in place. Its fund taxation is
sufficiently light to attract fund providers. Its regulators
understand the hedge fund industry and are sensitive
to the needs of fund distributors and investors. There is
also expertise in fund administration. There is market
expertise and knowledge, plus well-qualified auditors
and lawyers.”
He adds: “Malta’s reputation is increasingly rapidly.
The value of funds administered on the island has
moved from €1bn to €7.5bn since 2004, but given that
the pan-European funds market is €5.5trillion it has
some way to go.”
Butler believes
Dermot Butler Chairman of Custom House
Administration & Corporate Services believes cost will
be a key advantage for the country. Custom House
relocated its holding company there from the British

Virgin Islands because it was cheaper to operate and
had skilled fund administration. He believes that
Malta’s business will probably come at the expense of
these jurisdictions.
Costello, on the other hand, believes it may be Jersey
and Guernsey who lose out as Malta grows. Ramy
Bourgi, head of emerging markets development at
SocGen Securities Services, says that Malta is unlikely to
see players who are already established in Dublin and
Luxembourg move across. He believes it will be those
who are moving into Europe for the first time. He sees
some opportunities for Malta coming out of the
Middle East.
A key problem for Malta in the short term is the lack of
an active double taxation treaty with the U.S., Costello
says: “This is Malta’s big stumbling block. It has 46
double taxation treaties in place. It actually has one
with the U.S., but it is not yet in force and there is no
date for it to become operational. It means that, for the
time being, Malta can’t capitalise on the AIFM for U.S.
providers. It is a particular disadvantage at the moment,
because the U.S. has recently brought in onerous
withholding tax on non-domestic funds.”
She suggests that this is likely to be a huge priority
for the Maltese authorities and puts it at a material
disadvantage to Dublin and Luxembourg. She says that
while Malta has attracted some established names –
Deloitte and Touche, Butterfield Bank, Custom House –
there is not the same depth of service providers are there
is in other jurisdictions. She believes there are a number
of service providers sitting on the sidelines waiting until
the double taxation treaty takes effect.
Workforce too small?
A lurking criticism has been the relative size of the
Maltese workforce. Established players such as
Dublin and Luxembourg have tended to have a strong
‘backyard’ on which to call for additional staff. This
issue is at the forefront for fund promoters. Ian Pascal,
Malta focus: offshoring
marketing director at Baring Asset Management, says:
“Jurisdictions need to have the resources. Having the
resources to review all applications effectively and
in a timely fashion is vital to firms such as ours that
are operating across multiple jurisdictions in a highly
competitive environment. Speed to market is essential
and an under-resourced regulator would affect that.”
Malta has a population of around 400,000. However,
Butler believes the island is some way from having
a staffing problem. He says: “It may be small next to
Ireland, but the Cayman Islands and Bermuda only have
populations of around 50,000, so there is little scope for
expansion there.”
Malta hasn’t yet become a strong player in the UCITS
market. Its fund regime is generally seen as sound,
but 75% of funds administered there are professional
investor funds. It has attracted some hedge funds that
are happy to operate outside the UCITS regime. It
operates with relatively low thresholds for regulated
funds, which has appealed to some fund promoters.
Jean-Michel Loehr, chief executive officer of RBC Dexia
Investor Services Bank, believes Malta will have to carve
out a specialism for itself. He says: “It is not enough
for it to declare that it wants to be a fund centre. At the
moment, its problem is the lack of a track record. Cost
is not the best way for it to differentiate itself. It has to
make a decision as to whether it is going to compete in
the UCITS field.”
Loehr concludes that the expansion of the European
funds market post-AIFM should leave plenty of room
for everyone and the focus should be on ensuring the
continued expansion of the European market rather than
fostering competition between the different European
jurisdictions. Malta has a number of advantages, among
them cost, expertise and a popular fund regime - but
it will need its double taxation treaty with the U.S.,
needs to resolve where it will specialise and will need to
build a track record before it can truly emulate its more
established peers.
Fall 2010 | Fundamentals Magazine | 21
 Profile: Sam Hocking
Pro Soccer
From goalkeeper to news anchor, to global head at BNP Paribas,
FundFront
I s there a Venn diagram set showing the
number of people who were (a) once a
professional soccer player and (b) are now a
global head of prime brokerage sales? If there
is, it must surely be very small. We know of
only one: Sam Hocking, currently global head
of prime brokerage sales at BNP Paribas in New
York played the 1986 season with the Orlando
Lions in the precursor of the modern US soccer
leagues. If you know of any other members of
this exclusive set, do please write and let us
know. In the meantime, Hocking is very much
in a league of his own.
He also has one of the most chequered careers in
our experience, in terms of industries he has worked
in, from broadcasting to banking, and continents he
has worked in, from America to Africa. Brought up in
Dallas, Texas, USA, Hocking was born in 1963, a month
before the assassination of President John Fitzgerald
Kennedy. He studied economics as an undergraduate at
Rollins College in Florida, where he was a scholarship
athlete and a four-year letterman (for non-US English
speakers, that means he played for the college in each
of his four years there). He has played soccer all his
life, and formerly a Texas State goalkeeper and part of
the pool of talent that was selected to try out for the
US National under 19 team. He exploits made him
a hot target for college sports recruiters, ultimately
culminating in his post-graduation stint between the
posts at Orlando.
From there, in what sounds like one single bound, he
became a correspondent anchor for ABC-TV affiliates
across the USA for five years, after which he decided
to go to graduate school as well as work. He worked
for the BBC World Service in London, then Russian TV
in Moscow, Dutch TV in the Netherlands, Swiss TV
in Geneva and Austrian TV in Vienna. He then had a
stint teaching media courses in Vienna and Leiden at
Webster University.
Africa and apartheid
After a spell of research into behavioural finance
including the role the media and information had on
how FX traded, he began working in Africa, where he
studied the role the media played in the dissolution of
apartheid. In 1997, he made up his mind to work on a
22 | Fundamentals Magazine | Fall 2010
more commercial sector, and returned to Dallas where
he worked for and helped build up a small technology
company called Lamp Technology (the principal owner,
he tells us, was named Aladdin). In 1999 he joined Bank
of America and married Jennifer, whom he had met
a year earlier. He and Jennifer now have three sons,
Mac, Oliver and Finn, aged eight years, six and two
respectively. Today they live in San Francisco while he
flies to New York, a weekly commute of five-and-a-
half hours each way, which he feels is worth it for the
quality of life on the west coast, allowing him to spend
quality time with his family.
In 2002 he went back to business school while
working full-time. He attended the Kellogg School of
Management at Northwestern University in Evanston,
a suburb of Chicago. He attended the top five business
school while still living in Dallas.
The next step on this very unorthodox career ladder
was to start Bank of America’s prime broker office in
Dallas, following which he was asked to restructure
BofA’s prime broker office in California, then to oversee
the Chicago office, and then to run global sales, and
finally to serve as one of the leaders in the transaction
that saw the business sold to BNP Paribas. The deal
closed in October 2008. On October 1, 320 staff, $59bn-
plus of assets and over 500 clients migrated from BofA
to BNP Paribas.
“Since then, I have helped with the integration and
right sizing of the business into BNP globally,” he says.
“It has been a very interesting time. I worked for what
was almost a 100% domestic bank, and then found I
had joined a global bank which is constantly trying
to optimise its strengths around the world. We are
now trying to take the best from the bank’s experience
in operating in Europe and Asia and grow those
capabilities for US clients. Our mission is to be in the
top five in the world in this business in the next three
years.”
London prime build-out
An important first step in achieving that goal will
be the building out of the London prime brokerage
office in the second quarter of 2011, followed in the
latter part of the year by global product development
build out and staffing in Europe and Asia. The prime
brokerage industry is, he feels, on the brink of changing

Prime Brokerage
Sam Hocking is not your average prime broker.
dramatically. In the future, only players with genuine
scale will be able to compete successfully. There is little
or no profitable future for mini prime brokers servicing
sub-$25m hedge funds. “Any sizeable hedge fund needs
a large counterparty like BNP Paribas,” he says. “Clients
need the security of knowing that their bank is not
going to become insolvent. Banks with excellent credit
ratings and strong balance sheets will win, and there
will be consolidation further down the market.”
Which leads the conversation neatly to the events of
the past three years, which have seen banks that had
excellent credit ratings and strong balance sheets run
into such trouble. What are the lessons he has learnt
over that time?
“Firstly, I think I’ve learnt that a strong balance sheet,
good credit rating and the funding of business really
do matter,” he replies. “All of us previously took that
for granted. Secondly, how people manage their risk
exposure and their own balance sheet is extremely
important. A lot of people found out in 2008 that their
balance sheet, their credit exposure and their risk
exposure were not aligned appropriately. Thirdly,
Profile: Sam Hocking
I learnt that capital is so dear (for non-UK English
speakers, ‘dear’ is a synonym for ‘expensive’).”
Duration suddenly in fashion
Hedge funds, he adds, have learnt that capital can
leave at very short notice, something that reinforces
the imperative to market continuously, even when
business looks perfect. They should also have learnt to
structure their vehicles to enable them to lock money
up for longer maturities than has been customary.
“You want duration in capital and financing; you don’t
want a mismatch,” he says, bringing a tear to the eye
of many a traditional, old-fashioned, conservative
banker around the world. “The last thing I’ve seen is
that business owners really need to understand their
staffing and expense ratios, and operate to much tighter
budgets. Those firms which kept back retained earnings
were able to keep staff as conditions deteriorated.
Those which had nothing in reserve couldn’t.” Mr
Micawber, from the classic novel by English author and
social campaigner Charles Dickens, could hardly have
expressed the basics of economics any better.
HEDAY: HOCKING, SECOND FROM RIGHT
Fall 2010 | Fundamentals Magazine | 23
 Short Selling overview
FundFront
Short selling:
A market scapegoat?
James Clunie takes a look at the ins and outs of an often misunderstood practice.
S hort-selling is a financial market practice
that allows an investor to act on a negative
opinion about a security. Short-selling may
be defined as the sale of securities that the
seller does not own. The short-seller borrows
securities in order to fulfil delivery obligations to
the purchaser. At some later time, the short-seller
purchases the same security, effectively closing
out the position.
Traditionally, short-selling has been perceived as a
speculative activity. More recent studies suggest more
subtle motivations - short positions are generally
entered as part of a broader trading strategy, designed
to benefit from perceived pricing anomalies between
two or more securities. These trading strategies, often
referred to as ‘risk arbitrage’ strategies, involve the
simultaneous positioning of the trader in one or more
long positions and one or more short positions. At
some later time, the positions are unwound, with any
profit being earned by the relative price movements of
the positions, less any transactions costs associated
with the trades. Examples of such strategies include
convertible bond arbitrage, merger arbitrage, index
arbitrage and capital structure arbitrage.
Short-selling also allows for more ‘informationally
efficient’ portfolios to be created. In a traditional long-
only portfolio, securities deemed to be over-priced
can, at the extreme, be zero-weighted in a portfolio.
By lifting the restriction on short-selling, over-priced
securities can be short-sold, allowing negative opinions
on stocks to be more fully reflected in portfolios. This
is particularly helpful when a manager has a negative
opinion on a smaller company, as merely holding a
24 | Fundamentals Magazine | Fall 2010
zero weighting in a smaller company will have little
benchmark-relative impact on performance. This
insight has led to the development of so-called ‘short
extension portfolios’ in recent years – portfolios that
permit some degree of short-selling, but that re-invest
the proceeds of short-selling so as to have a net 100%
long position in stocks.
Short-sellers face a number of barriers, such as
legal and regulatory restrictions on short-selling, costs
associated with borrowing stock to facilitate the
settlement of a short-sale, and cultural and institutional
constraints. Short-selling is also full of risk. Some of
these risks, including fundamental risk and noise trader
risk, are also associated with ‘long-only’ investing.
Others, such as ‘recall risk’, are unique to short-selling.
Recall risk arises when a stock loan is recalled. If the
short-seller is unable to replace the stock loan, he/she
is forced to purchase the stock to close his position,
and this is known as a short squeeze.
Short-sellers face more general liquidity problems
in the form of ‘crowded exits’. These arise in stocks
where short-sellers hold large positions relative to
normal trading volume, and when a catalyst prompts
short-sellers to cover their positions rapidly and
simultaneously. Catalysts include, but are not limited
to, public news releases by companies. The temporary
excess of demand for stock relative to normal trading
volume leads to upward pressure on the stock price
and these events are associated with losses to
short-sellers that are economically and statistically
significant. In summary, short-sellers face a series of
barriers and risks, and this can limit the extent of the
practice.

Short selling often comes under intense
scrutiny during bear markets. Politicians, listed
companies and investors can become outwardly
hostile to short-selling and regulators often feel
the need to respond to this hostility.
To help understand the true impact on markets from
short-selling, we can draw upon over thirty years of
research and evidence. Theory suggests that with
barriers to short-selling, stocks can become over-priced
by optimistic investors and bad news will be reflected in
stock prices at a slower pace than good news. Recent
empirical studies show that constraints on short-selling
are associated with poorer
pricing efficiency.
But the evidence also reveals a darker side to short-
selling. There is, for example, empirical evidence that
some short-sellers target stocks prior to seasoned
equity offerings, so as to produce artificial discounts
in the price of new shares. Short selling can also be
used as a tool in ‘predatory trading’ against those who
are unable to maintain their stock positions. Where the
positions and capital resources of a weakened trader
become known to others, predators can trade against
them, driving stock prices away from fair value until
the victim closes out his position at a loss. At the same
time, the predator closes out his own position at a profit.
Victims could include leveraged hedge funds unable to
meet margin calls as stocks fall, or underwriters left with
stock after a rights issue. For more on this subject, see:
Clunie, J., 2010. Predatory Trading and Crowded Exits.
Harriman House.
Some investors fear that short-selling can be used
to manipulate stock prices. For example, trade
manipulation can exploit the predictable behaviour of
others, such as price momentum traders. It can produce
yet more dramatic effects when combined with false
rumours. Manipulation and the dissemination of false
rumours are already deemed to constitute market abuse
and are prohibited by regulation. In practice, though,
it is difficult to prove that a trader has manipulated
a stock price, as this requires knowledge of the true
motivation for a series of trades. Nevertheless, the
SEC, in particular, has been very open over the years in
disclosing examples of charges it has brought against
traders for manipulation. Some manipulation cases
involve short-sellers; but many others cases do not.
Short Selling overview
Disclosure rules over short-selling remains an area
of contention. Because full disclosure of the positions
of market participants can expose them to predatory
trading, disclosure rules present a dilemma to
regulators. Current disclosure rules on stock lending or
short-selling provide a degree of transparency, but by
delaying publication and using aggregated data, short-
sellers are protected somewhat from predatory traders.
Those who call for ‘full disclosure’ might be unaware of
this dilemma faced by regulators.
Managers of short extension funds, absolute return
funds and hedge funds were inconvenienced by the
restrictions on short-selling imposed during the financial
crisis of 2008/09, as their opportunity set diminished
with the temporary restrictions. Nevertheless, these
restrictions served an important role in maintaining
confidence in world markets. Since 2009, short-selling
has been largely de-regulated around the world.
And in Q2 2010, mainland China began to allow short-
selling, in a sign of its growing financial maturity.
If you are interested in learning more about short-
selling, FinTuition’s one day Short-selling course
provides a thorough exploration of risks and trading
strategies around short-selling, plus a detailed
explanation of the informational value in stock
lending data.
Find out more about courses and how to register
at www.fintuition.com
James works at Scottish Widows Investment
Partnership, where he manages a UK equity
long-short fund and a long-only fund. Previously,
James was at the University of Edinburgh for four
years, conducting research into stock lending
and short-selling. He also set up and ran their
Masters programme in Finance and Investment.
Prior to this, James worked at Murray Johnstone
International, where he was Head of Asset
Allocation, and at Aberdeen Asset Management,
where he was Head of Global Equities. James
graduated with a BSc (Hons) in Mathematics
and Statistics and a PhD in Indirect Short-selling
Constraints, both from the University of Edinburgh.
He is also a Chartered Financial Analyst.
Fall 2010 | Fundamentals Magazine | 25
 High Frequency Trading
Trading in Top Gear:
Are the Exchanges Ready for another flash crash?
FundFront
With fears of a technology gap between front and back offices,
the high frequency trader’s future looks uncertain.
T he New York Stock Exchange’s May 6 ‘Flash
Crash’ has almost been enough to give High
Frequency Traders (HFTs) a bad name. These latter
day market-makers received a lot of unwanted
publicity in its aftermath, although HFT and its
venues and must-have accessories, including
alternative trading systems, dark pools and black
boxes crammed with algorithms, are not new to the
securities industry.
The UK’s Financial Services Authority states in its May
2010 market regulatory report: “High frequency traders
have become important providers of continuous two-way
liquidity on electronic order books, acting in some respects
as quasi-market-makers. High frequency trading is now
estimated to account for between a third and a half of all
equity trade volume in the EU.”
Since the May 6 event, when there was a nearly 1,000
point drop in the Dow Jones index in a matter of minutes,
regulators, especially in the U.S., have been trying to
formulate solutions to prevent a recurrence while the
high frequency traders have been deflecting criticism
that they’ve tried to game the system. On June 11, the
Securities and Exchange Commission called for a pause
in trading on any stock in the Standard & Poor’s 500
index which moved 10% or more in a five-minute period,
with each pause lasting five minutes. Two weeks later
it released proposals from U.S. exchanges to expand the
recently adopted circuit breaker programme to include
all stocks in the Russell 1000 index and certain exchange-
traded funds (ETFs). ETFs were probably affected more
than any other type of security. The circuit breaker
programme will remain in effect until December 10 on a
pilot basis. “We look forward to receiving comments from
the public on the proposed addition of the Russell 1000
Index and selected EFTs to the circuit breakers,” said SEC
chair Mary Schapiro.
Technology divide increasing
Whether or not HFTs are beating slower competitors fairly
or unfairly, new trading speed is made possible by more
26 | Fundamentals Magazine | Fall 2010
robust systems, and the divide is increasing between the
technology haves and have-nots.
“We’ve seen a tremendous amount of IT innovation,” said
Sang Lee, managing director of the Aite Group on the
High Frequency Trading panel at the June 23 Securities
Industry and Financial Markets Association (Sifma)
Financial Services Expo in New York. “May 6 was the first
time I can remember, where the argument was made that
competition did not benefit the market.”
“In some places the infrastructure hasn’t kept up,”
said Tower Group senior analyst Dushyant Shahrawat,
also on panel. “Are the middle office, back office and
some exchanges lagging?” Stuart James Grant, financial
services business development manager at Sybase, asks in
an interview with ISJ: “The gap between the front office
and the back and middle office is growing bigger. If that
sounds dangerous, it’s because it is. What happens if the
back office is too far out of line with the front?”
And the cause of the crash continues to be debated, even
as plans are being made to prevent the next. Shahrawat
said: “We still don’t know really know what happened.”
“We absolutely know what happened,” countered Larry
Tabb, CEO of the Tabb Group and a Sifma conferee.
“These transactions triggered programme trades and the
downward pressure crashed the market. As stop losses
triggered they plummetted through liquidity in other
books.”
A perfect storm?
Tabb seemed to suggest that the event was a perfect storm.
“What role did HFTs play in the flash crash?” he asked
rhetorically. “They didn’t start it, but the situation was
exacerbated when they pulled out. The question is how do
you get people to come back into the market. ”
Regardless of the cause, there is a view surfacing among
some people in the securities industry who have proposed
that trading speeds should actually be retarded. That itself
could be an expensive and prolonged initiative. “Unless
we force Cisco to develop hardware with less capacity and
 Have a safe journey.

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or visit clearstream.com
Fall 2010 | Fundamentals Magazine | 27
 High Frequency Trading
have Intel design slower chips, it’s not going to work,”
said Tabb.
“Capital markets today are a tech market,” said Aite’s
Lee. “We could slow things down but what would that
FundFront
achieve? There are a handful of firms chasing a few micro
seconds. I’ve seen the price tag associated with High
Frequency Trading regulations and it’s in the billions of
dollars. I don’t know if it’s worth keeping track of what a
few firms are doing.”
Those firms will continue to try to run faster inside their
own shops and reduce data latency. “Whether they do
it with co-location or carrier pigeons, some people have
speed and some don’t,” said Tabb. “Firms that don’t have
speed are at a disadvantage. They need to invest in their
infrastructure. I don’t know that it’s the fast traders who
are the bad guys. Maybe the bad guys are the ones who
aren’t re-engineering their platforms.”
Even if HFTs played an important role or even instigated
the crash by shutting down their terminals, pulling
liquidity is not unprecedented. During the 1987 U.S. crash,
traders simply walked off the trading floor rather than
be exposed to a plunging market. How well any yet-to-
be implemented regulations will perform in a crisis is
impossible to know.
Solutions in place
Some exchanges claim that they have had solutions
in place for years. Eurex, Deutsche Bourse’s futures
exchange, introduced volatility interruption rules in
November 2002 as part of an ongoing market surveillance
effort. A price interruption occurs if the last effected price
of a futures contract is outside one of the price ranges with
respect to specific time frames. The prices and time frames
are determined by the Eurex Board of Management.
Xetra, the Deutsche Bourse’s all-electronic equities
trading system based in Frankfurt, was launched in 1997
and is operated by the Deutsche Bourse. In addition
to opening the German markets for increased foreign
The London Securities Lending Summit
Still on Ice?
As the hedge fund capital of Europe, London is ideally
suited to talk about securities lending demand.
Thursday, 28th October, 2010
Registration/Lunch 13:15
Four Seasons Canary Wharf
London
To register visit www.GSL.tv/London
28 | Fundamentals Magazine
For more
| Fall 2010information contact: Craig.McGlashan@2i.tv
participation, it is being used by equity exchanges in
Ireland, Shanghai and Vienna.
Xetra also has a trade interruption mechanism, which
kicks in when the potential execution price of an order
lies outside the dynamic or static price range around a
reference price. Incoming orders are partially executed
until the next potential execution price leaves the price
corridor. Fill or Kill orders are an exception.
Michael Krogman, head of Xetra institutional equity,
did not say whether price-time benchmarks were
subject to change depending on market conditions, but
noted that the cash market trading system “features
volatility interruptions as safeguards against potential
flash crashes.” He added: “The mechanism ensures
price continuity. These safeguards were developed in
consultation with our customers and were implemented
in 1997. We monitor the parameters and make adjustments
on an as-needed basis.”
Stock-specific ranges
Stocks have price ranges that are specific to each
instrument. “Volatility interruptions are automatically
initiated if the potential execution price of an order lies
outside a pre-defined price range around a given reference
price,” said Krogman. “Once a volatility interruption
has been initiated, continuous trading is halted and an
auction format is triggered.” Market participants are kept
informed.
Aite’s Lee questioned the prospects of a standardised
solution for a market meltdown and for his part Christian
Katz, CEO of the SIX Swiss Exchange, has said that a May
6-style crash could happen in Europe. Xetra’s Krogman
was convinced that it could not happen at Deutsche
Bourse. “Given the circuit breaker mechanisms we have
in place, it would be impossible for an event similar to
the May 6 Flash Crash to occur on Xetra,” Krogman said.
“This is particularly true since the DAX is calculated using
only Xetra data, effectively taking into account trading
interruptions on Xetra while other platforms may continue
to trade.”
Presented by
GSL |
Global
Securities
Lending
GSL.tv/London

AIFMD – The Big Five
Eliza Dungworth and Michael Booth of Deloitte name the top five
factors to think about before the new Directive arrives.
E uropean policymakers have spent the past 18
months constructing the Alternative Investment
Fund Managers Directive (AIFMD), but there are
still several holes that will need to be plugged
when CESR, the European supranational regulator,
(soon to be replaced by ESMA) sets down the more
detailed granular rules within the implementing
Directive. There is always a lag in submitting these
articles so it is difficult to talk about timeframes.
Consequently what we discuss below are the top
five things service providers and managers should
be thinking about over the short, medium and
long term.
We will not discuss the marketing provisions within
the Directive. Politics has, unfortunately, produced a
situation where the details on this area are so unclear
and still subject to change, such that any comment
would be purely speculative.
Short-term
We have classified the first three points into the short-
term category i.e. you need to know the answers,
implications and take action to these questions now.
Delegation
What are investment managers responsible for? The
short answer is everything, but for the
long answer you need to take a look at
the article on delegation which says “in
no case shall the AIFMD’s liability…
be affected by the fact that [it] has
delegated its functions to a third party”.
“Its functions” in this instance mean risk
and portfolio management but there is
similar wording for the article that deals
with outsourcing valuation. This is a
strong statement and managers must be
aware that there is now an even greater
need for the effective due diligence
and on going monitoring of outsourced services to
avoid being liable. Do not forget that this process
needs to be evidenced, if you were asked to show this
documentation to the FSA today would you have it
available?
Regulation: AIFMD
The Directive has a long reach as it also talks to those
delegated function providers and, in essence, says
that you need to go through the same procedures, and
managers need to check that this is happening. You can
imagine this going on indefinitely as the delegated chain
extends downwards. This methodology also holds to the
depositary requirements; does the investment manager
know the finer points of how a global custody provider
sub-delegates its functions?
Liability
When something goes wrong, perhaps your counterparty
goes into administration, the exchange has a technical
problem or at the very worst the holder of your assets runs
off with them, who do you blame? The initial version of
the Directive, in essence, said
the depositary was immediately
liable, no questions asked.
We have moved on and
Depositaries should now feel
comfortable, provided their
controls are working effectively
when sub-delegation occurs.
What happens when they are
not in place? The Directive
says that managers must make
sure they appoint a depositary
that is up to the job and is in
compliance with the rules as they are laid down. How are
managers going to check that the controls within the service
provider, and indeed service providers in general, are in
compliance with the text? If they don’t check adequately
how much are they on the hook if things take a turn for the
worse? These two questions will impact the going concern
of the company (as distinct
from the fund), what additional
procedures, if any, should
auditors be doing in these
instances? All these questions
may have a simple answer, but
do you know what it is?
Third country equivalence
Many of the operational
changes that may be required
by investment managers and
service providers are under
their own control, but what
Fall 2010 | Fundamentals Magazine | 29
 Regulation: AIFMD
about those that aren’t? Do you know what these are?
Broadly these matters relate to non-European activity
and relate to the requirements that talk about regulatory
‘equivalence’ in the jurisdiction of custody providers,
FundFront
delegation portfolio or risk managers and the investment
fund itself. Many of the main jurisdictions are either saying
that they will be equivalent or will change their laws
accordingly, but given the wide range of locations this may
not be true for all. Managers with global investors, assets
or operations will need to think carefully.
Medium-term
The next point is classified as medium-term in that you
will not need to take action now but it is something to
consider.
Disclosure and leverage
Auditors will be very familiar with the multiple
disclosures firms need to provide in their annual reports in
respect of credit, market and liquidity risks. The directive
requires additional disclosure points in the annual report,
both that of the fund and the investment manager.
It is worth noting a couple of these; leverage and principal
markets. Investment managers are required to disclose to
the FSA (who then pass it on to ESMA) the leverage used
within the fund and also the principal markets in which
it operates. This is so that the directive can achieve its
objective to identify systemic
risk, but there is a worry that
the new European regulatory
could say to fund XYZ, you
need to limit your leverage in
the oil market.
The supervisory package has
broadly been finalised but it
will be important to see how the
newly created regulator uses
its power. Managers should
be on notice that there is a
small chance this Directive will
impact the strategies employed.
30 | Fundamentals Magazine | Fall 2010
Long-term
Domiciles, fund vehicles and structures
It is important to note that for the longer term this
directive becomes less important. Domicile choices for the
fund or investment manager will mostly be driven by tax
rules and other regulatory requirements, and therefore cost
savings, which may be possible under this directive, but
should only play a marginal role.
The relative merits of fund vehicles will depend on, firstly,
how the UCITS framework
evolves with its fifth iteration;
the possibility of restricted
permissible structures and
secondly, on investor preferences,
is the kite mark of being AIFMD
compliant a pull for investors?
Perhaps the most interesting
change will be the interaction
between and indeed the very
existence of funds service
providers. Administrators who
typically provide the underlying
valuations for assets in addition to striking the NAV
and Transfer Agents who affect the subscription and
redemption of units should both be put on notice. The
Directive gives responsibility for both striking the NAV
and for affecting the subscriptions and redemptions to the
‘depositary’. If those functions remain with providers how
will depositaries gain comfort, unless they undertake them
directly, that they are being properly performed?
Clearly, the Alternative Investment Fund Managers
Directive will require changes; it will not be business as
usual. All parties should be actively thinking about these
matters now to ensure the smoothest transition possible
prior to implementation in early 2013.
Eliza Dungworth is head of investment
management at Deloitte
Michael Booth is an assistant manager in the
investment management team at Deloitte

Thinker, golfer, soldier, sailor, ski man, golf man,
auditor chief. This variant of the old childhood
rhyme helps capture the essence of Peter De
Proft, director general of EFAMA, in his school
and university days and in later private life. A
lifelong interest in, and regular participant in,
several demanding forms of physical activity have
exacted a heavy toll on his knees. He practised
a particularly demanding form of skiing, tour
skiing, which involves climbing a mountain or hill
carrying one’s skis, rather than taking a lift.
Other ambitions include sailing the Atlantic, drawing
on his background as part of a crew that won the
Belgian championships five times in the Standfast 40
class. “In 2004 I sailed from Lisbon to Malaga with
a few friends. That took 10 days, but I can’t at the
moment take a month off to cross the Atlantic,
even if I would like to.”
Other sporting honours include playing
volleyball as a left-handed attacker at first
class level for the Belgian national juniors,
the national military and the national
university sides. “We trained with the
Polish team that won the World and
Olympic Championships in 1976,”
he says. Other ambitions include
taking up golf properly, once
he can find the time. For the
moment, he restricts his golfing
activity to a weekly visit to a
nearby driving range.
Despite this track record,
and his status as
chairman of the audit
board at the Flanders
Royal Philharmonic
Orchestra, and
independent director of the University Hospital of Anvers
where he is the acknowledged financial expert, he comes
from what he himself describes as a humble background.
“All four grandparents were schooled only till around 10 to
12 years of age,” he says by way
of explanation.
De Proft has a degree in law (specialising in economic,
financial and tax law) from The Free University in Brussels
(1971-76), and a further degree in economic law from the
same institution (1976-77). Notable steps in his professional
career to date, starting at the International Tax
Documentation Bureau in Amsterdam, include Banque
Belge pour l’Industrie, Banque National de Belgique,
Petercam, Banque Nagelmackers 1747/Group Delta Lloyd,
and Fortis Management Belgium. He has been the director
general of EFAMA since 2007 (his time at Nagelmackers
has left him with a leaning towards the Standard Liege
football club: “I love to go there,” he says. “The people of
Profile: Peter De Proft
that part of Belgium are so warm-hearted and outspoken.”)
His post at EFAMA places him at the heart of the
relationship between the European fund management
industry and the European Commission, the source of a
series of directives issued down the decades that affect the
industry directly or indirectly. “We are a trade organisation
representing the buy-side of the European asset
management industry, with responsibilities to our members
and end-investors,” is how he sums up EFAMA’s basic
mission. He goes to some lengths to stress that EFAMA is
not a lobbying body, but is recognised as a partner of the
European Commission, acting as a consultant in relevant
negotiations.
Recent manifestations of its activities abound. They
include the report issued in September and catchily
entitled Analysis of the tax implications of UCITS IV.
In this paper, co-authored by EFAMA and KPMG’s
European investment management practice,
those of us who did not already know it learn
that significant tax complications exist in the
new Undertakings for Collective Investment
in Transferable Securities (UCITS IV)
Directive that prevent the achievement
of a harmonised European funds
industry. The report identifies critical
tax issues and numerous examples of
unequal treatment (discrimination)
and inefficiencies across the 27
European Union (EU) member
states.
The report recognises that
the UCITS IV Directive
to be implemented
by member states
by July 2011 offers
considerable scope
for restructuring
fund management
operations in the EU. The directive introduces six efficiency
measures, which could make the European fund industry
more competitive and attractive to investors. However, the
directive does not deal with critical tax reforms required
to enable effective use of the efficiency measures of the
directive.
EFAMA and KPMG make a number of recommendations
to resolve the tax barriers preventing an efficient single
market:
Fund mergers: Under UCITS IV it will be possible to carry
out cross-border mergers of UCITS funds. Certain member
states currently tax fund mergers at the investor level,
which leads to a situation where investors would pay taxes
on unrealised gains. In order to make UCITS IV a success,
the report recommends that fund mergers should be
carried out in a tax-neutral manner at the fund and
investor level.
Fall 2010 | Fundamentals Magazine | 31
 Profile: Peter De Proft
Management company passport: UCITS IV will make it
possible to establish a UCITS fund in one member state
which could be managed from another member state.
In this respect, the main issue is that in certain member
FundFront
states, the management of a fund cross border could lead
to a fund becoming tax resident (and therefore liable for
tax) in the management company’s state of residence.
The report recommends that the fund should
only be taxable in the country where the
fund is established or registered, even if its
management company is resident elsewhere.
Master-Feeder fund structure: under UCITS
IV, a feeder fund will be allowed to invest
its assets in another fund, a master fund. As
it currently stands, certain member states
levy withholding taxes on cross-border
dividend distributions to foreign feeders, or
impose tax on redemptions in the country
where the master fund is located. The report
recommends that there should not be tax
leakage between the master and feeder
fund in order for the master–feeder
structures to become a reality and
offer investors a cost effective
product.
EFAMA and KPMG
recommend the adoption
of a tax directive at EU
level that would remove
the tax barriers of UCITS
IV being fully effective.
In particular, it should
provide for:
Tax neutrality of fund
mergers;
Uniform rules governing the tax
residency of funds and the place of
incorporation and registration;
Tax neutrality on the flow of cash between master and
feeder funds.
In the meantime, in the absence of a directive, EFAMA
and KPMG encourage each member state to take the
appropriate measures at national level in order to resolve
the remaining tax obstacles.
De Proft said: “UCITS IV offers great opportunities to the
funds industry and is another important step towards
a single European market. EFAMA welcomes the six
efficiency measures, but in the interests of the funds
industry, and particularly its investors, it urges individual
member states to resolve these important tax issues.
Otherwise, there is a risk that the objectives of UCITS IV
will not be achieved and that the funds industry will not be
able to make full use of all the efficiency measures.”
Georges Bock, global chairman of KPMG’s funds tax
network, said: “If the EU member states want to achieve
their single market ambitions, they need to press at least
32 | Fundamentals Magazine | Fall 2010
for a merger directive for investment funds based on
the principle of a tax deferral so that investors would
only pay tax on mergers of funds once money truly hits
their pockets. A deferral would not lead to an ultimate
loss of tax revenues for the various EU member states.
It is therefore hopefully possible to reach the required
unanimity for the adoption of such a measure.”
In the same week as this paper was launched,
EFAMA welcomed the publication of a
regulation on OTC derivatives, central
counterparties and trade repositories,
representing an important further step
towards strengthening the financial system
and fulfilling the G20 commitments.
EFAMA said it applauds the European
Commission’s aims to increase transparency
of the derivatives market, reduce risk, and
enhance market integrity and oversight.
In particular, the investment management
industry welcomes the reduction of
counterparty risk that central counterparties
would bring and the enhanced transparency
to mitigate systemic risk.
Commenting on the adoption of the
regulation, De Proft said: “EFAMA fully
supports the Commission’s
efforts to introduce
regulation for OTC
derivatives and move
from OTC bilateral
clearing to central clearing
for standardised derivative
contracts. Derivatives are a very
important tool for institutional
investors seeking to hedge their
risks, therefore we welcome the
creation of a robust clearing infrastructure,
truly enhancing protection for all market
participants. However, derivatives regulation must benefit
all stakeholders and protect market users, in particular
buy-side investors.”
“A move to mandatory central clearing will have a big
impact on all investors and savers, as derivatives are
widely used by pension funds, insurance companies
and retail fund managers,” he continued. “Commission
proposals should provide for risk reduction for buy-side
investors through effective segregation of collateral and
for robust risk management and governance for central
counterparties. Most importantly, allocation of the costs for
central clearing among market players must be fair, and
EU citizens should not shoulder excessive costs with their
pensions and savings.”
Strong words from the man patiently waiting for his
second replacement knee and a return to the slopes of
the Austrian Alps, where he and his family spend time,
allowing him to indulge his love of skiing, in which,
Fallll 2
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Basel One Two Three
Brian Bollen in conversation with Sébastien Boschiero and Paul-François De Zerbi,
senior consultants at Logica, on the Basel III capital proposals.
BB: How far down the road would you say we are to a
new Basel III framework?
Sébastien Boschiero and Paul-François De Zerbi:
Not that far. In December 2009, the Basel Committee
issued a consultative document entitled, ‘Strengthening
the resilience of the banking sector’. This was designed to
prepare the market for the incoming reforms of the Basel
InvestorServices
II regulation, gather their reactions and remarks, and
evaluate the impact of this in terms of capital requirements
and costs. Financial institutions, as well as attorney and
advising cabinets, have conducted impact analyses and
issued their comments. First adaptations to the initial
paper’s suggestions have been issued by the committee
mid-September, mainly softening it down.
The next step for the Basel Committee is to publish the
final rules (nicknamed “Basel III”) at the end of 2010.
They are to be integrated in the Capital Requirements
Directive as well as in local regulations before the end of
2011. Financial institutions will then have to implement the
revised framework according to a schedule starting in 2013
and ending in 2023.
If this schedule stays on track, we are only at the beginning
of the process.
BB: Its predecessor took rather a long time to pull
together, didn’t it? Shouldn’t we expect lengthy delays
before the framework is announced?
SB & PF DZ: This revision is intended to be enforced
more swiftly than the original framework. There is a sense
of urgency among the Basel Committee members about
the necessity of improving the efficiency of the current
regulations.
Nevertheless, the consultative paper raised a number
of difficult questions that are yet to be answered. First
reactions to the paper by financial institutions and
their stakeholders were mostly negative. Key criticisms
included the increased pressure on the cost of running a
financial institution in this future regulatory framework
and its expected impact on profitability. Detractors argued
that the availability and cost of credit for customers is at
stake. Financial institutions have also claimed that the first
consequence of this new regulatory framework could be
the slowing down of the global economic recovery.
Other areas of the reform that have been called into
question include the counter cyclical buffer determination,
the definition and calibration of the leverage ratio, the
34 | Fundamentals Magazine | Fall 2010
parameter of what can be considered highly liquid assets
for the short term liquidity ratio, and the discrepancies
between accounting standards across the economical
world.
While these issues mainly revolve around the impact of
the reform in terms of costs and capital requirements, they
also reveal the inevitability of competitive issues if this
new framework is inconsistently implemented globally.
Responding to these criticisms, the Basel Committee has
lengthened the implementation schedule, mainly to avoid
being blamed for slowing down the economic recovery.
Increases in capital requirement ratios, mainly aiming at
the core tier one, were also scaled back.
While the remaining regulatory measures are still being
discussed and calibrated (including the leverage ratio, the
counter cyclical buffer and the liquidity ratio), the final
rules might well be published on time.
BB: Who is doing the work behind the scenes? Are there
any named individuals we can point to and talk to? Or is
just nameless officialdom carrying out the task?
SB & PF DZ: Apart from Nout Wellink, leader of the
Basel Committee and member of the ECB Governing
Council, it would require an insider to identify names
behind this initiative. Nevertheless, the Basel Committee
comprises a number of government officials and central
bank managers who share the common goal of improving
the resilience of the whole financial system.
Governments are backed by public opinion on this issue
and have been urged to prevent major crises from taking
place again. One can see this initiative as part of a global
effort to anticipate systemic failures and prevent
their occurrence.
The G20 is also exploring new regulatory requirements
that fall in line with the Basel Committee initiative,
although not all G20 countries agree on what needs to be
done and how. The current regulatory proposals should
be discussed and hopefully approved during the next G20
meeting in November in Seoul.
BB: How long, realistically, do you think it will take
between announcement, implementation, and compliance
with its eventual requirements?
SB & PF DZ: The initial schedule was very ambitious.
The new version is more likely to be adhered to.
The application of the new solvency ratio is due in

2013, while the leverage and liquidity ratios are not to be
implemented before 2018. As for the counter cyclical buffer,
it has been delayed until 2019. The ‘too big to fail’ principle
is not included in the current revised
schedule yet.
In the meantime, financial institutions are expected to
improve the quality of their capital by excluding less
reliable assets, such as hybrids. This should allow the banks
to use their future earnings in the next few years to help
finance the requested increases in core tier one capital, in
addition to classical capital increases.
BB: History is not on the side of those who like to see rapid
movement, is it?
SB & PF DZ: History doesn’t reward those moving
at a snail’s pace either. A few countries, mostly mature
economies, have already taken significant steps to
strengthen their own regulatory frameworks without
waiting for the Basel consensus. France, for example,
has already asked for measures to be taken by financial
institutions to reduce liquidity risk. Europe has created new
supervisory committees to monitor the financial world. The
United States is currently enforcing the Dodd–Frank Wall
Street Reform and Consumer Protection Act to improve
accountability and transparency in its financial system.
BB: Will banks and other financial institutions inevitably
succeed in diluting any restrictions that Basel III might try
and impose upon them?
SB & PF DZ: It is expected that the Basel III reform will
include new ways of ensuring institutions operate within
regulatory guidelines. As part of this, the regulation
is likely to propose sanctions that directly impact
shareholders, such as constraints on dividends/bonus
distribution and shares buy back.
However, it is true that current negotiations around the
new framework have already succeeded in adjusting and
calibrating the dispositions requirements to limit their
impact – especially those deemed ineffective or counter-
productive. For instance, proposed limits on the extent
to which banking institutions can transform short-term
deposits into long-term credit, are being highly targetted.
They are considered a threat to the very essence of the role
a bank should take in the economic system.
BB: Why should we have any confidence that Basel III will
be any more effective than the previous
two incarnations?
SB & PF DZ: Basel III differs from the previous
frameworks in that it addresses liquidity risk and
includes a systemic approach to reinforce key components
of the financial system and thus reduce the ‘domino effect’.
This means financial institutions will not be considered
Regulation: Basel III
equal before the law anymore. Specific areas of each
institution that are deemed crucial to the financial system’s
existence will face new regulation.
Nevertheless, some of the new regulatory measures will
be less strict than the standards banks already expect from
each other. Self-regulation should be encouraged on top of
the regulatory framework.
BB: Might we not be better advised to return to the Cooke
Committee standards that used to prevail in the days before
the Bank of England’s famous paper on competition and
credit controls?
SB & PF DZ: The leverage ratio proposal marks the
return to direct limits in the spirit of the Cooke Committee
standards: simple, readable and
hopefully efficient.
In the meantime, Basel III also capitalises on the
progress brought by Basel II through the continued use
of risk sensitive indicators and calculation models, while
proposing adaptations to limit its pro-cyclical
side effects.
BB: One of my personal criticisms of Basel II, right at the
outset, was the readiness to let banks decide for themselves
how much capital they should have. Do you see that
freedom being removed?
SB & PF DZ: Basel III will impose restrictions to this
freedom in the form of a tighter definition of what can be
included in each bank’s own funds. The leverage ratio will
also limit their exposure as a whole.
On the other hand, the crisis has shown that not all
financial institutions were tempted to play on the edge
of the regulatory limits. A significant number of banks
used the regulatory framework as a mere tool in their
management portfolio, along with other tools such as key
risk indicators, credit portfolio management and stress-test
results. They reserved more capital than was required by
regulators. The result was a higher resilience to the crisis.
BB: If so, what are the implications for banks and their
customers and their regulators?
SB & PF DZ: In general, first estimates from the financial
institutions were that the new framework would:
• Decrease profitability
• Decrease return On equity
• Diminish the availability and increase the cost of
capital/financing
• Create worldwide disparity in competitiveness
between economic areas
• Restrain economic growth, mostly in highly
intermediated economies, such as Europe.
With the new version of the proposals, the credit crunch
Fall 2010 | Fundamentals Magazine | 35
 Regulation: Basel III
impact should be reduced to a slight increase in credit cost.
The other impacts, if diminished, remain.
Winners in this new paradigm would be economies that
either do not implement the framework or companies that
get direct financing from the market without using the
intermediation of financial institutions.
The USA, currently not applying Basel II, has stressed
in particular that Basel III should be evenly applied
throughout the financial world without distortions or
exceptions.
BB: Basel II’s approach to risk-weighting heavily skewed
bank lending policies towards those assets that were
deemed ‘risk-free’ (eg OECD domestic mortgage lending
was very lowly rated, even zero-rated, IIRC). Are we likely
InvestorServices
to see a repeat of that mistake?
SB & PF DZ: One could consider the leverage ratio as a
means to prevent unlimited commitment from financial
institutions on deals that are deemed risk-free.
But the key point in the OECD domestic mortgage
lending crisis was less about the risk-weighting indicators
and more about the fact that they were unduly deemed
‘zero-rated’ by credit analysts. If not directly impacted by
the new framework, rating agencies will be under more
scrutiny and could face a reform.
BB: Or is Basel III likely to be creative in its introduction of
novel mistakes?
SB & PF DZ: The consultation currently taking place
aims to prevent such side effects. It is expected that the
framework will not be enforced without thorough testing
and estimation of its impact on the economy. Nevertheless,
side-effects could occur, the magnitude of which should be
limited by the aforementioned precautions.
BB: Who will police compliance with
Basel III requirements?
Enforcement will mostly be the same as in Basel II,
with supervision by the regulator completed by market
discipline. The latter will be enhanced by additional
requirements on the extent and depth of the disclosures
that banks should communicate to the market regarding
their application of the Capital Requirements Directive.
Financial institutions will also be asked to publish
reconciliation figures between regulatory capital reports
and financial statements
. accounting standards framework is associated with the
BB: Will they have any effective sanctions?
36 | Fundamentals Magazine | Fall 2010
SB & PF DZ: As indicated above, it will be possible to
impose sanctions directly on shareholders’ interests.
BB: Banks will inevitably get round any new regulations.
How can they be stopped?
SB & PF DZ: Given that these regulations aim to improve
the resilience of financial institutions, banks should be
trusted to play their part. Not every bank tries to get
around the regulatory framework.
Banks are currently expressing their concerns with the
new regulatory requirements. Once their questions are
answered and this process is completed, there will be
as many regulatory-abiding institutions as there was
previously – if not more, due to new modes of sanctioning
non-compliance.
Banks which don’t abide by the regulation will face
sanctions and might have a hard time getting government
help in times of crisis.
BB: If banks do decide to play fair, what will be the
implications in terms of managing capital and liquidity?
SB & PF DZ: Initial analysis has concluded that a steep
rise in requirements for capital and highly liquid assets is
to be expected. Financial institutions are currently working
to limit this ‘step’ effect. In the long term, however, these
requirements should improve resilience and more durable
growth. This was demonstrated by the performance of
the more prudent French banking sector when faced with
global economic crisis.
A side-effect will likely be a new round of concentration
in the financial services sector, in local markets as well as
cross-borders, while mid-sized establishments will have
more difficulties in gaining access to capital and liquidity.
This should be all the more true for capital intensive
activities, such as investment services.
BB: Anything obvious I’ve missed that you would like
to address?
SB & PF DZ: There is a hidden issue behind the
regulatory framework, which could also be deemed a
never-ending one – the accounting standards convergence.
Current implementation of the framework is based on local
standards, which are very different from one another when
it comes to own funds, liquid assets, or even exposure
appraisal. This means that whatever the rules and ratios
the committee intends to put in place, unless a common
reform, it will always result in disparity in competitiveness
between countries.

In their Prime
SEB has packaged the whole asset management process under one electronic roof for
faster and safer banking, writes Niklas Nyberg, global head of GTS Financial Institutions.
T o address the new regulatory environment and
client needs, SEB has developed a tool for financial
institutions called Prime Services. The Prime Services
offering is based on SEB´s Global Custody and
Prime Broker concept, which has been distributed
successfully to the Nordic financial institutions
community. On the back of recent turmoil in the
financial markets, the model has attracted increasing
interest from asset managers outside the the Nordic
area. SEB is regarded as a credible counterparty
with a unique combination of merchant banking
capabilities and the safety and trustworthiness of a
wholesale bank with stable funding.
Prime Services is a combination of products including
clearing and settlement, custody, reporting, and financing
of positions for institutional investors. Prime Services is
aiming to package the whole asset management process
from advisory (ALM, asset allocation etc.) and execution
to asset servicing and performance reporting. This will
simplify the banking relationship, mitigate financial risk
and minimise operational risk. A concentration of all assets
and positions to SEB Prime Services enables one point of
entry, integrated services and consolidated reports.
SEB Prime Services has built an electronic infrastructure
which is tailor-made to meet the changing needs of
financial institutions. SEB invests greatly in the ability to
consolidate different product areas through a reporting
infrastructure. This is one of the areas where SEB has the
ability to differentiate itself from other providers as well as
living up to one of its goals: One SEB.
The client interface is a fully integrated reporting system
consolidating all activities with SEB Prime Services. The
range of reporting covers:
• Financial Instruments: equities, fixed income, credits ,
commodities , fund units, fx, etd, otc-derivatives
and cash;
• Daily activities: settlement, corporate actions,
securities lending;
• Payments: domestic and international;
• Cash balances, Liquidity concentration tools
and transactions
• Total summary with currency breakdowns;
SEB prime services
• Collateral management: consolidated and detailed
exposures and valuation of collateral;
• Compliance reporting;
• Risk reporting with independent valuation.
• Performance reporting
All reports can be viewed in and downloaded or scheduled
directly to clients mail address or server. All reports are
fully compatible with on-screen, PDF and CSV format.
Other types of reports can be produced to individual client
specifications.
All communication is carried out through standard
formats via SWIFT, file transfer or interactive interface
where electronic power of attorneys are administered by
the user and optional duality check of transaction and/
or file transfer is performed. As our risk management and
performance measurement services are fully integrated
with our portfolio management system and custody
platform there is no need for the client to send files with
portfolio data. Currently we have clients using a wide
range of different portfolio management systems that
already have established connectivity with SEB. These
services are continuously delivered or upon request by our
clients.
Prime Services has been built utilising existing staff at
SEB. We have a dedicated team of sales persons that can
rely on experts in different areas depending on the client’s
individual needs. Improvements and new developments
take place in accordance with client feedback.
Having analysed the workflows of a number of
companies active in the financial industry, we find that
for most, a substantial part of their overall costs are
attributable to internal processing costs. We believe
that in the future service providers should adopt a
more holistic approach. This entails moving towards an
expansion of the advisory business, adapting a common
methodology, taking into consideration best practices and
benchmarking against one’s peer group. Banks will have
to move closer to their clients and work together in a more
structured manner in order to achieve better and more
effective performance and more effective administration.
Any investor services value chain should cover the full
investment process and all asset classes, as well as integrate
all relevant internal and external workflows.
Fall 2010 | Fundamentals Magazine | 37
 Russian focus
The use of a common methodology allows a bank to work
effectively with its clients, both internally and externally,
to improve their processes and deliver the best solutions
and services possible. There are several advantages with a
common methodology.
These include:
Company's perspective
• Lower total trade-related costs through increased
efficiency in processes and optimised utilisation of
available solutions;
• Access to advice and expertise and continuous
development of processes and organisation through
the implementation of best practice solutions;
InvestorServices
• Allows quantitative measurement of its level of
efficiency in such processes;
• Allows benchmarking with industry peers.
Bank's perspective
• Improves understanding of clients businesses
and processes;
• Attracts clients by adding value through the provision
of holistic solutions and advice;
• Benefits are made more visible to companies so that
they recognise the total value generated for their
businesses. This approach enables the focus to shift to
solutions and value
SEB Primes Services is now fully functional, following a
‘soft launch’ through bilateral meetings with clients and
prospects. SEB believes that the difference between the
needs of traditional asset managers/pension funds and
absolute return managers are diminishing. We also see an
increased need for a more holistic approach from service
providers. We believe that a more consultative approach
will benefit both clients and us. We can offer our Prime
Services solution in Sweden, Denmark, Norway, Finland
and Luxembourg. We will launch Prime Services in
Germany at the beginning of 2011.
We will launch Prime Services in Germany at the
beginning of 2011.
Niklas Nyberg is Global Head
of GTS Financial Institutions.
Since joining SEB in 1996 Nyberg
has worked primarily Global
Custody, Sub-Custody and Cash
Management in different roles,
mainly within business and product
development. Since 2010 he has
headed SEB´s fund administration
and global custody business.
38 | Fundamentals Magazine | Fall 2010
The Russian Evolution
A milestone is reached as plans for an International
Financial Centre are given the go-ahead.
T he road to the creation of Russia’s International
Financial Centre looks certain to be long, and very
possibly rocky. But every journey starts with a single
step, as either Confucius, Chairman Mao or Chinese
philosopher Lao Tse is thought to have said. In
Russia’s case, this summer saw it take a number of
single steps which added up to something rather
important. One of these steps is the creation of a
CSD.
The story has been running since the mid-90s, as in the
wake of the collapse of Communism Russia rather half-
heartedly set about putting in place the infrastructure that
its newly liberated markets would need if it were to emerge
as a properly functioning modern capital market. Series
after series of interminable discussions with custodians,
settlement depositories in other countries, and local
registrars unfolded. But even with the support of a decree
from the Russian President it took more than 10 years to
publish the final framework of the mooted entity.
It was only the announcement of ambitions for Russia to
become an International Financial Centre that triggered
the final round of activity, says Eddie Astanin, director-
general of NDC. Despite some criticism, the idea of
creating a single CSD on NDC’s base has now been more
or less accepted by market participants and commentators,
he says. The merger of NDC with the MICEX Settlement
House (MICEX SH) is another milestone on the journey.
The NDC routinely describes itself as the largest
settlement depository in Russia, servicing on-exchange
and OTC transactions with all types of debt and equity
securities of Russian issuers. NDC provides storage of
global certificates and depository accounting for 99% of
corporate bond issues, sub-federal and municipal bond
issues. It services 100% of transactions conducted in the
federal bond and the Bank of Russia bond markets, more
than 99% of transactions conducted in the corporate and
regional bond markets, the majority of transactions with
equities and also services UIT units and Eurobonds. The
international rating agency Thomas Murray has assigned
the NDC an AA-rating as a central depository which
corresponds to average rating of Western European CSD’s.
The MICEX Group is an integrated exchange providing
electronic trading, clearing and settlement services as
well as depository and information services. The group
comprises MICEX, the MICEX Stock Exchange, the
National Mercantile Exchange, the MICEX Settlement
House, NDC, commercial bank National Clearing Centre,
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Fall 2010 | Fundamentals Magazine | 39

 Russian focus
regional exchange and settlement centres, as well as other
organisations. The group serves over 2300 participants
in the on-exchange market – leading Russian banks and
broker companies from Moscow and other large financial
and industrial centres in Russia. At present, the MICEX
Group is the largest exchange in Russia, the CIS, Central
and Eastern Europe. In terms of the volumes of on-
exchange trading in securities, the MICEX Stock Exchange
says it is one of the world’s top 20 stock exchanges.
The MICEX Settlement House (MICEX SH) is Russia’s
largest non-banking credit institution specialising in
providing settlement services to participants in financial
markets in the Russian Federation. MICEX SH provides
settlement services that meet present-day requirements
for efficiency, continuity and operational reliability. In
InvestorServices
accordance with agreements concluded between MICEX
SH and the Bank of Russia, MICEX SH acts as a settlement
centre for the organised securities market.
Services provided by the MICEX SH are in high demand.
Its clients number more than 890 major banks and
financial companies from various regions in Russia, such
as Sberbank, GPB (OJSC), Vnesheconombank, JSC VTB
Bank, financial companies Troika Dialog and BCS, major
foreign financial institutions subsidiaries, including CB J.P.
Morgan Chase Bank, ZAO Citibank, Deutsche Bank, ZAO
UniCredit Bank, ZAO Raiffeisenbank, Russian and foreign
exchanges, the largest international brokerage company
subsidiary Cargill Yug and other organisations.
The merger, says Astanin, will give the NDC a new
competitive advantage, as well as a new name: the
National Settlement Depository. The fact that it can
handle equities, corporate bonds, UIT units, government
bonds and Eurobonds will also help. “After the merger
with MICEX SH our total equity capital will rise by a
factor of three. As a bank we will improve DVP and PVP
multicurrency settlement services and can offer to our
client some new settlement services with precious metals,
derivatives and collateral management services as well. We
also have enough financial and technical resources to draw
on as we try to become the country’s only CSD.”
In August, the two announced the launch of a new
“delivery versus payment” settlement using the NDC and
MICEX SH accounts at Clearstream Banking.
NDC is responsible for the securities record, and MICEX
SH controls the flow of funds. The settlements are to
be conducted in a range of foreign currencies involving
transactions with Eurobonds, ADRs and GDRs. Alain
Meyers, Executive Director, Relationship Management
Northern & Eastern Europe, Clearstream said: “This is an
important step into the direction of establishing Moscow
as an International Financial Centre, providing real-time
risk management across all asset classes and establishing
true DVP functionalities linking international central
securities depositories and central securities depositories
internationally.”
40 | Fundamentals Magazine | Fall 2010
He deals deftly with a question asking whether, if the
NDC does eventually acquire a monopoly position, will
it abuse that position and allow service to deteriorate
and push up prices? “There is a theoretical risk, but there
are mechanisms of control. One of these is the board of
directors, which features representatives of market players.
The other is the Federal anti-monopoly service will also be
able to act. Clients will benefit from a single CSD’s cheaper
services and one ‘window’ access to all Russian markets.”
Astanin concedes that the creation of an International
Financial Centre will take approximately 10 or more years
but believes that a good start has been made in improving
Russia’s business environment. Great strides will need to
be made, however, the journey is to proceed smoothly and
successfully in terms of improving information technology,
legislation, transport, financial services, etc. “A working
group has been set up by the Russian President,” he says.
“Part of the road map setting out local tasks that need to
be carried out was the creation of a CSD.” Interoperability
with other national and international CSDs is high on
the agenda for future advances. “We have good direct
communications with Euroclear and Clearstream and some
of their experts are already helping us to move towards our
goal, acting as fully fledged partners.”
Russia, he says, is committed to a fully modern market.
“We see good co-operation between different market
regulators, as we attempt to become more attractive to the
community of global investors.”
Eddie Astanin, 48, was born in “the Silver Lakes” district of
Moscow. He married Alexandra in Leningrad/St Petersburg
in 1983 and they have two children, a boy, Artyom, and a girl,
Paulina. He is a real-life rocket scientist, having studied aerospace
engineering at the Mozhaiskiy Military Engineering Institute in
Leningrad/St. Petersburg. Completed his Ph.D. in 1992. He also
studied at the Finance Academy in Moscow, majoring in banking.
He joined MICEX in 1994, working on government bonds to
provide trading, clearing and settlement facilities, and became a
director of government bonds & money market department. In
2004 he was invited to become
deputy director general of
the NDC, and was appointed
executive officer in November
2009. As chief executive officer
of the newly merged NDC/
MICEX SH he is responsible for
successfully merging the two
operations. He enjoys cycling
and travelling, but “won fame
by swimming competitively in
Bakonur City in Kazakhstan,
the former USSR’s rocket
centre,” he jokes proudly.
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 Global custody
Look East
Fundamentals examines the strategie of Deutsche Bank since the disposal of their
European sub-custody section in 2002.
A previous issue of this magazine (ISJ47)
touched upon the activities and ambitions
of Deutsche Bank in custody in Central and
Eastern Europe. David Penstone, director at
Deutsche Bank in Vienna, has very helpfully
come forward to spell out just what the bank
InvestorServices
is aiming to achieve. Some history is needed
first, for context and texture. Deutsche Bank
sold to State Street Corporation large parts
of its Global Securties Services business in
November 2002. . .
“We started in our new life on January 1, 2003 with
a network spanning 23 countries,” says Penstone.
“Over the past seven years we have grown regionally
and into other markets [it now services 32 countries],
and have also expanded our product range,” he says.
“We continue to look at opportunities for organic
and non-organic growth.” In December last year,
for instance, readers will recall, Deutsche Bank
announced the completion of its acquisition of
Dresdner Bank's Global Agency Securities Lending
business from Commerzbank. The Dresdner Agency
Securities Lending business has been integrated
into Deutsche Bank's Trust & Securities Services
(TSS) business in Global Transaction Banking as
part of its local custody franchise and is overseen
by Roger Harrold, Head of Domestic Securities
Services (DSS). Tim Smollen, the head of the Agency
Securities Lending business, reports to Harrold, who
commented: “The addition of this service represents
a logical complementary fit to our existing range of
services comprising sub-custody, securities clearing,
and fund services."
What is the strategy that David Penstone and some
of his former colleagues are driving forward? “We
are building a business on a global basis with a great
breadth of solutions,”Penstone says. “The business has
become more scalable and we placed a bet on buying
patterns changing. We’ve seen the death of single
market providers to all intents and purposes. We are
going to see the same thing happen over
42 | Fundamentals Magazine | 2010
the next five years to the single region providers.
Providers face a number of challenges if they are to
continue in this field, especially after the introduction
of T2S in Europe. They will have to have a more
global approach to the business. For clients, a five-
year project lies ahead to determine who has the
best global capability in the post-T2S environment.
Deutsche Bank has the greatest combination of
footprint and post-T2S strategy and is extremely well
placed otherwise. For decision-makers, it ticks the
safe harbour box. And it ticks the ‘who’s building the
business?’ box.”
Putting its money where its mouth is
Deutsche Bank, in the narrative related by Penstone,
is putting its money where its corporate mouth is,
creating what he describes as an immensely attractive
breadth and depth of product. “If the product is
commoditised, you have to turn to whoever has the
best bandwidth,” he argues. “Everyone wants remote
membership of stock exchanges; Deutsche Bank can
act as a facilitator for investors seeking to access the
markets we cover. We also offer access to multilateral
trading facilities. We are looking to expand our
market footprint to take advantage of Deutsche
Bank’s global presence. The bank has the tools and
the breadth of knowledge to move quickly to seize
the opportunities we identify. ” There was only one
international sub-custody provider with a bricks
and mortar presence in Vienna until Deutsche Bank
arrived on the scene. It had clients on its books within
nine months of starting to build, he says. Deutsche
Bank’s big advantage over regional providers must be
its international span, enabling it to offer multi-direct
access to many markets regardless of region.
Discussion of the subject was prompted by
developments we noticed earlier this year as Deutsche
Bank continued to ratchet up its sub-custody
capabilities in the region. Deutsche Bank announced
a number of important changes to its Direct
Securities Services (DSS) arm in February. Maria
Ivanova joined DSS Russia as Head of DSS, reporting

to Michael Aschauer Deutsche Bank’s Co-Head of
Sales and Relationship Management and head of
DSS Austria & Eastern Europe). Ivanova has held
Client Management roles at Fortis Bank, Belgium
and Clearstream Banking, Luxembourg and most
recently worked at the National Depository Center
(NDC) in Moscow, where she was responsible for
the promotion of NDC’s services in international
markets and the development of the NDC’s custody
and settlement services. Overall, she has 14 years of
international securities market experience.
In October 2009, Deutsche Bank announced a
senior hire in Poland. Radoslaw Ignatoiwcz joined
from the National Depository for Securities (KDPW
SA) where he was a Board member.responsible for
the operational aspects of KDPW’s central depository
and clearing house functions. Radoslaw has joined
Deutsche Bank Polska as the head of Trust &
Securities Services, Cash Management for Financial
Institutions business and Global Markets Operations
in Poland.
Radoslaw has actively participated in the lobbying
efforts of the custodian community in Poland,
being appointed the Chairman of the Custodian
Banks’ Council at the Polish Banks’ Association
from 2001 until his move to KDPW in 2008. He
represented Polish custodian banks in various market
development initiatives and committees dealing with
amendments to regulations. For his work within the
Council, he was awarded the Silver Cross of Merit
in 2005 by the President of the Republic of Poland
and in 2008 he received the Badge of Honor of the
President of the Polish National Bank for “merits for
the Polish Banking Industry”.
Michael Aschauer, head of DSS Austria &
Eastern Europe and Co-Head of Global Sales &
Relationship Management, Michael Aschauer, said:
“These developments are a strong indication of the
importance of the CEE region as part of the overall
DSS global franchise.”
Global custody
dy
More evidence of the goal
More evidence of the strategic goal came with the
appointment of Rebecca Walsh to the position of
director, global sales and relationship management,
in the DSS business. Based in London, Walsh. joined
from Standard Chartered Bank where she spent three
years in transaction banking sales. Prior to joining
Standard Chartered Bank, Rebecca worked in various
relationship and o2perational management roles for
10 years with Citigroup.
Commenting on that appointment, Rob Scott
and Michael Aschauer, co-heads of global sales and
relationship management for DSS said: “We continue
to focus on strengthening our Direct Securities
Services business by developing new business
opportunities. The appointment of Rebecca, with
her extensive broker dealer and investment bank
relationships, and expert knowledge demonstrates
our continued commitment in this regard.”
The Bank does not only invest in hiring prominent
people to further grow the business, it also keeps
investing in regional expansion. In June 2010, the
bank announced the newly built operations in the
Kingdom of Saudi Arabia, now offering custody
services for the Tadawul Stock Exchange. Further
such developments are well under way. “Whilst the
competition has been contracting and re-assessing,
Deutsche Bank has been expanding” according to
Penstone.
As we have already noted, to be fair, and to give
credit where credit is due, Deutsche Bank’s moves are
drawing admiring glances and favourable comments
even from rivals. “They might have sold their global
custody to business to State Street a decade ago but
they never exited sub-custody and they are building
a business that is very quality conscious,” says one
observer. “I am full of belief that they are and will
remain successful.” The last word, for now, goes to
Penstone. “Everyone says they are totally committed
to this product; Deutsche Bank is spending money on
it. In this space, if you stay still, you’ll be challenged.”
Fallll 2010 | Fundamentals Magazine | 43
F
Fa
 Company Profile: Clearstream
In the fast lane
InvestorServices
As Clearstream celebrates its 40th anniversary, Jeffrey Tessler, CEO of Clearstream International,
talks about the company’s past, present, future and how the company has evolved over time.
Clearstream celebrated 40 years of existence
on 28th September 2010. How has the company
evolved over time?
Clearstream’s founding fathers would probably not
have believed that their company would one day
be a leading provider of post-trade services with a
global reach. The company was founded in 1970 in
Luxembourg, by 66 institutions from 11 countries, to
reduce the costs and risks of settling securities in the
Eurobond market. Today, we are part of the global
organization Deutsche Börse Group and we have offices
around the world to be where
our customers are.
The settlement and safekeeping of Eurobonds is still
our core business, accounting for almost 50% of our
revenues, but the portfolio of what we do today is much
larger and includes cross-border custody, investment
funds services and global securities financing – we
are one of only four global providers of collateral
management services.
We are still on this journey from a market infrastructure
to a provider of value-added services, a process that
we accelerated when I joined Clearstream at the end of
2004. At that time we already understood that post-
trade service providers need to move up the value chain
to respond to certain business threats and to cope with
the regulatory requirements of the future.
How did you do this?
We launched a multi-year strategic project in 2005. We
placed a strong emphasis on interoperability and on
partnerships and both elements have since been the
guiding principles of our strategy: interoperability,
because we do not believe in the idea of “one size fits
all”; partnerships, because we do not want to impose
our solutions to the market, but develop solutions
44 | Fundamentals Magazine | Fall 2010
with and for the market. We took a certain risk: not
everybody was convinced that our approach would be
sustainable over time. But the feedback we receive from
the market until today and the fact that others seem to
embark on our path has proven us right.
Interoperability is the way forward in our industry
and the nucleus of our four strategic pillars: the core
business with settlement and custody, the value-added
services, our Global Securities Financing offering, and
our Investment Funds Services. By the time we started
to develop our strategy, we also put a strong emphasis
on service quality – an area where Clearstream had
traditionally been very strong. Excellence in how we
serve our customers – which translates into the “human
factor” we are known for – is still a differentiating
element today and I am happy to see that our people
do a great job as we continue to be rated as best ICSD in
recent industry surveys.
Clearstream has 2,500 clients around the globe and,
believe me, I travel a lot and I know almost all of them.
It is one of my duties to know what our customers
want, to understand their needs and to ensure they are
happy with what and how we deliver.
However, Clearstream is now going through a
cost-saving programme...
Clearstream is a very healthy company, but the market
environment isn’t and we do not act in isolation. If
interest rates go down due to their impact on net
interest income we suffer just like almost all players in
the financial sector. If our customers merge, our pricing
is under pressure as, in simple terms, one plus one is
not always two.
There are also some question marks in the regulatory
environment. We cannot make any equation without
taking these external factors into account, so we need
to be cautious. The financial industry is currently
Fall 2010 | Fundamentals Magazine | 45
 Company Profile: Clearstream
navigating through turbulent waters. Clearstream does
quite well because we took the right measures at the
right time. It seems to be contradictory that a profitable
company needs to reduce its cost base, but it actually
isn’t: cost-savings are necessary to ensure our future
viability just like past cost exercises ensured we are not
in deep trouble today.
Our customers should know that we have done our
homework and that they can continue to expect a high
level of service at a stable price. Stability and continuity
in turbulent times – this is certainly one of our main
value propositions. But we also continue to invest in
our products and services. There is a lot of creative
potential at Clearstream and have to make sure projects,
like our Liquidity Hub, which is an expansion of our
repo product into Deutsche Börse Group’s CCP Eurex
InvestorServices
Clearing, or our Central Facility for Funds or the joint
venture Link Up Markets continue to come to fruition
- we can claim to be the innovators in the post-trade
industry.
Looking ahead, what are your plans with
Clearstream?
We are well positioned to play a dominant role in the
post-trade landscape of the future. We have a growing
46 | Fundamentals Magazine | Fall 2010
market share in our core business and we are already
the leading provider for certain value-added services,
e.g. in the collateral management area.
We are expanding globally: in November 2009 we
inaugurated our operational hub in Singapore; in June
of this year we signed an agreement with São Paulo
CSD Cetip to jointly develop, promote and distribute
collateral management services for the Brazilian market;
together with Bolsas y Mercados Españoles in July of
this year we launched our trade repository “REGIS-TR”
and we will offer a European infrastructure to increase
transparency in the OTC derivatives market; we
continue to be strong in Asia, a region that contributes
roughly 20% to our revenues – in September we opened
our settlement system to the Chinese Renminbi held
outside mainland China.
At the same time, we follow the regulatory
developments very closely to take advantage of the
emerging European market infrastructure and we will
continue to build competitiveness in the cross-border
securities processing area – through interoperability
and partnerships – to transform our company from a
settlement house to a full service securities processing
bank. Clearstream is in the fast lane – and we are
certainly not running out of ideas.
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Fall 2010 | Fundamentals Magazine | 47

 Exchanges technology & regulation
A clear path for Europe
Fundamentals had an in-depth conversation with Euroclear‘s new chief
executive officer, Tim Howell. He explained what he sees as the most
important goals for Euroclear during the period ahead.
E uroclear is one of the most trusted service
providers in the securities services business. This is
a sentiment echoed by many clients and regulators.
It was most vividly evidenced in the role Euroclear
and other market infrastructure service providers
played during the recent financial crisis; Euroclear’s
InvestorServices
reputation as a ‘safe haven’ was accentuated by
the rush of clients seeking a venue offering asset
protection.
Moreover, Euroclear’s regulators exempted Euroclear
Bank, the international central securities depository
(ICSD), from the recent round of stress tests, undoubtedly
and largely due to its single-purpose bank status and
sound risk-management practices. Howell assures us that
Euroclear Bank would have passed the test with flying
colours, as it maintains regulatory capital ratios well above
the minimum requirements.Having worked at one of
Euroclear’s clients, HSBC, for 20 years and having served
as a Euroclear Board member for three years, including
chairman of the Euroclear Board’s risk committee, Howell
is well acquainted with risk management at Euroclear.
Euroclear’s DNA
“Conservative and prudent risk management is part of our
DNA at Euroclear,” he says. “We take great pride in the fact that
clients trust us and view Euroclear as a means to manage their
own operating risks.”
Euroclear’s expertise in the area of collateral management
is also helping its clients to manage their exposures to risk.
Howell continued: “As a consequence of the financial crisis,
the market is moving from unsecured to secured transactions.
This means that collateral is in greater demand and clients
will need to optimise their use of collateral in order to secure
exposures arising from many different types of transactions, such
as repos, loans, derivative transactions and more.”
This is a role that Euroclear says it is already expanding as
it manages more than 500bn per day in collateral for its
clients. Howell sees more growth possibilities for this
business by collaborating with central counterparties and
their clients in managing collateral required for clearing
operations, including derivatives. Euroclear Bank already
has an agreement in place with LCH.Clearnet along
these lines.
“Helping clients gain access to liquidity through collateralised
transactions is one of the important measures of Euroclear’s
value proposition,” explains Howell. “It is indeed imperative for
Euroclear to ensure its relevance to the market. Offering ways
to reduce risk is one dimension, but this is a goal that resonates
across the entire service portfolio of the Euroclear group,”
he continued.
48 | Fundamentals Magazine | Fall 2010
Adding value
Howell says his mission is for Euroclear to deliver
strong products and services that clients need, when
they need them. Even though Euroclear runs its business
commercially, its philosophy is to put client and market
interests first. Unlike Euroclear, similar service providers
have public shareholder interests to consider. This,
the organisation reminds us, is one of the reasons why
Euroclear remains a low-cost service provider, yet
invests heavily in protecting the infrastructure itself with
developments that do not necessarily generate income for
the company.
“We are eager to explore with our clients how Euroclear can
add value in new domains,” says Howell. “For example, one of
our subsidiaries - Xtrakter - is exploring how we can enhance
our relevance to clients and the market in general by potentially
extending our role as a trade repository for several asset classes,
building on our well-established trade reporting services.”
Euroclear clients can also expect to see more agility and
flexibility in how Euroclear moves forward on delivering
the benefits of its domestic market for Europe programme.
Delivering these benefits in a sequence that meets client
needs when they need them most, is the new mantra.
Accordingly, Euroclear will complete the launch of a new
common communications interface (CCI) as quickly as
possible. This will allow clients to use a single gateway
of their choice to access all of the harmonised custody
enhancements that Euroclear will be delivering in
2011 and to access the largest single pool of collateral
available in Europe that is held across the Euroclear
group international and nationals CSDs. The CCI will
provide clients with the opportunity to rationalise their
communications networks and benefit from the economies
of scale that fewer interfaces entail.
“Service will become the differentiating factor among post-
trade ‘service’ providers in the future,” claims Howell,
“which is why we need to concentrate on building an even
more client-focused service culture at Euroclear.
According to Howell, all of the various Euroclear entities
have worked hard to earn the trust of their clients over
decades, which is a formidable achievement. Many central
securities depositories continue to look to Euroclear, first
and foremost, as their preferred partner to attract foreign
investors to invest in their local securities. For example,
most recently, Euroclear Bank was the first ICSD to create
links with the CSDs of Korea and Chile.
Reinforcing pre-eminence
“I aim to reinforce Euroclear’s reputation as the pre-eminent
infrastructure service provider worldwide,” says Howell. “I
am convinced that Euroclear has the vision, skills, people and

drive to serve as the world standard for depository and securities
information services.”
While technology is a critical enabler for infrastructure
service providers to automate and increase efficiency in the
processing of various types of transactions, it’s the quality
and timeliness of the deliverables that sets service providers
apart.
“We aim to become better listeners and deliver client benefits
faster across a broader spectrum of business disciplines. Clients
will see Euroclear strike a new balance between the pursuit of new
business opportunities and the risk of going after them in that
we will become more agile and pragmatic in our approach,” says
Howell.
In that regard, Euroclear believes its independence
from being owned by a stock exchange group gives it a
competitive edge. Today, CSDs comprising the Euroclear
group work with more trading and clearing infrastructure
partners than any other settlement infrastructure service
provider. Thus, it should come as no surprise that Howell
intends to emphasise Euroclear’s ability to provide a single
point of access for clients to multiple markets, securities and
counterparties.
Simplifying complexities
Clients will save money and benefit from less complex
processes to settle and safe-keep domestic and foreign
securities as harmonised asset servicing becomes the norm
at Euroclear. Furthermore, Euroclear clients will have
a single entry point to the Euroclear group through the
Euroclear ICSD or CSD of their choice.
This means that securities professionals choosing Euroclear
will have easy access to about two-thirds of all blue-chip
equities in Europe, about 50% of all European domestic
bonds and the majority of international securities through
one relationship. Those choosing to work with Euroclear
Bank, the ICSD, will have access to domestic securities from
more than 40 countries and will be able to settle transactions
in any of more than 50 currencies.
Taking a holistic view, Howell observes: “Today, we can say
that the securities infrastructure bears little resemblance to what
it was 10 years ago, especially in Europe. Five years from now, we
will probably make the same observation compared with 2010.”
There has been general agreement that the traditional
securities infrastructure (stock exchanges, central
counterparties and CSDs) are effective for domestic
transactions, but too expensive and complex for cross-
border transactions. However, there is no common
agreement, either from the market or the public authorities,
as to whether competition or organised consolidation is the
better way to achieve lower costs and risks.
One of the reasons was that, at trading level, there was an
expectation that market forces and competitive pressures
would lead to consolidation among European stock
exchanges. Instead, the mergers have been trans-Atlantic
and the endgame has probably not yet been reached. The
popularity of multi-lateral trading facilities (MTFs) have
made the future of Europe’s trading venues even less
certain, with some exchanges and MTFs likely to pair
off together.
At the clearing level, a wide but not consensual view was
that a single central counterparty (CCP) covering different
Exchanges technology & regulation
markets and transaction types would be the most effective
for Europe. This was referred to as the ‘hour glass’ model,
with many trading and settlement providers working
with a single CCP. The benefits of trade netting would be
maximised with a single CCP.
But, clearing has become a very competitive business.
MTFs have sought to leverage their lighter structures and
business models by introducing new CCPs that compete
with previously established CCPs. We are starting to see
overtures towards CCP consolidation, but the path is far
from linear and neither will it be smooth.
The continuum of change
Howell judges that two factors may lead to a more coherent
post-trade environment in Europe in the coming years: the
emergence of Target2-Securities (T2S) and true open access
so that competition can play its full role.
T2S will profoundly change the landscape in which CSDs
operate, and equally so for securities intermediaries that
offer services in Europe. The business models of each will
need to change, which will lead to a blurring of boundaries
between securities service providers. Open access in a
competitive environment will not come about as a result
of moral suasion, and risk reduction objectives cannot be
attained without clear standards and involvement from
the public authorities. Change is on the agenda of Europe’s
regulatory community in their review of MiFID and the
introduction of new legislation.
For all its successes to date, Howell knows that Euroclear
will have to adapt to maintain its leading industry position,
as the world in which it operates is changing. According to
Howell, the main drivers include:
• The aftermath of the financial crisis and the new
regulatory framework that will emerge from it;
• The fierce competition facing CSDs as a result of the
need to redefine business models as settlement is
commoditised across Europe through T2S; and
• The impact of changes taking place in the trading and
clearing domains where traditional exchanges and
CCPs are under siege from new entrants and where
mergers and acquisitions are apt to affect
transaction flows.
Maintaining a low-risk profile and helping clients reduce
their own risks will continue as Euroclear hallmarks.
Connecting markets and customers across the world is also
important to Euroclear’s future.
Tim Howell has joined a strong company that he intends to
make even stronger and more relevant to its user owners.
He is also committed to help make the post-trade market
safer and more efficient.
“We recognise there is great value in reliability as an
infrastructure service provider,” concludes Howell. “In fact,
values and volumes are the two inter-related dimensions
of our business that measure our success. At Euroclear, we
will put our expertise to work to ensure we are sufficiently
nimble to meet our client needs, today and in the future.
However, we see no other way to gain market trust than to
do it the old-fashioned way – by earning it.”
Fall 2010 | Fundamentals Magazine | 49
 Corporate Actions imperfect data
Corporate Actions Special
Defusing a dirty bomb: the drive for cleaner corporate actions data.
By Anthony Depalma, Assistant Director of Operations at BBH.
A nyone who has ever put a wool sweater in
a clothes dryer quickly learns that machines are
very good at doing their job, but completely unable
to save their user from shrinking their beloved
pullover three sizes.
When applying this to securities trading, the stakes quickly
InvestorServices
escalate from shrunken clothes to shrunken (or negative)
returns. Algorithms used for securities trading are long
on speed, but can be short on intelligence, leaving little
room between the quick and the dead. As the marketplace
gravitates to high frequency trading, quantitative models,
and trading turnaround times measured in microseconds
(millionths of a second) the likelihood that an erroneous or
untimely data feed could quickly spiral into a bad trade or
a systemic 'flash crash' grows. A possible 'data bomb' lurks
in the dissemination of corporate actions data.
The corporate actions arena is facing new challenges
beyond the difficult market conditions of the last few
years. The volume of corporate actions and the increasing
complexity of instruments are bringing the challenges from
the back office to front office trading functions, prompting
an urgent need for greater automation and straight-
through processing of corporate actions.
Obstacles abound
The obstacles around processing unstructured and
imperfect data persist as the speed and volatility of today’s
markets force interpretations and decisions to be made in
an ever-shrinking window. The risks have evolved from
the traditional risk of failing to execute an instruction in
the market to a multitude of downstream risks ranging
from foreign exchange to cash management and trading
strategies. Managing this evolving risk profile becomes
even more difficult as investment mechanisms increasingly
become quicker and more automated.
Imagine a common action where a company announces
a reverse 1-for-3 stock-split. A stockholder’s volume of
shares falls by two-thirds while (all other things being
equal) the price of the stock triples. Any quant model not
consuming this data correctly considers the security to be
trading at an all-time high without realising the number of
shares has been reduced and executes a sale of the pre-
split shares. Before settlement date, the seller will need to
acquire more shares to cover their sale, possibly at a loss.
To mitigate the possibility of this risk, significant efforts
50 | Fundamentals Magazine | Fall 2010
are underway to standardise and automate corporate
actions information.
Key examples of these efforts include:
Unique corporate action event reference ID – These IDs
identify a central body in each market to issue a unique
event reference number to be used throughout the lifecycle
of an event by all parties;
Option standardisation for corporate actions – Option
standardisation is designed to reduce the risk of mismatch
on options across multiple providers for the same event;
New corporate action ISO 20022 messages – ISO 20022
represents a new XML messaging standard for corporate
actions based on an accepted business process.
The I2I Corporate Action Stakeholders Group is sponsored
by XBRL, DTCC, and SWIFT, to build consensus on
improving issuer to agent communications for corporate
action announcements of leveraging XBRL technology and
an ISO Standard Taxonomy.
When will we be ready?
So how soon will XBRL for corporate actions be a reality?
I, along with my BBH colleague Sonda Pimental, have
worked on a number of industry boards, including the
SWIFT Asset Servicing Advisory Board, ISITC Corporate
Actions Working Group, and Global Securities Market
Practice Group (SMPG) and can provide an inside view of
current developments.
While everyone recognises their own individual
challenges, the committees are positioned to drive
strategic solutions that address the needs of all entities
throughout the corporate action lifecycle. These initiatives
represent significant milestones within the industry
and lay the foundation to finally transform corporate
actions processing. Through the adoption of these
catalytic mechanisms, the industry as a whole will receive
consistent, structured and timely dissemination of data.
Ultimately, this will afford more time to investment
decisions and significantly reduce risk to all parties.
The road to automated corporate actions has been a long
time in the making; however, the upcoming introduction
of XBRL is expected to greatly improve corporate actions
processing and reduce the likelihood of a ‘data bomb’
flowing from the back office to a trading algorithm.
Ten markets, ten cultures,
one bank.
For further information please contact:
Global Head of GTS Banks: Göran Fors, goran.fors@seb.se
Global Head of Sub-Custody, GTS Banks: Ulf Norén, ulf.noren@seb.se
Global Head of Client Relations and Sales, GTS Banks: Patrik Thiis, patrik.thiis@seb.se

Fall 2010 | Fundamentals Magazine | 51

 Focus on Asia: HSBC & J.P. Morgan
Focus on Asia
C olin Brooks, global head of sub-custody at
HSBC in Hong Kong, identifies the focus on risk
management as one of the major trends affecting
Asia over the past 12-18 months. “It’s not very
sexy but it focuses everyone’s mind,” he says.
“Regulators are obviously looking more closely at
the securities business in the light of the Madoff
scandal and other events, while investors are
looking more carefully at financial institutions and
InvestorServices
who they use for services,” he continues.
In this context, HSBC has benefitted from its inherent
traditional conservatism, but even it not only needs to
have the right products and practices in place, it also needs
to be able to demonstrate that to clients and regulators.
“There’s a lot more transparency than previously,” he
adds. “It’s a hot topic.”
Another hot topic on his radar is the increasing amount
of consideration being given to the outsourcing of non-
core functions, especially by broker-dealers. “During the
crisis, and afterwards, they realise that settling trades
and corporate actions does not add value for them. It’s
simply a chore they have to take care of, and they are very
keen on outsourcing parts of the back and middle office.”
Much discussion is also taking place, he says, on the
subjects of agency clearing and third-party clearing. With
agency clearing, broker-dealers retain their membership
of the clearing system, but assign their duties to another
institution as agent. With third-party clearing, they
give up their membership and clear through a qualified
third party such as HSBC. “Post-execution, their name
disappears from the market, and we assume the clearing
and settlement responsibilities,” he adds, helpfully.
This side of the business has performed soundly for
HSBC in recent times. A large agency clearing mandate
won in Hong Kong in 2009 has seen much higher
volumes than originally planned, he confides, while the
bank is aiming to bring on board two new third-party
clients. “We’re rolling out those services in markets
where regulators allow. Where they don’t allow them we
are talking to local bodies to try to persuade them that
perhaps they should.” The advantages to broker-dealers
are obvious, removing the need to have an on-the-ground
local presence in any particular market they want to move
into.
Capacity demands attention
Capacity is another issue demanding attention. “We are
running at record levels of activity in terms of assets under
custody and transaction values,” he explains. “There has
52 | Fundamentals Magazine | Fall 2010
been significant growth over the past 12 months, and we
are doing analysis of capacity in different markets. Where
are the bottlenecks? What can we do to remove them? We
need to make sure we have capacity if this rate of growth
continues, and are working hard with clients to develop
the capacity we will need in the next few years.”
It is not, though, currently a pressing problem, he insists.
“We always have a significant buffer between activity and
capacity.” The investment programme focuses mostly on
IT but does not overlook the human element needed to
analyse bottlenecks and engage in discussion with local
bodies. Straight-through processing rates are a clear target.
“We want to help clients increase efficiency and we have
systems in place to help identify recurring problems, and
to help avoid them.” In value terms, assets under custody
have risen 2.5 times since January 2009 across the 39
countries that HSBC services as a sub-custodian. Brooks
calculates that the bank has increased its market share by
around 3 percentage points, to 35-40%, but acknowledges
that the total value of each market player’s own market
share can quickly add up to in excess of 100%, such is the
difficulty in making accurate estimates.
CSD linkages paramount
Which areas, then, require most attention? “Linkages to
CSDs,” he answers, without hesitation. “The speed of
linkage to some CSDs needs to be improved.” He is far too
diplomatic to name names, but singles out markets such as
Australia, Japan and Hong Kong as being up to speed. “At
others, where improvements can’t realistically happen in
the short term, the option of multiple linkages needs to be
considered as a partial solution.”
In at least some cases, in the Middle East, for example,
much has been achieved to address issues that can be
traced back to rapid increases in volumes over the past
18-24 months. “In such cases, we had to work with clients
who were unaware of how markets worked on such basic
matters as what they needed to put in instructions to us,
and on timing,” he says. “We were always under client
pressure to provide competitive deadlines, and that was
OK if volumes were low, but if there is a sudden surge in
volume in markets with a strong manual element to the
processing of transactions, problems can arise.”
HSBC will not, of course, be resting on its laurels
or allowing strategy to stagnate. “We have strong
competitors, and expansion is very much on our agenda.
We have plans to build out our network further especially
if opportunities arise in the Middle East and Africa. We
will also be looking to build out in the Latin American
market.” Opportunities in Asia are by definition limited,

As firms face mounting pressures from regulation and cost, Brian Bollen asks
HSBC’s experts why the East is becoming a major target for outsourcing.
given that HSBC is already present in pretty much every
market where foreign investment is permitted. It is,
though, currently studying possibilities in Laos, Burma
and Cambodia. “We won’t be opening in new markets just
for the sake of it, there has to be a business reason,” he
insists. “We will be rolling out new products and investing
to improve and build out information analytics, delivering
more added value information.”
J ohn Murphy , Asia product executive at J.P.
Morgan Worldwide Securities Servicing, identifies
the distribution of Dublin and Luxembourg
products as a key current driver in Asia.
“Luxembourg as a brand has done a fantastic job,” he
says. “Over 70% of the funds distributed in Asia are
Luxembourg funds. We continue to see that as a big
trend; anything out of Luxembourg has a significant
Asian element to its stratey.” Outward investing
moves from Chinese funds will feature strongly in
the long term, he predicts.
Asian institutional investors will increasingly seek to
broaden their investment spectrum, he continues, with real
estate, private equity and intra-Asia investment proving
popular. The US and Europe will remain the predominant
home for investment outflows, but Asian interest will grow
in emerging markets. Against this backdrop, the ability to
handle fund administration is important, and will become
even more so.
What, then, is the impact on providers of securities
services? “In recent years, we’ve put a great deal of
effort into customising our products to suit local
Asian sentiment,” he replies. “For example, around the
benchmarks we follow, clients want custodians to be
more active on their behalf. The tasks of safekeeping and
settlement are a given. Managing the manager is more
important today. Is he doing what he is supposed
to be doing?
He has a word or two of warning for anyone thinking
of entering the market, without correctly assessing the
demands it will place on them. “You can’t have an Asia
strategy,” he says. “You need a multi-country strategy in
the region.” An added complication is that the extreme
efficiency of the infrastructure and culture in some markets
(he cites Korea as an example) can make global investment
structures and processes look very inefficient
by comparison.
Focus on Asia: HSBC & J P Morgan
Asked to provide an example, he cites HSBC’s automated
query tracking system, which (as it name might suggest)
analyses queries and advises clients where they are
spending most time resolving queries. “We can be more
proactive in helping to shed light on weaknesses that exist
in clients’ systems.”
This almost inevitably leads to the subject that virtually
no article on investment can appear in print without:
education. “One of the big efforts we have made is in
arranging seminars with clients, not about products but
about market structures and practices. Chinese clients,
for instance, are eager to learn how markets elsewhere
work, and what are the deep drivers in different markets.
Asian clients appreciate knowledge on the part of a service
provider, and the willingness to share that knowledge with
them.”
When it comes to the Asian custody landscape, buying
behaviours are different for different customers, he
explains. “Global insurance companies want distribution
and local administration. So you need a local distributor
to act as trustee and custodian. Global assets flow through
local banks who sub-contract to global custodians. So
domestic investment is handled by domestic players, while
global investment is handled by global players.” In this
multi-textured multicultural market, the consensus seems
to be that there is something for everyone, and enough of
that something to go round. Eternal optimism prevails;
while the past two years have been challenging, in the
long run all the global and domestic providers should
make money. Asia is, after all, home to some of the world’s
largest pension funds, such as Japan’s Government Pension
Investment Fund with around $1.3 trillion of total assets,
and a number of Australian funds.
“You have mature businesses in Japan, Australia and
New Zealand, and growth-oriented emerging markets
elsewhere,” Murphy goes on. “You can take a portfolio
approach. The NSFF in China had a growth rate of 35% a
year over the 2004-09 period, according to Towers Watson
while Korea was up nearly 15% a year. This is for funds that
are already worth $100bn or more. But relationships are
everything. For clients to appreciate you fully, you have to
be there for the long term. And with Asia so big that it will
be able to dictate standards, in future, you just have
to be there…”
Fall 2010 | Fundamentals Magazine | 53
 Technologies transactions
Dangers of the Out-of-Sync Front and Back Office
With reporting requirements higher than ever, harmony between departments has never been more
important. Stuart Grant, EMEA Business Development Manager - Financial Services, Sybase.
T he impact of the global economic downturn
over the last three years has changed the way
banks and firms operate. With more ad-hoc
reporting requirements for regulators and senior
management, firms, more than ever before, require
better understanding of their data. While they
may have an understanding of their data in one
department, they lack full visibility of how it is
used across the entire organisation and particularly
InvestorServices
struggle to understand the cohesiveness of how it
is used across the front and back office.
A recent Sybase survey, conducted at SIFMA Technology
Management Conference 2010 in New York and at
TradeTech 2010 in London, showed that increasing
demands for competitiveness and the need for speed are
altering the front lines of trading. This is putting increased
pressure on algorithmic models and blurring the lines
between the front and middle office.
The economic situation has highlighted the disparity
between the way the front office and the back office
manage data. But what happens when the front and back
office are too far out of line? What dangers does it present
to firms and what steps and regulations are needed to
ensure the situation improves going forward?
Front Office
The front office is the interface to the market and includes
the team responsible for generating revenue. Whatever the
financial services market, the front office requires copious
amounts of data to make the decisions that generate
money. The data required by this office needs continuous
improvements as competitors instigate new methods,
sources and execution capabilities to generate revenue.
Without ongoing enhancements, there is no way a firm can
maintain a competitive advantage.
Firms are in a position of low latency data use for
front office applications from market monitoring to
order execution and position keeping. More specifically,
they are required to react to market events faster than
the competition to increase the profitability of trades.
The opportunity to take advantage of a price difference
between two or more markets may only present itself for a
few milliseconds before the price equalises. This represents
significant financial profits or loss. For example, a few
years ago, one large global investment bank stated that
every millisecond lost, resulted in $100m per annum in
lost opportunities.
54 | Fundamentals Magazine | Fall 2010
Whilst this is relatively straightforward for the heavily
traded asset classes, where there is an element of
transparency, the gap to the most complex and illiquid
asset classes can be sizeable. And yet, in many cases there
is a link to a more liquid underlying asset, or even several.
As a transaction is executed, this unique record or set of
data is often sent in many directions, either to the middle
or back office functions for further post trade activities
to be performed. Consequently, any corrections or
‘enhancements’ to this record are then performed locally,
not at source, which means the initially unique record
distributed many times then becomes many disparate
records which no longer correlate due to the locally
performed update. Subsequent reports then generated no
longer match and this is a problem often seen just between
finance and risk systems, let alone others.
Back office: The trouble with STP
The back office is the team that provides the support
services to the front office. It is obviously of a slower pace
than the front office as it deals with the confirmation,
settlement and accounting of the front office activity. The
importance of both timeliness and accuracy are paramount
to this confirmation, settlement and accounting process to
prevent future loss of revenue through inaccurate exposure
analysis. The concept of straight-through processing (STP),
which has existed for over 10 years, should, theoretically,
address this issue of ensuring that a transaction is
progressed efficiently from the front to the back office.
However, it is far from reality. As a result, the middle and
back office accuracy and timeliness are often severely out
of sync with the front office position.
The Sybase survey found that algorithmic and high
frequency trading (HFT) comprise the trading platforms
for 85% of respondents, with six out of 10 respondents
employing quant models in particular. Keeping trading
models current is a major challenge. The heavy use of
algorithmic models in HFT environments helps explain
why a combined 89% of respondents describe the feeding
of their models with multi-frequency data rates as either
‘important’ (65%) or ‘very important’ (24%). While more
than half of respondents (55%) said their trading models
are up to date, 28% said they are not—with 68% of that
group saying their models will be out of date within three
to six months.
With the popularity of algorithmic and HFT trading
spreading to debt asset classes, the disparity between front
and middle office functions, and subsequently middle
and back office functions, is increasing. This leads to

late and inconsistent data being used across the front and
back office process, resulting in a costly cleanup process.
The seriousness of this situation for the business is clearly
demonstrated by looking at the swathes of reconciliation
teams that spend hours, sometimes even days, confirming
transaction details and enriching often incomplete data
provided by an array of front office systems.
That syncing feeling
The implications of an out-of-sync front and back office
can clearly impact the entire business’s profitability. The
inconsistency between front and back office is largely down
to a combination of issues, such as: disparate internal and
external data sources; misinterpretation of data descriptions
or metadata; and lack of scalable quantitative processes
used in the front office for functions like asset valuation as
they cannot easily be replicated in the middle office in a
robust or auditable way.
In addition, timing has a big effect on the front, middle
and back office systems. All of these systems are rarely in
sync within a 24-hour period leading to data inaccuracies
and an inability to maintain an agile workflow. The
‘knock-on’ effect is a firm’s inability to understand its actual
position at group level within a given 24-hour period,
thus reducing its ability to react to Black Swan or other
unexpected systemic events.
The biggest challenge faces firms that are called upon to
understand their exposures and position on an intra-day
basis. An event such as the collapse of a major counterparty
relies most heavily on the firm’s actual position, and this in
turn is down to the middle and back office functions having
consistent and up to date information. However when the
offices are out of sync and do not run on the same clock,
knowing a firm’s exposure immediately, as with the case of
a collapsed counterparty, is almost impossible.
Dangers to the firm
As the general pace of the financial markets increases and
individuals as well as institutional investors become more
au fait with how to monitor and invest in markets, firms
will need to ensure they are not only seen as stable but can
prove it in times of stress to maintain their customer loyalty.
However, dealing with a lack of insight into a firm’s actual
position by overcompensating for potential short falls
or volatile movements in the market will make a firm
uncompetitive in the long term.
If the gap between front office and post trade activities
is allowed to grow, the future costs of maintaining
reconciliation teams and processes will become a major
burden, and one which may require significant investment
to fix. However, in the Sybase survey, nearly half of
respondents downplayed risk to the model creation and
execution process imposed by using separate environments
Technologies transactions
for development and production. Executives participating
in the survey frequently pointed to increasing efforts within
their own businesses to bring these environments closer
together.
There is clearly the recognition that dangers are present and
a need exists to rectify this situation, however the severity
needs to be understood fully. Failure to truly understand
intra-day positions and also funding requirements could
easily translate in to failure.
Regulation to improve the situation
For these problems to be resolved, regulators must begin to
look more towards standards in data creation, management,
interpretation and supply. In particular firms must either
take more responsibility to own the data creation or
interpretation process, or it needs to be forced upon them.
Some 65% of respondents claim to be satisfied with their
ability to capture data from trading systems for audit,
compliance or future analytical purposes. However, just
over a quarter (28%) said they are struggling to accomplish
this, leaving it uncertain whether that number will shrink
any time soon. Whether this is for internal audit or
compliance purposes or not, having the ability to complete
these tasks when requested by regulators is essential.
Take ratings as an example. Currently too many firms
extrapolate ratings across non-rated entities rather than
creating their own and linking the data into an entity and
company hierarchy. This leads to an inability to truly
understand relationships and exposure.
How to sync the front and back office
Merging front and middle office has challenges, yet they
are clearly outweighed by the business benefits. As the lines
continue to blur between front and middle office functions,
six out of 10 respondents (60%) are seeing clear demand for
a tick database to be closely associated with their front-
office trading strategies.
The current situation of maintaining data silos by business
function and geography needs to be broken down to enable
one consistent view of data, in real-time across front,
middle and back office functions regardless of business
line or location. Essentially, firms must strive to allow any
functions, even at group level, to answer any question of
any data at any time. Ensuring this will provide ultimate
agility and ability to both ride the future waves of volatility,
whilst retaining customers and profit margins.
A fundamental change
A fundamental change in infrastructure is required – having
a number of different management applications is no longer
good enough. The information in a trading environment
is critical to the existing environment and centralised
management and visibility of this information is a necessity.
Fall 2010 | Fundamentals Magazine | 55
 Regulation mobile telephones
Big Brother will be listening
With the FSA’s mobile call recording legislation just around the corner, Charles
Rich tells firms to fight the fear and use it to their advantage.
C harles looks at the UK Financial Services
Authority’s new mobile call recording legislation and
what it means for the financial sector. Rich believes that
rather than fear the regulations, financial institutions
should embrace the opportunity to utilise these tools
to improve their business processes while dramatically
reducing IT and communications costs.
InvestorServices
Since the beginning of the economic downturn and the
collapse of financial markets across the globe, governments
have targeted traders and the banking industry with new
regulations. While the vast majority of investment banks
and their employees act within the law, the significant
number of high profile illegal insider trading cases has
cast a shadow over the entire industry. These cases have
seen traders, lawyers and executives arrested in a variety
of countries in the Americas, Europe, Asia and Australia.
One major ongoing case has seen more than 20 individuals
charged with securities fraud and conspiracy after a
number of phone calls were recorded by the FBI in the
United States.
The UK’s Financial Services Authority (FSA) has taken
the lead in proposing new rules to help enforcement. In
March 2010, it outlined its proposals for new regulations
that will require all financial institutions to record relevant
communications on mobile phones. This will enhance
its March 2009 call recording legislation which required
the recording of all voice and electronic communications
except for mobile phone conversations.
Seven-year hitch
The new regulations require that any call that involves
advice, deals, transactions or agreements must be
recorded, archived and available for up to seven years.
The sourcing of a suitable solution for recording calls and
maintaining the archived records will be the responsibility
of the individual organisation. Although it may be the
natural reaction to resist any increased government
oversight, we believe that the FSA’s legislation is actually a
risk management measure designed to protect institutions
from ‘rogue traders’ within their organisation.
As a result of this legislation, financial institutions will
be forced to implement or upgrade their existing call
recording solutions. With a number of the world’s leading
56 | Fundamentals Magazine | Fall 2010
investment firms headquartered in the City of London, it is
likely there will be a global adoption of these call recording
rules. Therefore, multinational organisations will need to
utilise a tele-management system that can simultaneously
record and monitor communications across various
devices in multiple regional and international offices.
A solution where call recording is integrated with other
business measurement tools, such as speech analytics and
call accounting, offers a number of advanced business
management tools with benefits beyond compliance,
dispute resolution and the meeting of regulations.
The integration of real-time speech analytics into a
call recording platform means that organisations have
a simple programme that will analyse traders’ calls in a
quick and straightforward manner. Our technology gives
organisations the power to proactively look for any trading
activity, as well as human behaviour, which indicates
potential wrongdoing before it occurs.
Combining this technology with an effective call
accounting system will also enable a business to monitor
network usage to save costs, verify usage, increase staff
productivity and guard against fraudulent use of the
organisation’s telecoms network.
We designed our Proteus Trader call accounting tool
specifically for the financial services sector. As a result it
will simultaneously monitor voice activity across trading
floors, mobile phones, PBX systems, private wires, IP links
and PSTN connections. It is engineered to be scalable,
flexible and user-friendly while reducing the amount of
human intervention required.
An example of the cost savings that a robust call
accounting solution provides can be seen in one of our
ongoing projects. In August 2009, we were asked to install
Proteus Trader across four trading floors of one of the
world’s largest financial services firms to track private wire
usage and identify any unused private wires. Historically,
when a trader requests a new private wire connection, it is
ordered and installed as long as the business case is there.
However, when a trader moves positions or companies, it
is common for the private wire connection to be forgotten
about.

Savings: $32,000 per month
As a result of this installation, our client saw an immediate
cost reduction of $32,000 per month merely through
the identification and removal of unused private wires.
Proteus Trader also allows the organisation’s telecoms and
IT managers to liaise directly with dealer floor managers
to review private wire connections on an ongoing basis.
Additionally, the firm is able to take advantage of Trader’s
other features and benefits including real-time statistics
on individual trader activity, standard report production
on usage and costs, alarm notification of unusual trends in
trader activity and cost comparison of carrier charges.
Ultimately, new regulations and compliance are likely
to continue to be the driving force behind financial
service organisations deploying voice monitoring
applications. However, the utilisation of call recording
and call accounting tools should be viewed as more
about improving business intelligence through the better
Data integration and distribution:
Unlocking the full potential of data
By Rick Enfield, Product Director, Asset Control
F inancial institutions have long recognised
the importance of understanding and controlling
the data underpinning their trading, operations
and management processes. The challenge has
resided in the data management strategy driving
effective control of data while making it accessible
to business users who need it. That challenge
has increased in recent years as financial markets
become more complex and subject to greater
regulatory scrutiny. As such, data management
and integration have become crucial for financial
institutions to understand and report on
exposure, valuation, compliance and risk
quickly and correctly.
While data management has traditionally focused
heavily on acquisition and validation, delivering quality
data to the right users and applications quickly continue
to drain firms’ resources, time to market, and ability to
meet business objectives. Many organizations continue to
struggle with data silos and legacy applications throughout
the enterprise, even among those using a centralised data
approach. Firms are overwhelmed by the sheer volume of
data, and the cost to acquire, store, mine, distribute and
organize data continue to increase.
Data Management software
understanding of the data that flows through a company,
while at the same time reducing IT and communications
costs. To this point, the true value of call recording and call
accounting has yet to be fully realised by the
banking community.
The majority of call recording suppliers have developed
products that simply satisfy regulations. We work closely
with clients to transform call recording and call accounting
into tools that support and improve an organisation’s key
business operations. We believe the most vital benefits are
found in the improved business management processes that
come from a centralised and easily analysable workflow.
CTI Group is a global leader in the development of call
recording and call accounting solutions for the Charles
Rich is sales manager for global financial markets
for CTI Group, which develops call recording and call
accounting solutions for the international financial
services industry.
Financial institutions need to unlock the full potential of
their data management investments by rapidly delivering
data when, where and how it is needed, while reducing
both project and ongoing operational risk. The right
approach for data consumption and integration will help
firms meet business objectives more quickly and effectively,
reduce cost and risk, increase operational efficiencies, and
ensure more successful system implementations.
The consumption of data
Increasingly, business users need to engage directly with
their data in order to deliver compliant, accurate and
reliable data within a controlled, auditable environment.
Data compliance has become the most notable effect of
increasing regulatory requirements, where regulations
put immense pressure on firms to prove that they have
adequate systems and controls in place to establish the
provenance and quality of underlying data.
These changes have forced firms to pay closer attention
to three main aspects of data management: transparency
of where data originates and how it is used; the need to
provide data to a wider range of systems as firms introduce
electronic interaction to as many points of the trade lifecycle
as possible; and the need to support a growing number of
departments and business functions requiring access to
their own versions of data.
Fall 2010 | Fundamentals Magazine | 57
 Data Management software
These challenges are driving demand for flexible data
distribution based on consumption requirements, where
data is available on demand and structured in ways
that are easily consumed by existing applications. Such
software solutions should be able to both take advantage
of centralised data management operations, while offering
localization-based augmentation of data as it is required.
Ideally, these solutions should be highly configurable, yet
easy to use with pre-configured,
‘out of the box’ functionality.
Historically, technology solutions have included data
warehouses and ETL (extract, transform, load) tools. Data
warehouses are typically costly and slow to implement
from scratch, as well as inflexible once installed. ETL
tools are very technical, requiring heavy IT development
involvement, and can raise issues with data persistence
InvestorServices
and transparency.
Financial institutions are becoming increasingly focused
on how data is consumed within the business. This is
driving the adoption of a set of guiding principles for data
management:
• Full audit trails down to the granular level;
• Data models that can be extended for local variation
yet support regular upgrades;
• Ability to shape and distribute information per
consumer needs;
• Analysis and reporting on data compliance, with
support for quality metrics and score cards;
• Flexible data acquisition to control long-term cost
of ownership.
The integration of data
Financial institutions are under constant pressure to reduce
risk in all aspects of operations, while also controlling costs
and evolving their product offerings to meet the needs
of their customers. The right data integration platform
can help firms achieve faster time to market and return
on investment on their data management and business
application projects, by reducing or eliminating the need
for costly technical development skills and third party
integration tools.
According to Aite Group, firms are likely to spend
$1.76bn on data integration alone in 2010, not including
point-to-point data integration. Large sell-side firms report
data management staff of more than 50 people supporting
upwards of 100 applications, while medium and smaller
firms have staffs in the 5-15 person range supporting from
5 to 15 applications.
In addition, many application implementations fall
short of expectations due to lacking or poor quality data,
resulting in the need to develop workarounds and other
shortcuts, or pull back the scope of the project. Financial
data management projects require integration, yet is often
underestimated or overlooked until too late in the process.
Data integration is a key step in successful application
implementations and data management projects, enabling
58 | Fundamentals Magazine | Fall 2010
applications to realize their full potential in supporting
business drivers and objectives. However, many firms’
existing models are difficult to maintain and scale.
Effective data integration can have a significant impact on
the firm’s operational integrity and its ability to mitigate
errors throughout the trading process.
Meeting business demands
The financial services marketplace demands that firms
continually innovate and evolve their product offerings
to meet the needs of customers. Flexibility is needed to
capture all of the information required at each stage of the
investment process, and accommodate differences in the
ways individual systems need to consume information to
properly manage, trade, settle and evaluate the results of
these products and services.
A data management platform should capture, evaluate,
enrich and model to the full spectrum of products and
services used in the financial community. This requires
a flexible data model, the use of extensible web services,
the ability to publish changes as needed, and rapid
distribution of large blocks of data to meet
specific timelines.
Lower costs and faster ROI
Better data visibility and control can make a real difference
in gaining a competitive advantage in the increasingly
complex financial environment firms are operating in
today. Understanding how and where data is used can
help firms reduce costs and risks, and capitalize on new
market opportunities quickly.
Firms need to be able to leverage their existing
infrastructure while also rapidly deploying data to
downstream systems, without increasing costs. By giving
firms the ability to configure data subscriptions and the use
of data, they will not only be able to increase the speed of
implementation, but also control costs by eliminating the
need for additional ETL applications and processes.
Overcoming the challenges
Firms can overcome the challenges of data integration
and distribution by implementing best practices, such
as developing strong partnerships with business users,
establishing realistic service-level expectations, and
dealing with the large number of legacy applications that
continue to exist in business silos in most organizations.
Data integration and distribution should be part of a firm’s
decision making and analysis at the start of the project to
minimize substantial costs down the road.
Firms should seek software providers that are focused
on providing configuration rather than custom coding,
helping firms gain agility, enhanced performance and
integrity of the process, and full data traceability. Data
management should be business oriented and self-service
in nature, and focused on solutions rather than products
to provide many types of data to many consumers, and
address a variety of needs and problems.
 As a partnership for more than 190 years,
Brown Brothers Harriman (BBH) applies
the principles of partnership to everything
we do. Each client relationship benefits
directly from our relationship excellence,
trust, and long-term commitment. With

Partnership.
Not just a word. A culture.
offices worldwide and a network covering
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Custody
Accounting
Fund Administration
Offshore Services
Fund Distribution
Outsourcing
Securities Lending
Foreign Exchange
Brokerage
Consulting

Fall 2010 | Fundamentals Magazine | 59

 Regulatory reporting technologies
Comply or compete?
Data governance delivers the balance writes Norbert Boon of
PaceMetrics
W hile the liquidity requirements of the
impending Basel III financial reform have been
pared back, the regulatory reporting demands on
banks remain a vast challenge – especially in terms
of data management. In this article, Norbert Boon,
global head of solutions at PaceMetrics, looks at
InvestorServices
how banks can best cope in the risk-averse, more
transparent new world order, while maintaining a
sharp competitive edge.
As regulators around the globe clamp down on liquidity
and capital to drive down operational and systemic risk,
financial institutions are under increasing strain. Not
only do they have to hold more capital and liquidity and
report on this daily, but they also need to demonstrate
the processes and controls used to put together reliable
information. Never before have risk and data management
been so interwoven. This places the governance of data
firmly under the spotlight.
Siloed business units, manual processes and lack of
transparency are sadly still common traits in banking
today. These have created operational hurdles for many
as they scramble to appease the regulators and cope with
evolving regulatory requirements and shifting goalposts.
The gut reaction is to throw more resources at the issue,
making compliance severely costly at a time when
budgets are strictly limited. Spiralling compliance costs
are naturally an undesirable option. Instead, banks need
to find a balance between compliance and competitiveness
– meeting the regulatory requirements while maintaining
business as usual.
Banks have always had to report capital at risk on a
daily basis. However, the fines that come from falling foul
of the central bank reporting stipulations are relatively
small when compared to the high margins many banks
now incur. Moreover, the figures on the surface are no
longer simply accepted at face value – what’s behind
them matters just as much. The regulatory focus now
incorporates the audit trail and business process used,
which has disrupted everyday operations and brought
independence and transparency to the fore.
60 | Fundamentals Magazine | Fall 2010
Good price, bad price?
All too often, sell-side institutions find themselves
in a situation where they can’t determine a good
instrument price from a bad one, or even tell who issued
the instrument. If they can’t do this, demonstrating
independent pricing is near impossible. This inability can
largely be tracked back to poor quality of data and an
inflexible approach to data management.
These challenges are compounded by the fact that, very
often, data management falls under the responsibility of
IT. The problem remains though that IT doesn’t have the
specific front and middle office insight needed to ensure
that data is managed according to business requirements
and expectations.
In many circumstances, banks look to databases to deliver
data to downstream systems and users, believing this will
address their data issues and silo obstacles. Instead, it’s
simply adding yet another silo to the mix – and often one
that struggles to meet the data quality demands of new
financial instruments.
In these times of stringent regulation, banks need to
get their data in order if they are to conquer the art of
regulatory reporting. This means taking a business process-
led approach to data governance, based on the principles
of independence and transparency.
When it comes to price data, to prove independence banks
have to source prices externally. The problem with this is
that for some products there is no secondary market, which
means external prices are not available. However, the buy-
side’s ramped up approach to valuation verification – on
top of the requirements of MiFID – have greatly increased
the need to prove that appropriate checks and controls
have been applied.
Proving independence
Banks can only prove this degree of independence by
ensuring that business rules have been incorporated into
data management. These rules or service level agreements
will be specific to the bank – such as the guaranteed
delivery times of prices from specific countries. Most banks
 Regulatory reporting technologies

haven’t yet joined this up to the data management process,
which is what makes it so difficult to determine what
went wrong or gain an early warning of potential issues.
As a result, what could have been addressed as a small
discrepancy often snowballs into a big problem.
Equally important is being able to draw up a full audit
trail of the data. This should not only show exactly where
the data has come from, but must also provide real-time
information about all data events, such as errors, new
product take-ons and model updates. This should span
the lifecycle of transaction data across asset classes, as well
as corporate actions. In addition, such an audit trail will
demonstrate that both the business and regulatory rules
have been adhered to throughout the process.
Continuous monitoring for data governance of the
complete, and preferably centralised, process is also
paramount. This starts with monitoring requirements
coming from systems and users in need of the data. It
should capture changes relevant to each system and the
associated users. It should then verify, approve and deliver
changes to data in the most automated way possible. This
level of monitoring means the performance of systems
can be measured and business expectations effectively
managed. Moreover, it should produce the metrics needed
to assess the cost/income ratio of the service. The process
should also be visible through a dashboard. In putting
this in place, banks will achieve better compliance and
drive down operational risk by giving business users
unparalleled transparency. This is true data governance
at work.
Lean and adaptive
In order to drive business efficiencies and enterprise-wide
cost reduction, banks should also consider a lean and
adaptive data model that models and monitors only the
data that is actually being used. Such models don’t have
to reside in one system but can be combinations of best in
class front-, middle- and back office systems. By not having
to embrace a large data model from the outset of a new data
strategy, new products can be brought to market sooner.
This also means that the cost of supporting and maintaining
data models is dramatically reduced – leading to a
significantly lower total cost of ownership and a quicker
return on investment.
These best practices – particularly if applied across
price, reference, counterparty and corporate actions data
– are key to mastering the compliance and competitive
balancing act I referred to earlier. This level of data
governance will help departments that face extensive
reporting, such as risk and asset and liability management,
meet their daily regulatory obligations more efficiently.
They will also enable the institution to plan effectively and
dedicate appropriate resource to the more extensive month-
or quarter-end reporting. In turn, higher levels of data
quality and the ability to demonstrate independence, good
governance and controls, will go a long way in helping
institutions improve their rating with central banks.

Norbert Boon
Norbert Boon joined PaceMetrics as global head of solutions in
2008. Before that, he was responsible in 2005 for restructuring
Morningstar's Tenfore data provider. Boon previously worked
for Asset Control from 1994 to 2005 as vice-president of sales,
growing the company's Basel revenues before moving Asset
Control into enterprise data management and first introducing
the concept of the 'golden copy'. Boon’s earlier experience
includes hands-on experience of risk management, market
making and derivatives trading.

Fall 2010 | Fundamentals Magazine | 61

 Sponsored section
Sourcing will strengthen
banks’ market positions
Michael Steinbach
T he financial market is subject to considerable
and structural changes. The current economic
climate, technological developments, market trends
and increasing competition will require banks to
adapt to the changing environment. Banks will
InvestorServices
also need to seriously reconsider their operational
models concerning payments. What are the barriers
in this respect, and which considerations should be
taken into account? Michael Steinbach, Chairman
of the Board of Directors of Equens SE, has good
arguments for banks to have a close look at today’s
and future sourcing possibilities in the area of
payment processing.
Why should banks consider sourcing?
“In reassessing and optimising their operational models,
banks have several options. First of all they can take
efficiency measures and work on optimisation of their
internal processes. Another option is to join forces with
other banks. And last but not least, they can look at
sourcing options offered by external service providers.
Since the crisis, banks are more than ever considering the
sourcing of activities that can be performed cheaper and
more efficiently by third parties.”
Is payment processing a logical 'candidate' for sourcing?
“Payment processing is one of the most likely areas to
consider as clear benefits can be obtained here. After all,
what is the point of building and maintaining systems
yourself and maintain procedures when these have to
comply with the same SEPA standards that apply to all
European banks? By sourcing all this to a reliable partner,
banks can reduce operating costs. It creates flexibility and
it will free scarce resources for core business activities.
However, this is not an easy decision to make since
payments processing is strongly embedded in the internal
organisation.”
What factors should be considered?
“While investigating their sourcing options, banks need to
take into account which activities they want to outsource.
Are these purely payments related, or are also cards
activities involved? Are only standard functionalities
62 | Fundamentals Magazine | Fall 2010
required, or should your sourcing partner also be able to
handle specific market or client needs? From efficiency
perspective and in terms of a future-oriented solution it is
strongly advisable to choose a partner who can cater for all
the required services and processes.”
What are important factors for banks in the
decision-making?
“Sourcing processes – whether they involve a standardised
service or full outsourcing – require building a relationship
of mutual trust. Banks have to select extremely solid
sourcing partners who can guarantee long-term
continuity. This is only possible when a sourcing partner
has reached sufficient scale to facilitate a low cost price,
but at the same time has an earnings model that leaves
room for investment in innovation and keeping systems
and processes compliant with regulations. In today’s
market price is highly decisive, but banks really should
carefully consider the aspects of continuity and capabilities
for continued state-of-the art services. Offering excellent
payment services is vital for banks. Doing this together
with a future-proof sourcing partner banks can raise their
commercial profile, while at the same ensuring a flawless
operation.”
What could be differentiating factors?
“In former times, a sourcing partner was merely a supplier.
Today, the role of a sourcing partner has changed more
and more into a consultancy partner. To fulfil this role,
you need certain skills. For instance, you need to know
exactly how a bank operates. This is of crucial importance,
as in considering the sourcing of payments you need to
look at the entire infrastructure of the bank. Furthermore,
besides offering scale, scope and a full range of basic and
client-specific services, you need to do more. As a future-
oriented sourcing partner you should also need to provide
an HR model, which helps banks to deal with the social
burden which is often related with sourcing decisions.
We recognise this as well and are therefore prepared to
discuss models with the individual bank for taking over
employees involved in the outsourced activities.”
 Pan-European payments

Which processing activities can be outsourced?
“Looking at the market, this decision in most cases entirely
depends on the requirements of the bank and the needs of
its customers. For Equens this means we are able to take
over parts or the entire payments processing value chain,
starting from the sphere of the payer to the sphere of the
beneficiary, and all the steps in between. And varying from
international, SEPA-compliant to domestic payments,
and from tailor-made bilateral corporate solutions to
standardised collective mass payment solutions. Above
this, we have the knowledge and experience to connect the
payment processes to all other relevant banking processes
and systems with the required interfaces, such as customer
databases, and the different product systems.”
And cards?
“Good question, especially since we are a dual processor,
offering both payments and cards services. Together with
our subsidiaries PaySquare and montrada we cover the full
value/functionality chain of cards processing. We thus offer
our clients issuing processing, issuing processing services,
switching, acquiring processing, acquiring processing
services, and commercial (merchant) acquiring for debit
and credit cards, including prepaid solutions. We are
ready for the fundamental changes the cards market is
going through, especially in the area of acquiring. Large
European retailers need more services on a pan-European,
SEPA basis as they want to avoid having to deal with many
different domestic schemes. When banks are not able to
follow their customers into Europe, retailers often want to
arrange their own central processing. This will lead to an
intensified relationship between merchants and acquirers,
which will push banks to the background on this point. For
quite some banks it is not feasible to set up an organisation
to provide the required international acquiring services. To
support banks in overcoming possible lags in their offering
and lose market share, we offer them a white labelled
complete acquiring business model, including a complete
dedicated organisation for processing, risk management,
call center for questions from customers et cetera. This way,
banks are able to continue to offer acquiring services to
their merchant customers and remain independent.”

About Equens
Equens is a leading pan-European payments and cards processor, with
roots and offices in the Netherlands, Germany, Italy and Finland.
Recognising, understanding and optimising the processing of payments
and cards – both domestic and international - has been Equens’ core
competence and core business from the outset. The company has more
than four decades of experience to build on. Its national roots and local
expertise allow Equens to meet national and bank-specific market demands
right across the payment processing chain. With clients and partnerships in
Michael Steinbach

multiple European countries banks can rely on European market coverage

and full reach throughout Europe. Equens even offers reach beyond SEPA –
via the IPF Association and a strategic partnership with the Federal Reserve
Banks. The organisation is bank and brand-independent and has a stable
governance structure with shareholders all over Europe. This, combined
with an explicit European growth strategy, ensures long-term continuity.
www.equens.com

Fall 2010 | Fundamentals Magazine | 63

 Custody & Clearing

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64 | Fundamentals Magazine | Fall 2010

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Fall 2010 | Fundamentals Magazine | 65

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66 | Fundamentals Magazine | Fall 2010

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 Register free for the GSL Weeklywire - GSL.tv/membership

People M o v e s
Senior management Walter Kraushaar, head of short-term products at
Dekabank, joined Maple Bank as head of securities
Northern Trust appointed Wim van Ooijen as finance.
country head for the Netherlands, replacing Eric
Pouwels who moves to EMEA. Chris Clark from SunGuard joined Mizuho
International as head of equity finance.
Euroclear reshuffled its senior management team
to strengthen the company’s leadership. This The new global head of equities at Standard
month Frederic Hannequart will replace Tim May Chartered is Simon Brookhouse, previously CEO
as chairman of Euroclear UK & Ireland. Bernard of Execution Noble Group.
Frenay, managing director and head of the financial
division, will take on May’s role as chairman of Client services
Xtrakter Ltd. Euroclear also hired Lieve Mostry
Pirum signed up Chris Byrom in client service
– who joined from BNP Paribas Fortis in Brussels –
manager role. He joins from J.P. Morgan where he
as executive director.
held a role as securities lending process specialist.
Former Goldman Sachs managing director Meurig
Northern Trust appointed two new senior
Williams has joined Daiwa Capital Markets as
relationship managers in Nordic region: Annika
SecuritiesLending

regional head for Europe and the Middle East.

SunGuard Astec Analytics placed Richard Allin in
charge of its Asian operations to become senior vice
president for Asia.
Abdu Dhabi Investment Authority hired Ted
Chu – from General Motors in Detroit - as chief
economist.
ICMA has a new chairman of UK, Ireland and the
Americas. Simon White joins from Lloyds.
Securities lending and equity
Steve Pitkin moved from Citco Fund Services to
Citi to be head of investor services for hedge fund
services.
John Sisterson has moved from EquiLend to
Macquarie Securities where he will be responsible
for securities lending and equity finance for the
firm’s Asian business.
TradeStation Securities hired Robert Sackett from
Citigroup as new senior managing director to start
up a new securities lending department.
Larsson and Erik Norland.
Sven Weinhold joined UniCredit Bank Germany in
Munich to focus on funding and collateral solutions
for clients.
BNP Paribas launched a global reorganisation
with four new global business lines and a client
development team.
Prime services
Rule Financial appointed Kevin Neville and Alec
Nelson as joint heads of expanded prime services
and securities finance consultancy team.
Deutsche Bank has expanded its global prime
finance business with the appointments of Sean
Duff and Zachary Rubin in director roles.
Credit Suisse appointed Myo Schollum as the new
head of prime services in Japan.
Barclays Capital hired 10 managing directors at its
prime services business in New York and London,
including Jack Inglis who joins from Ferox Capital
as head of prime services.

70 | Fundamentals Magazine | Fall 2010

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 Risk central counter party

Join the central counter party

Roy Zimmerhansl provides his view on the latest developments in securities lending CCP.

“For securities lending to return to, and exceed previous

heights, it needs a more efficient roadway ahead of it. Even
if that road includes a toll booth.”

T he subject of central counterparty for

securities lending has been floating around the
market for several years now. It has evolved from
a whimsical flirtation with a concept borrowed
from other parts of the financial markets and
transformed into a reality. Or at least a reality
for some - for many it is still like extraterrestrial
encounters: some people swear that they have
been abducted, but there is precious
little evidence.
Yet subtle, but detectable signs of the creeping influence
SecuritiesLending
the business future for this industry, why are there still
question marks? Searching long and hard to answer this
question, there appear to be three gaps that are slowing
forward progress. I have labelled these barriers as
"Concept Gaps", "Product Gaps" and "Implementation
Gaps" and we examine each of these below.
Concept gaps
There are two primary objectives for CCPs - business
risk mitigation and operational risk reduction through
enhanced processing efficiency. People are either
convinced by the arguments or they are not. If they do

of central counterparty (CCP) are beginning to
accumulate. Several domestic markets have adopted
CCP for exchange-driven securities lending activity. The
grandfather of securities lending CCP is the Options
Clearing Corporation in the US which has operated a
securities lending CCP for options market makers since
1993. Last year, OCC teamed up with Quadriserv in
the US as another pathway for trades to enter the CCP
network. Brazil, Malaysia and Singapore all have CCPs
as integral to their domestic market activity. In Europe,
LCH was first past the post, launching in June 2009
(fed by trades from SecFinex), followed this year by a
SecFinex tie-up with SIS x-clear. Waiting in the wings is
Eurex which has pushed back their target launch date
from early 2010 to sometime in 2011.
At the ISLA conference in Berlin earlier this year the
audience vote during the CCP panel session indicated a
strong belief that CCP was inevitable - the only question
was when. At the recent IMN Beneficial Owners
conference in London that inevitability was again
reinforced. The white paper that my co-author Andrew
Howeison and I recently released examined the key
conceptual challenges facing the industry and the title
"Good, Bad or Inevitable" captures the prevailing mood.
Volumes in existing CCPs are growing, albeit at
different rates and with varying degrees of enthusiasm.
So if all of the signs are pointing towards CCP as part of
not believe the CCPs satisfy these two objectives, there
is a concept gap and there will be no forward progress
as there is no value proposition in the eyes of the
naysayer.
The key argument in favour of the risk mitigation
objective is that CCPs have multiple layers of protection
that mitigate potential losses from spreading beyond
the defaulting entity. By definition, these multiple
layers cannot exist in bilateral relationships - lenders
and borrowers are dependent on their counterparty
remaining a going concern or failing that, sufficient
overcollateralisation exists to protect lenders for the
next default. Of course, borrowers have real and
constant exposure to lenders. If there is any key sea-
change in regulatory consideration it is that there is a
clear acceptance that firms WILL default in future. In
2008, Bear Stearns needed last minute rescuing, Lehman
wasn't saved, and AIG was bailed out. It seems entirely
more plausible in future for governments/central
banks/regulators to bail out market participants in an
industry that centrally clears the bulk of its business.
That's because the market will bear the cost of the
overwhelming bulk of losses through the layers of CCP
protection before the first penny of government money
is required. That is politically "sellable" to the public.
That in itself may drive regulators to force CCP
on the community.

72 | Fundamentals Magazine | Fall 2010

 Risk central counter party

Operationally, CCPs are the obvious next step in somewhat self-serving feeling that securities lending
evolution. First firms concentrate on their internal weathered the perfect storm in good shape) and you
practices, procedures, data, etc. Then, having maximised have a powerful mix of anti-CCP sentiment.
their internal efficiencies, they turn to their external
counterparties and establish connections that facilitate What next?
easy problem identification and resolution. That is where
As much as some might dismiss CCP as a useful, even
we are today - best practice requires use of automated
essential part of other parts of the financial market
reconciliation tools to identify "breaks" and expedite
place, the securities lending future must include CCP
error correction. Clearly eliminating the potential for
as an important element of the business. For all those
discrepancies for source data of all types is to use a
who say that securities lending has survived with few
"golden record" which all parties must adhere to - enter
losses, then look at the wider CCP community across a
the CCP.
dramatically bigger financial market place. If securities
lending did well, CCPs did even better and were tested
Product gaps
more heavily. Those who don't see the need for more
Despite the severe drop off in borrowing demand from efficient capital and balance sheet allocations either don't
2008 peak values, the business still has an estimated remember having to close out trades or rebook under
USD 2 trillion of outstanding balances. For CCPs to other structures, or their firms have avoided capital
capture a significant portion of that activity, their costs.
product offering must be robust and satisfy the needs
As business volumes increase, pressure will return, and
of a diverse community of users. It is clear that none
regulators will scrutinise more deeply those that don't
of the existing CCPs have a perfectly formed product.
allocate capital today or don't have it charged to their
Each has flaws that limit the amount of uptake for the
business lines. And for those that claim CCPs just add
widest group of participants. Rather than pointing the
"more work and extra cost", they need a history lesson as
accusatory finger and exclaiming: "A-ha, THAT'S why
each major technological change in the financial markets
we don't use it", rational market voices are saying:
has required investment well before the return was
"These are the gaps, if you fix them we'll use it, if you
realised.
don’t, we won't”. Products develop and evolve over
time - at least successful ones do. Securities lending is indeed a complex product that
carries exposures and responsibilities that most other
Is there value in the current configurations of the CCPs?
products don't have. It is harder to standardise, and
Yes, but they are limited in terms of upside potential. To
flexibility to open and close loans almost at will is both
have a meaningful impact, the CCPs will need to deliver
a blessing and a curse. It has very successfully managed
on the initiatives they have under way. If they don't,
to extricate itself from the past few years relatively
they might as well shut their doors, concede defeat and
unscathed and market participants are rightly proud of
hand the baton to competitors and the next generation of
that fact. But as we drive forward into the future, people
CCP providers.
are well advised to remember that cars work with
manual gearboxes, but operate more smoothly in heavy
Implementation gaps
traffic as "automatics".
We live in the real world, with competing demands
The high volume of trades that will in future be
on the projects and resources that firms have at their
put through CCPs will form the bedrock that will
disposal. Aside from the imposition of a requirement to
facilitate the bespoke, customised, more complex and
use CCP, individual firms will deal with the issue within
profitable trades to be booked with few restrictions
the constraints of their individual businesses. Those
and constraints. For securities lending to return to,
interested in promoting the use of CCPs should not
and exceed previous heights, it needs a more efficient
underestimate the practicalities of the changeover from
roadway ahead of it. Even if that road includes a toll
the bilateral model to one where CCP plays a significant
booth.
role. Client education, changes to documentation and the
implementation of a parallel operational environment all
represent real challenges at a time when the main focus
for most is self preservation of profitability. Add apathy,
inertia and fear of change, mix that with the true (but

Fall 2010 | Fundamentals Magazine | 73

 US Regulation national bureau of economic research
Reality v. Regulators
Short selling does not affect pricing, according to an experiment by the US National
Bureau of Economic Research into the effects of stock lending on securities prices.
Researcher Tobias J. Moskowitz explains the results and tells Fundamentals why
he’s sceptical of regulators.
What led you to conduct the study? What was
the motivation behind it?
We knew a money manager that was considering lending
its shares and was weighing the pros and cons. It was an
obvious opportunity to run an experiment and the money
manager agreed.
Unlike other sciences, in financial economics we almost
never get to run experiments. We are usually presented
with the data and have to figure out how to interpret it.
When we got an opportunity like this, which is rare in our
field, to be able to run a controlled experiment where
we can get a definitive answer, we jumped at it. We just
happened to get lucky as there was a manager who
wanted to answer the same questions that academics
wanted to answer. So it worked out beautifully.
Did the money manager contact you or did you
seek him out?
SecuritiesLending
We were in contact with the money manager
professionally. We talk to the money manager and other
practitioners regularly.
Did the manager need much convincing?
The money manager was trying to weigh the benefits
(lending revenues) of lending out its shares against the
perceived costs of doing so (stock price instability). The
experiment provided a way to answer the question. We
didn’t know which way it would turn out, obviously, but
that’s what’s nice about running an experiment. It was a
great way for them to get an answer on something they’d
been thinking about for some time.
The timing of the first phase came during an
interesting period - did you know something was
coming?
The timing was serendipitous. That was simply when all
the approvals had been obtained and the lending agent
engaged.
It is also what allowed us to run the experiment a second
time. The first phase was such an unusual period and
there were so many things going on that both we and
the money manager thought it would be useful to run it
again during a more normal period. That was a very nice
feature and helped us because it gave us two different
experiments instead of one, making the results stronger.
Originally you had only planned one phase, but
74 | Fundamentals Magazine | Fall 2010
the conditions meant you had the opportunity to
run it again?
Correct. Allowing us to run it twice was really nice, we
hadn’t thought about that originally.
It was post-Lehman that securities lending
appeared in the mainstream media, so it was
prescient that your results became even more
news-worthy after what happened.
We don’t know about prescient but certainly lucky...
Was it a conscious decision to release it close to the
second anniversary of Lehman’s collapse?
We wrote an early draft, we presented it a few times at
different schools, we received comments and criticisms
then addressed those, making the paper better. When we
thought the paper was in good shape, which we think it is
now, we made it public and submitted it to an academic
journal. The second phase ended a year ago and so this
was the time when we thought about revising everything,
we thought the paper was in good enough shape and
sent it out.
It does seem again to be a little bit fortuitous but tthat
wasn’t by design. If we could have predicted Lehman,
we’d have our own hedge fund by now.
You’d be far too rich to be writing academic
papers...
We’d probably still be writing academic papers.
You chose 10bps as the baseline for specials.
Would you say that 10bps is more around the
level for general collateral rather than specials?
We actually upgraded to 25bps for both phases.
Because the manager wanted to be able to vote its shares
any time a vote was held, the manager preferred to lend
out shares where they were making money, rather than go
through the headache and transactions costs for shares
earning just a small sum. Of course the average is much
higher than 25 basis points - the average stock was
several percent on special.
Were returns inclusive of the investment returns,
or just the rebate rate?
The returns we calculated are returns the stocks earned
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Fall 2010 | Fundamentals Magazine | 75

 US Regulation national bureau of economic research
over the period. Anyone who owned those stocks earned
those returns. They returns do not factor in any returns
from lending the shares. If the returns from lending are
factored in, the manager earned money by lending.
In your research did you normalise lender’s
activity? For example during the 2008 period
many lenders would have been thrilled to get
a new client to make new loans to support the
recalls/returns/drops in market values in 2008
period, but not 2009. Could that have had an
impact on your figures?
That is one of the nice things about running the
experiment twice – we recognise that there are lots of
reasons why the fall of 2008 was a very different and
somewhat abnormal time in the market, with lending
activity, government intervention, the financial crisis and
so on. What is nice for us is that running it at a different
time period and market environment, and getting the exact
same result, really says that all those things don’t affect
the experiment very much.
Two very different environments with the same results
suggest the results are pretty solid. That is why the money
manager, after seeing the results being the same twice,
said: “No more experiments at this point.”
The money manager is now keen to lend its
securities?
SecuritiesLending
Yes. They were convinced by the results and are now
lending all of their stocks (that meet the 25 basis point
hurdle).
Why did you run the second phase for so much
longer? Had you intended to run the first phase
for longer but decided to cut it short due to the
conditions?
The motivation for running the second phase for longer
was to get more robust results over a longer and different
period. We hadn’t intended for the first phase to be as
short as it was, the market environment probably dictated
that, but in the end it worked out well for us.
Do you plan on doing any follow up work, any
similar experiments?
Not in this one, but we are open to running experiments
with anyone who may be reading this article! One
experiment we would love to run is with someone who is
already lending out their shares, if they let us randomise
the quantity of what’s lent. Once you make the decision to
lend out your shares, the next question would be to find
the optimum amount you should lend, the tipping point
where you maximise revenue and minimise the cost. That’s
an interesting question to answer and we don’t know
the answer to that in the field of finance at the moment
and I think the only real way to get an answer is to run an
experiment.
We have lots of questions like that though that we’d love
to run.
76 | Fundamentals Magazine | Fall 2010
Within this experiment are there any areas that
if you ran it again you would do things slightly
differently?
The only limitation was the restriction to lend out no more
that 3-days trading volume or no more than 5% of the
shares outstanding. If we had had full control, we probably
would have just lent as much out as there was demand
for. At this point, we have to qualify our results by saying
they hold as long as you do not lend out more than 3-days
trading volume or 5% of shares outstanding.
Otherwise, we think the experiment ran very well.
From your research, do you think regulators
should leave securities lending alone, or take
more of an interest?
Our results show no harmful effect whatsoever from
making shares available for short selling. Actually most
of the empirical evidence, our paper and by others, finds
pretty much the same result. From our experiment, we
impose a big shock on these stocks where all of a sudden
you go from some short selling to a great deal more and
there’s no effect on the price. Our conclusion is that short
sellers aren’t affecting prices.
The experiment (along with the previous research)
strengthens our view that markets generally know how
to police themselves better than regulators. That doesn’t
mean we should have zero regulation, but we are sceptical
that politicians or regulators can step in and know the
price better than the market. That’s essentially what
regulations do when they ban short selling.
We think our experiment shows that, at least on the
supply side, there isn’t any effect from making shares
available, and so this type of regulation may be pointless.
We can’t say that for certain because we didn’t actually
run an experiment where we banned short selling on lots
of stocks, and we can’t do what a government regulation
does. Our results, however, do point in that direction.
‘The Effects of Stock Lending on Security Prices: An
Experiment’, issued this September, was carried out by
Steven N. Kaplan, Tobias J. Moskowitz and
Berk A. Sensoy.
Tobias J. Moskowitz
Fama Family Professor of Finance
and Research Associate National
Bureau of Economic Research
Toby Moskowitz is the Fama
Family Professor of Finance at the
University of Chicago Booth School
of Business, where he has taught
finance since 1998 and currently
teaches courses in Investments and
Asset Pricing. He also serves as a
research associate for the National Bureau of Economic
Research and is a former editor of the Review of Financial
Studies and is currently an associate editor at the Journal
of Finance. His work has been cited in the Wall Street
Journal, the New York Times, Financial Times, US News
and World Report, Money magazine, and a 2005 speech by
former Federal Reserve Chairman Alan Greenspan.
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 Staying on track?
Craig McGlashan follows up on a report from Deutsche Bank Global Markets
Research which highlighted the impact of securities lending on ETF tracking error.
T here is no doubting the increase in
popularity of exchange-traded funds (ETFs)
among European investors. According to
figures from Deutsche Bank, the European
ETF market is growing faster than its US
counterpart – 2.1 times faster in the first quarter
of 2010, during which there was an 8.5%
increase in asset growth.
This growth spurt should be tempered by the fact that
the European market is still three times smaller than the
US, but during that same quarter it did post comparable
cash flows (USD 9.9 billion net flows, compared with
USD 9.9 billion in the USA). Additionally, a survey by
Deutsche Bank has indicated that 88% of European
investors expect that they will increase their use of ETFs
in the future.
Deutsche Bank has a reason to be interested in
SecuritiesLending
these figures. It is one of three main players in the
European ETF sphere, the others being iShares and
Lyxor. In addition, there are two main flavours of ETF
available. Physically-backed ETFs involve a manager
holding a basket of securities from the exchange the
ETF replicates. Swap-based, or synthetic ETFs, use a
more complex system that, according to some, ends
up being more accurate than their physically-backed
counterparts.
A recent study by Christos Costandinides, ETF strategist
at Deutsche Bank Global Markets Research, looked at
tracking error in a series of physically-backed ETFs, and
sought to find the factors that resulted in these tracking
errors and the size of their impact. One such factor was
the lending out of securities contained in the basket.
How and why would an ETF lend out the securities?
“Typically the manager will make the decision to
lend and then they will enter into an agreement with
a securities lending agent,” explains Costandinides.
“They will give them a mandate and enable them to
lend out securities on demand, up to a certain level –
which could be as high as 60% or 70% of the securities
in the portfolio.
78 | Fundamentals Magazine | Fall 2010
“In terms of why securities are lent, it could be to bridge
tracking error that is based on not purchasing all the
constituents in the fund, or there might be other reasons
– a high level of fee spreads, for instance – and they are
trying to bridge that.”
Securities lending is generally seen as a low-risk
practice, despite some reports to the contrary during
and after the financial crisis, but that does not mean it is
without risk. Is Costandinides concerned that the use of
securities lending to improve the accuracy of ETFs may
be creating extra risk for investors?
“Securities lending is a fairly secured activity, although
you have to look at the underlying securities lending
agreement; how collateral is held, how quickly can
it be accessed and so on. If you look at the US repo
market, when a counterparty fails to return securities
they are served with a letter and after three days if the
securities are not returned the collateral passes to the
counterparty.
“European repo and securities lending is a bit more
complicated. For instance, different legislation means
you have to think about where collateral is sitting - is it
in the same jurisdiction as the fund? Eventually things
work out but it might take you a few days or it might
take you a whole year if you have to go through a court
in order to access that collateral.
“However, I would say that it is not a huge
amount of risk.”
(It may be worth pointing out that, according to
Costandinides, swap-based ETFs may also lend out
their securities. But Costandinides adds: “It is less of a
relevant topic in swap-based ETFs because most of the
risk is borne by the total return swap counterparty.”)
So if the potential risk involved with lending the
underlying securities does not concern Costandinides,
what does? The answer is disclosure, which is
“very limited”.
(At this stage it would be prudent to offer full disclosure
on ETF products in Europe. Among the main three
suppliers, Deutsche Bank and Lyxor offer swap-based although this can vary from agreement to agreement.
ETFs only, while iShares provides predominantly
“You have to look at the income – as an investor you
physically-backed ETFs but has recently launched
actually own the funds but yet when the securities are
swap-based products. It should also be made clear that
lent out 50% of the income does not come back to the
Costandinides does not work for Deutsche Bank’s ETF
holders, it goes back to other interested parties,” he says.
business)
The issue of transparency has long been a concern
Costandinides continues: “Basically the only official
within the securities lending industry and it seems
disclosure comes at the end of the financial year with the
that the emergence of ETFs has created another area
financial statements, when the fund has to declare the
where disclosure could be better. While the Deutsche
level of income that has been received from securities
Bank Global Markets Research report focused mainly
lending. This is very difficult to understand because a)
on tracking error within physically-backed ETFs,
it is a year later and b) if you were replicating an index
other voices within the industry believe that there
that holds 100 securities, you do not know which of
are issues surrounding synthetic ETFs too, both in
those securities were lent out, how long they were lent
terms of disclosure and underlying securities lending
out for and what rates were charged.”
transactions.
However, Costandinides goes one further and suggests
that investors may even be unaware that the securities On a positive note, the growth of ETFs has also seen
being used in their ETF are also being lent out. the market mature. In Europe in the past, suppliers
have tended to offer only one type of ETF. As outlined
“I think that most of the time investors are oblivious
earlier, Deutsche Bank and Lyxor offer swap-based
unless they ask about it. In the last six months to a
only, while iShares predominantly provides physically-
year, people have been sharing the fact that securities
backed ETFs but has now entered into the swap-based
lending is occurring but still we are a long way from
sphere. However, these lines are beginning to blur.
a satisfactory level of disclosure. In fact, if you are an
This diversification is likely to be healthy for the
investor in one of these funds and you ask to see the
industry, with particular product types not associated
securities lending agreement it is not immediately clear
with particular suppliers, and the increase in choice
that it would be made available to you.
providing further piece of mind for investors.
“It is very difficult because if you imagine that an index
has 50 constituents and you are holding 50 different
The issues raised by Costandinides and his report are
types of securities in the ETF, not all of them will be in
worth addressing, and the next issue of Fundamentals
demand to be lent out all the time. It is very difficult for
will include an in-depth article hearing from all voices
a manager to report, ‘Today we had security X for three
in the ETF sphere.
days, tomorrow we have security Y for five days,’ and
that is not what I am advocating.”
Additionally, Costandinides claims that even when
investors may be aware that their shares are being lent,
the exact fee split may not be so obvious. During his
research, Costandinides found that generally, if £100 is
generated through securities lending, £50 of that will
go back to the fund as income, £25 will stay with the
manager and £25 will go to the securities lending agent,

Fall 2010 | Fundamentals Magazine | 79

 Regulation European Union
Italy: Feeling the heat?
Craig McGlashan finds that the Italian securities lending industry could soon be facing more
pressure from regulators.
S ecurities lending could soon be facing tougher
scrutiny by Italian regulators, after the Italian
Revenue Agency revealed it had uncovered a scheme
where Italian firms were avoiding tax, to the sum of
more than EUR 300 million in the first few months of
2010 alone.
According to the Agency, more than 200 small and
medium-sized firms were involved, utilising a scheme
where the firms would enter into a stock lending
agreement with an eastern European company, transferring
shares held in a Madeiran company. Through a mechanism
where the Italian firms would pay a commission to
the eastern European company if the Madeiran firm’s
dividends fell below a certain level (which they almost
certainly would) the Italian company was able to avoid
paying its full tax obligations.
At the time of the announcement, the Agency did not
specify which exact laws had been broken by the firms.
However, in a more recent development, the local court
SecuritiesLending
in Treviso delivered a first-level sentence over the claims
which provided more details about the scheme.
Daniela D'Ignazio, from Italian tax advisory firm Studio
Professionale Bracchetti e Calori Associati, explains that
the court effectively decided that the transaction was only
technically stock lending from a “formal point of view”.
She continues: “From a structural point of view, it could
be instead qualified as a ‘contratto aleatorio’, meaning a
kind of a bet. However, this ’contratto aleatori’, as it was
structured by the parties, is invalid because it was built
with the only purpose to save tax and with no
economic rational.”
The case is interesting because, despite a high degree of
monitoring from Italian tax authorities over any exchange
of stocks, Italy “lacks a complete set of rules on the topic,
resulting in a high level of uncertainty and an increase in
the number of tax litigation”, according to D’Ignazio.
She adds: “The approach of the Italian authorities in this
sentence seems similar to the one adopted in the past to
crack down on ‘dividend washing’ practices. Initially,
in the absence of a specific law on these practices, the
Revenue Agency and the jurisprudence concluded that
the contracts were invalid and, later, regulators passed a
specific law.”
The law in question was inserted into the Testo Unico delle
Imposte sui Redditi (“Tuir” for short) and was passed by
the Italian Parliament towards the end of 2005. It stated
that capital losses generated by selling shares after
a dividend payment are non-deductible, with the intent
80 | Fundamentals Magazine | Fall 2010
of prevent tax arbitrage via the fact that only 5% of the
dividend is taxable but the capital loss is in principle 100%
deductable – similar to the technique used in the scheme
uncovered in August by the Revenue Agency.
Of course, this law should not be applicable to securities
lending, because a stock loan does not produce a capital
loss from a fiscal point of view, unlike dividend washing.
The firms involved in the scheme were snared by the
fact that securities lending has increasingly been on
Italian regulators’ radars. D’Ignazio explains: “In recent
years regulators updated an anti-abuse law to exclude
the possibility for the borrower to benefit from the 95%
exemption on dividend if the final beneficiary (the lender)
does not meet, in turn, the requirements for the exemption.
“Before 12th April 2009, the same article applied only to tax
credit but not to the exemption on dividend. Legislators
have also introduced the possibility for fiscal authorities to
question transactions realised before 12th April 2009 on the
basis of the general tax avoidance law.”
However, there are still areas that require work. “One
of the most important issues still under discussion is the
treatment of the manufactured dividend,” says D’Ignazio.
“Part of the doctrine sustains that the manufactured
dividend could be considered not deductible for the
borrower because costs related to the purchase of rights on
participations producing untaxed revenues (i.e. dividends
95% exempt) cannot be deducted.”
This view was challenged in 2008 by a commission from
the Ministry of Finance which called for a specific law
provision. In addition, the fact that the Revenue Agency
did not reference this section of the Tuir legislation in the
case against the firms could indicate that this disposition
will not apply to securities lending, D’Ignazio believes.
Despite this, there are still potential regulatory pressures
for Italian securities lenders. The Revenue Agency is able
to investigate securities lending transactions via two
processes: the general tax avoidance law, which prohibits
transactions that do not support sound business purposes
and are used for avoiding tax; and the ‘abuse of law’
concept.
“In recent years, the Supreme Court (Corte di Cassazione)
has supported the Revenue Agency by using an overstated
concept of the ‘abuse of law’,” says D’Ignazio.
Given these recent developments, along with noises
emanating from the Revenue Agency, D’Ignazio and her
colleagues at Studio Professionale Bracchetti e Calori
Associati believe that securities lending is set to face “more
attention” in the near future from both tax authorities
and regulators.
Fall 2010 | Fundamentals Magazine | 81
 European Repo European Repo Council
Repo resurgent
As the latest European Repo Council survey finds that the European
repo market has exceeded pre-crisis levels, chairman Godfried de Vidts
expands on the results in a Q & A session.
ERC baseline figure for European repo market size:
June 2010: EUR 6,979 billion
December 2009: EUR 5,582 billion
June 2007: EUR 6,775 billion (previous high)
T he report said to take the results cautiously, but do you still
think there is reason to be optimistic?
There is an improvement of feeling about the market
recovering a little bit and you see that in the ECB’s
allocation of cash going down quite dramatically of late.
There seems to be more lending between banks and
that has been seen in the repo survey. Because the shift
from the unsecured market to the repo market is now
virtually total on the interbank sphere, the recovery of
this segment will be noticeable in repo use. My guess is
this will continue and we will see even more use of repo
SecuritiesLending
as a product, in all areas: central counterparty clearing
(CCP), bilateral and tri-party.
There is quite a lot of confidence in this market again,
although there are many uncertainties. There is more and
more focus on how you actually do your business and
I would even say that unsecured lending to the non-
corporate sector is something for the past.
The ERC released a white paper calling regulators’ attention
to the healthy state of the European repo market. Is the survey
another sign that the market shouldn’t be constrained and is in
better shape than other areas of the financial system?
Definitely - the white paper was very timely and
appreciated by the regulators. Since then we have had
more discussions with regulators around Europe. It has
been recognised that you need to get the planning right;
it is not only about CCP. The OTC derivatives markets
did not collateralise like we do in the repo markets. So the
knowledge on collateral and CCP setups is quite beneficial
for the big banks that have repo desks and who use CCPs
for their business.
Also, I think the securities lending people who said that
CCPs are not for them have had a rude awakening and that
their business model is going to change dramatically in the
coming months and years.
The survey found that although electronic repo had increased, its
share of the market was down, while voice brokering had boosted
its share. This was mainly because of “forward-start repos” -
could you explain what these are?
82 | Fundamentals Magazine | Fall 2010
A bank, for its liquidity buffers, will stay long on cash
or square forward by the month, which places demands
for liquidity on the repo desk. Because there is a general
expectation that interest rates will go up over time, people
position themselves by borrowing cash for the future. You
can do this in two ways: you can actually borrow today for
extended periods or match your anticipated shortfalls with
forward-start borrows arranged today.
So if we were in September, and you see a shortfall from
December to March in your books, that is the period you
need to cover, not longer or shorter. If you borrow six
months from today to March, then you have to relend that
cash from now to the beginning of December and will most
likely lose on the spread for the first portion. If you wait
until December to borrow the money you need you may
find the price in the market to borrow cash from December
move higher, and in particular liquidity may be limited
towards the end of the year. Instead you can borrow today
with the value date of the trade starting in December and
matching your maturity date in March - that’s a forward-
start. Predictable pricing for the future. This is customised
to your needs and is used to support different strategies
but is something that cannot be found on an electronic
platform, as they can only do more standardised trades.
Voice brokers play a very crucial role in this to find parties
that have opposite positions and connect them together. We
have seen that whenever there are problems in the market,
the clients go back to the voice brokers because it is faster, it
is anonymous and it is an easier way to get what you want
specifically than going to electronic systems which are not
catering for that at this stage.
Do any of the electronic platforms have plans to allow these types
of trades?
It is possible now; it is more a question of getting enough
liquidity. This is part of the debate we have with regulators;
it is desirable to get as much as possible onto CCP, but it
also has negative impacts because the CCP has to take very
specific, opaque tailor-made trades. What does the CCP do
with these trades? It has to find a counterparty to unwind it
in case of default. There are many specifically driven trades
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Fall 2010
This advertisement has been issued by UniCredit Bank AG, a member of the UniCredit group of companies. UniCredit Bank AG is regulated | Fundamentals
by Bundesanstalt 83
Magazine (BaFin).
für Finanzdienstleistungsaufsicht |
 European Repo European Repo Council
that CCPs will not be able to cater for in the immediate
future. They will need a much bigger move that may
provide enough certainty of liquidity availability.
The survey found that tri-party repo was still well below its
historic peak. Do you expect it to reach such levels again?
In Europe, tri-party is used for non-government bonds and
for other small pieces of bonds that you want to finance.
The appetite for that has gone down and secondly it is
much more difficult to price so there is less comfort around
it, even while the tri-party agents have done enormous
amounts of work to improve this situation.
Basel III will place demand on liquidity buffers and banks
will need to allocate specific, highly-liquid collateral. This
can only be done in a very specialised way, so that if you
as a bank have, say, 10 different bonds, of which only five
are actually fulfilling the criteria for the liquidity buffer,
you are going to want to keep those available for trading.
This constant management of the thresholds you need to
put in place is actually best done through tri-party, because
that is what it is designed for. Collateral management can
be simplified, as compared with doing things bilaterally.
So this might actually give a lot of scope to the tri-party
agents in the future.
Tri-party can also benefit those on the buy-side as well,
because they do not currently have the required technology
for these processes.
The ERC also ran a course shortly after releasing the survey.
How was it received?
We had over 100 people and it was quite amazing in terms
of the population. We had legal people and repo traders
but we also had risk personnel, compliance personnel and
others. There was more and more focus on CCP. Many
people do not understand the difference between clearing
and CCP – there is a lot of misinformation.
It was also very proactive – there were a lot of questions.
Overall, there is a clear need for more education in this
market.
Is CCP a particular area that people need to be educated on?
Now that CCP is going to be much more of a focus it is
clear that many more products will be centrally cleared
and many more banks, insurance companies, pension
funds and asset managers will be forced to use CCP and
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84 | Fundamentals Magazine | Fall 2010
that creates a huge push to make sure that people are
educated about the workings of the model.
What particular misunderstandings were there?
Traders are usually unconcerned about how trades settle,
as long as they do. There have been many years of focus
on new ways for traders to make money but clearing
and settlement of these transactions is crucial because
the money that is made could be left behind because, for
instance, the wrong instructions for payment are entered.
Dealing with a CCP takes all these issues away, but the
CCP must be robust. Not everybody understands the
issues about a CCP. It takes away your counterparty risk
but it also has to settle, and settlement has to be very tight.
I have also been asked by people from risk departments
whether they need a credit line on the CCP, which they do
not because CCP will be triple-A rated, while the future the
capital charges on them will be between zero and 3%.
However, people should understand the potential risk of
default within the different CCPs that are used. If a firm
goes bust within a CCP they take away its initial margin,
its variation margin and its default fund - but if the
contributions from that firm are not sufficient, the burden
will go to the other members of the CCP.
What does the ERC have planned for the next few months?
We have our AGM in Amsterdam on 27th October where
the keynote speech will be by Patrick Pearson, the head of
the financial markets infrastructure unit at the European
Commission’s Internal Market Directorate General. He will
talk about the impact of EMIR on the repo market.
Within the industry we are looking at how Basel III will
influence which types of collateral will be liquid and is
this going to be enough to collateralise the OTC derivative
business, the repo business, the securities lending business,
or any other business that needs to be collateralised.
A recent study from the IMF actually calculated that, for
banks, the additional collateral to be put forward is in the
area of USD 200 billion. A lot of banks do not have that
collateral, so we are now thinking very hard as a group
about how to deal with this. In a way the regulators have
trapped themselves in a hole, and have not thought about
some of the consequences that could have large impacts in
the future.
The next ERC repo survey will take place in December 2010. Godfried de
Vidts is the chairman of the ICMA's European Repo Council (ERC).
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 Securities Lending
Deutsche Bank’s Global Transaction Banking division, offers its clients access to a
growing domestic custody and clearing network which currently covers more than Contact:
30 securities markets globally. We are dedicated to providing cross-border custody Tim Smollen
services, fund administration, securities clearing and agency securities lending
consistently in all markets to exceptional standards as part of our commitment to Tim Smollen
support our clients’ success. Deutsche Bank
Through offices in London, New York and Frankfurt, Deutsche Bank’s Agency Managing Director, Global Head of
Securities Lending team operates one of the world’s largest non-custodial agency Agency Securities Lending
securities lending programs offering institutional clients a comprehensive and Tel: +1 212 250 4611
efficient service for generating additional return on their fixed income and equity Email: tim.smollen@db.com
portfolios in a low risk environment.
Deutsche Bank has been recognized in Global Custodian’s Securities Lending www.tss.db.com
Survey 2010 achieving “Top-rated” status in a number of categories. It was also tss.info@db.com
the highest scoring regional provider in Europe, the highest scoring provider in the
Multi-Provider category and obtained 34 Best in Class awards.

eSecLending is a leading global securities lending agent servicing sophisticated in- Contact:
stitutional investors worldwide. The company’s approach has introduced investment Christopher Jaynes, Co-CEO
management practices to the securities lending industry, offering beneficial owners
an alternative to the custodial lending model. Their philosophy is focused on provid- Tel: US +1 617 204 4500
ing clients with complete program customization, optimal intrinsic returns, high
touch client service and comprehensive risk management. Their process is to begin Address: 175 Federal Street
each client’s program with a competitive auction to determine the optimal route to 11th Floor, Boston, MA 02110, USA
market for their portfolios or asset classes whether it is via agency exclusives or tra-
ditional agency lending. This differentiated approach achieves best execution while Tel: UK +44 (0) 20 7469 6000
delivering their clients with greater transparency and control, allowing them to more Address: 1st Floor, 10 King William
effectively monitor and mitigate risks. Additional information about eSecLending is Street, London, EC4N 7TW, UK
available on the company’s website, www.eseclending.com. Email: info@eseclending.com
Web: www.eseclending.com

Chris Doell
Northern Trust Corporation (Nasdaq: NTRS) is a global leader in delivering innova-
Senior Vice President
tive and customized Securities Lending programs to clients whose assets are cus-
Head of North American
todied at Northern Trust and elsewhere. Northern Trust Global Securities Lending is
Securities Lending Client Service
a leader in the industry, operating trading centers throughout the United States, Eu-
+1 312 444 7177
rope, Canada and Asia to take advantage of markets throughout the world 24-hours
Sunil Daswani
a day. Northern Trust’s Securities Lending program is consistently recognized as a
Senior Vice President
top lender; continuously outperforms the RMA’s Aggregate Composite; holds top
Head of International
positions at industry organizations; provides superior relationship management and
Securities Lending Client Service
technology; and maintains a strong 28-year track record.
+44 (0)20 7982 3850

Technology
4sight Financial Software is a leading supplier of innovative software solutions C: Judith McKelvey
to the Securities Finance, Settlement & Connectivity markets with offices and T: +44 (0) 207 043 8319
clients worldwide. 4sight Securities Finance (4SF) is a flexible modular solution E: judith.mckelvey@4sight.com
that empowers financial institutions of all sizes, from the smallest direct lender C: Jason Hayes
to the global custodian, broker or intermediary on an agency or principal basis. T: +1 416 548 7922
4SF contains market leading functionality that provides greater automation, faster E:jason.hayes@4sight.com
trading, improved risk management, and enhanced relationships with clients and C: Peter Sanders
counterparties. It supports borrowing, lending, repo, swaps and collateral manage- T: +61 (0) 2 90378416
ment across the equity and fixed-income markets and provides 24 hour continuous E: peter.sanders@4sight.com
operation, inter desk trading, a ‘global book’, real-time value dated position keeping W: www.4sight.com
and a powerful web reporting module, allowing full front to back office processing.

Pirum provides a full suite of automated reconciliation and straight through process- T: +44 20 7220 0961
ing (STP) services supporting Operations within the global securities finance indus- F: +44 20 7220 0977
try. The company’s on-line SBLREX service encompasses daily contract compare, C: Rupert Perry
monthly billing comparison, mark-to-market & exposure processing, pending trade E: rupert.perry@pirum.
comparison, income claims processing and custody reconciliation. Subscribers to com
Pirum’s services significantly increase their operational efficiency and reduce their A: Pirum Systems
risk by using Pirum’s solutions, as staff are able to focus on fixing the exceptions in- Limited
stead of using their time to check and process routine business. These automated 4 Eastcheap
processes are more scalable and risk controlled too, allowing significantly higher London, EC3M 1AE
volumes to be managed without corresponding increases in operations headcount. W: www.pirum.com

With annual revenue of USD5 billion, SunGard is a global leader in Visit SunGard at
software and processing solutions for financial services, higher educa- www.sungard.com
tion and the public sector. SunGard also helps information-dependent en-
terprises of all types to ensure the continuity of their business. SunGard
serves more than 25,000 customers in more than 50 countries, including
the world’s 50 largest financial services companies.

86 | Fundamentals Magazine | Fall 2010


Succession
As Brazil gets ready to decide the successor to outgoing president Luiz Inácio Lula
da Silva, Craig McGlashan looks at what it might mean for investors in the country.
B razil is used to winning on the football
pitch but the real victory the country has
achieved in recent years has been to emerge
as one of the fastest growing economies in
the world, earning it in a place in the BRIC
(Brazil, Russia, India and China) collection
of exciting young prospects.
This has not gone unnoticed by investors. Direct
foreign investment in the country increased from 43%
to 72% of GDP between 2001 and 2009, according to
finance ministry statistics, while the country is set to
host the 2014 FIFA World Cup and the 2016
Olympic Games.
Much of that success has been credited to outgoing
president Luiz Inácio Lula da Silva, popularly known
as Lula (a tradition of nicknaming that Brazil seems to
bestow on its politicians as well as its
football superstars).
It was not always so. Many were concerned that the
head of the left-wing Workers’ Party, who had ran
unsuccessfully for president three times before, would
introduce the kind of changes being seen in Hugo
Chávez’s Venezuela.
In 2002, as his victory looked increasingly possible,
Brazil saw some internal market hysteria, including a
currency maxi-devaluation on the real and a rise in its
risk factor of more than 2000 base points.
The fears proved to be unfounded. Whether by a
change in attitude or by a political shift to engender
more support from those on the right, Lula’s central
position has seen Brazil change from being the largest
foreign debtor among emerging economies to become a
net creditor, its debt rating at Fitch and S&P has moved
from speculative to investment grade, while Lula won
a second election and is arguably the most popular
president in Brazil’s history.
However, Brazil’s constitution only allows a president
to stay in power for two terms and Lula’s time is nearly
up (opting not to change the constitution to allow
another term in office is another area where Lula and
Chávez differ).
So who will step into the wings? The big favourite is
Dilma Rousseff, also from Lula’s Workers’ Party and
Brazil politics
the outgoing president’s chosen successor. The big
opponent for Rousseff is José Serra.
Many thought the result would be a foregone
conclusion when Brazilians went to the voting booths
in early October. However, Rousseff only garnered
46.9% of the vote, not enough to achieve the absolute
majority required to become president (Serra received
32.6%). The election will now go to a run-off at the end
of October.
What does all this mean for both potential and
existing investors in the country? Keep to the same
game plan, regardless of the result, according to Urban
Larson, director, emerging equities and Latin America
specialist at F&C Investments.
“Investors are neither particularly excited nor
particularly worried about Dilma. It remains probable
that Lula will still be involved behind the scenes,” he
said.
“Nevertheless, if Dilma's opponent José Serra were to
win (not likely), this would be received positively by
the markets. At a minimum the fact that Dilma did not
win in the first round while the opposition did well in
several key state elections makes it more likely that she
will need to govern from the centre.”
This hypothesis is backed up by the fact that the
election is probably the first in decades where politics
have not created any great market volatility.
Brazil has also shown maturity in its use of a central
clearing counterparty model (CCP) for securities
lending, a practice that is only beginning to take shape
in Europe and the USA (see page 72 for an opinion
piece on the use of CCPs).
For the moment though, the limelight still belongs to
Lula, who at the end of September went to the Bovespa
(the country’s main stock exchange) in São Paulo to
unveil the sale of USD70 billion of shares in Brazilian
energy group Petrobas, the largest share offer
in history.
Not bad for a man who admits: “Ten years ago I’d
walk past the [stock exchange’s] front door and people
would shake with fear. They’d say, ‘Where is that
capitalist-eater going?’.”
Fall 2010 | Fundamentals Magazine | 87
 Technologies processing
STP: Slow to progress
T o many, financial services might seem like one of
the first industries to look for the most cutting edge
technology that IT firms have to offer. However, while this
might be true for some areas
of the industry, such as security systems, much of the
industry still relies on telephone calls and
fax machines.
All this is changing, but not as fast as some would like.
There are various reasons behind this; legacy systems that
are too expensive to replace; the seven-year lifecycle of
software; and a plain old reluctance to change.
Another reason is that many worry the introduction
of straight-through processing – or STP to give its more
trendy name over the past decade and a half – might see
a reduction in workforces. This is not the case, according
to Les Gosling, head of EMEA at foreign exchange and
treasury cash management solution provider TwoFour.
“Our technology is not about removing people from the
equation, per se; it is more about helping them to work
more efficiently.”
TwoFour’s systems deal with exception handling, where
problems are highlighted for human users, allowing them
to make the best use of their time, Gosling explains.
“Exceptions will always require a human element – our
systems are about giving them the best information,”
he adds.
Many believe that this approach will be necessary in the
future, as the industry continues to move towards a high-
volume, low-margin business, with billions of transactions
being processed at ever increasing speeds. However,
Gosling points out that systems not only have to be able to
cope with this average demand: “You have to make sure
that you will still be operational when you have a spike
in transactions at any one time, perhaps one you were not
expecting.”
Seven-year ITch
Many of Gosling’s clients are beginning to move away from
the traditional seven-year software lifecycle. “Some of the
firms we are talking to are looking to treble their businesses
within two to three years – and they have to have the
software to keep up.” Indeed, many of the firms targeting
BackOffice
quick growth have been those that performed well during
the crisis, and have excess capital with which to invest.
George Ravich, executive vice president and CMO at
transaction banking solution provider Fundtech, points
to other reasons that STP in financial services has lagged
behind other sectors, particularly among the larger firms
which may not be as able to be as nimble as the smaller
companies looking for quick growth.
“In part it’s the complexity and size of the systems,” he
explains. “People do not have a sense of humour about
their money – these things need to operate flawlessly and
year after year, things are changed and optimised, and
they become so complex that changes to the system or
improvements to the system become really difficult and
also very risky, because often when you make a change you
have to hope there won’t be an unintended consequence.”
But there are other reasons, he adds. “A simple example
88 | Fundamentals Magazine | Fall 2010
is that you are booking airline tickets, and you make a
mistake, like having an earlier return date than leaving
date. The site will inform you that you have made a
mistake. In fact, most payment systems do not have that
simple intelligence which stops people from entering
erroneous or incorrect data. In the case of the consumer
website, these issues are the difference between doing
business and not doing business. At the banking level,
where you have someone in the back office to fix it for you,
it is not as critical until you start looking at the expense of
this and until someone comes up with a better way of doing
things it stays the way it is.”
Keeping humans in the process
Ensuring that humans remain in the process has been
something that has come increasingly to the forefront
of people’s minds. Perhaps the best example of where
machines can go wrong in financial services was the so-
called “Flash Crash” on May 6 this year, when the Dow
Jones Industrial Average dropped by 998.5 points – its
largest one-day decline ever. While the jury is still out on
what exactly caused the crash, many blamed the large
amounts of automation used by modern trading systems,
which continued to make poor choices long after a human
would have seen something was amiss.
Paul Thomas, managing director at financial services
technology provider Fiserv, explains that as fund managers
begin to deal with increasingly exotic asset classes – and
exotic counterparties – there is an increasing need for
controls to be set in place around these. “For instance, a
fund manager might trade in something exotic where he
does not want the transactions to be STP necessarily, so
we provide a solution that allows validation and increased
levels of authorisation against specific transactions,” he
says. “We believe this provides extra flexibility to the
fund manager.”
However, how easy is it to deliver a system such as this in
a world that is increasingly moving to high volume, high
speed trading? Thomas explains: “I think it’s relatively
straightforward - the organisation should have a strategic
view to implement processes and procedures and decide
how to set up instruments in systems appropriately. For
too long we’ve seen either workarounds or we have seen
the ‘copy and paste’ scenario. In the arena of fixed income,
while instruments appear similar in structure, there may be
specific processing implications or business nuances which
require greater control. “From our view the important
thing is for the customer to understand exactly what asset
they are trading in, set it up within the system and then
configure it with the appropriate levels of control.”
For example, in the event that a sovereign debt rating was
downgraded, a manager would be able to introduce a
business rule for ‘security of interest’ that any transaction
being made with a counterparty within that country would
be subject to higher levels of control.
It is clear that STP has moved forward in leaps and
bounds over the last few years and will continue to do so
in the future. However, with concerns over the potential
problems that could be created by completely automated
systems and the increasing complexity of transactions and
the instruments themselves, the main focus among decision
makers at banks may well rest on what STP can do to help
its human staff, rather than how it can replace them.
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