Markit Magazine Issue 14

/6 Markit News
Markit acquires quantitative

research specialist QSG
Markit has acquired Quantitative Armins Rusis, managing director
Services Group LLC (QSG), a leading and global head of data, indices and
provider of independent equity research at Markit, said: “We are excited
research, advanced trading analytics about combining Markit’s expertise in
and investment consulting services. data with QSG’s quantitative, factor-
The acquisition expands Markit’s based research and trade analytics.
capabilities in equities and enables The combination will allow us to develop
Markit to expose its high-quality data new services for the equity and fixed
products to QSG’s statistical processes income markets which will provide our
and create new tools for investment customers with unique ways to recog-
managers and traders. Markit intends nize trading signals both within and
to expand QSG’s services to the global across asset classes.”
Armins Rusis
over-the-counter markets.
News in brief
Commission Manager Markit and SuperDerivatives
launches
hosted a conference on OIS
discounting at the London Stock
Exchange which was attended by
Markit has launched Markit Commission their credits in order to reduce the buy- and sell-side firms, auditors,
Manager, a service which helps buy-side significant administrative burden associ- regulators, fund administrators and
firms manage and allocate commission ated with accessing numerous broker- a clearinghouse. The discussion
credits efficiently while addressing the specific platforms. focused on techniques for valuation
concerns associated with maintaining Markit Commission Manager will and collateral call margins.
such credits with a single institution. ease the load by enabling users to
Markit is introducing this new service reconcile their trading commissions Markit has launched Markit
as increasing numbers of buy-side firms with multiple counterparties and then Agent Services, a cost-effective
demand virtual aggregation of commis- instruct those counterparties to pay for solution for banks and other institu-
sion credits. Buy-side institutions are research and brokerage services – all tions to outsource back office opera-
looking for a single platform to manage from a single platform. tions and administration required by
the syndicated loan agent business.
Northern Trust chooses The Markit TRX II indices, a

new family of indices referencing
Markit iBoxx commercial mortgage-backed secu-

rities, started trading on October 3.
Northern Trust has selected Markit address the circumstances and needs DTCC and Markit have launched
iBoxx indices as the basis for two new of investors. the Loan/SERV Cash on Transfer
FlexShares ETFs: the FlexShares iBoxx Markit was selected for its ability to service, the first delivery-versus-
3-Year and 5-Year Target Duration TIPS provide well-constructed fixed income payment system for secondary loan
Index Funds. indices and securities pricing, a combi- trading. This represents a major
Northern Trust entered the US excha- nation that helped address Northern advance in reducing settlement risk
nge traded fund market in September

Trust’s concerns about perceived in the loan market.
2011, with products designed to tracking error.
the markit magazine – Winter 2011

Markit News /7
MarkitSERV acquires Markit Desktop
Logicscope CDS/bond basis

Understanding the relationship
Markit has acquired Logicscope, Logicscope’s complementary tech- between an issuer’s cash bonds and
a leading provider of post-trade work- nology and comprehensive product CDS curve gives a perspective on
flow solutions and straight-through suite will enable us to offer the same potential CDS/bond basis. Users of
processing for foreign exchange standards of trade processing, connec- the Markit Evaluated Bonds service
transactions. This will enable Markit to tivity and compliance to FX market receive daily CDS/bond basis
enhance its FX service offering signifi- participants that we currently offer for
metrics through the Markit Desktop
cantly. In turn, Logicscope’s clients credit, rates and equity derivatives.”
and can now chart historical data.
will benefit from MarkitSERV’s global
This provides asset managers and
reach and scale and additional workflow
functionality, making TradeSTP, their traders with a better insight into
existing trade processing capability, cross-asset dynamics that will
an even more compelling solution for enhance their investment strategies.
industry participants.
Jeff Gooch, CEO of MarkitSERV, said:
“Logicscope will provide MarkitSERV
with significant capabilities. The compa-
ny’s proven technology is remarkably
agile and its low-latency infrastructure
and flexible solutions are increasingly in
demand. We have been working with
the FX industry since October 2010 to
provide a complete trade processing
Jeff Gooch
solution for market participants.
Markit wins two To display CDS/bond basis for
awards in Asia
a given issuer on Markit Desktop,
enter the issuer name in the search
bar, select the Bonds tab followed
by the Evaluated Bonds screen.
MarkitSERV won the Asia Risk
You then need to select the Basis
Technology Development of the
tab on the chart. The chart above
Year Awards for its central coun-
shows a widening of the basis for a
terparty (CCP) middleware offering
which connects market participants to France Telecom 5.25 per cent 2014
CCPs. Judges noted that the Singa- global bond indices. The panel singled bond issue compared to the France
pore Exchange becoming the first out Markit’s work on the Markit iBoxx Telecom CDS curve on a matched
Asian exchange to offer OTC derivative ABF indices, the first family of inde- maturity basis (both Actual and IMM
clearing was “in no small part down to pendent local currency bond indices roll dates are displayed).
its choice of MarkitSERV as its middle- in Asia. The indices serve as bench-
ware provider.” marks for the Asian Bond Fund 2 If you are interested in a trial of
Markit was also named The Asset’s initiative, established to encourage the Markit Evaluated Bonds, please
Rising Star Index Provider for its devel- development of the region’s domestic contact sales@markit.com.
opment of the Markit iBoxx family of bond markets.
Winter 2011 – the markit magazine

Talking Business /9
A novel
view on
investment
As if the current financial climate was not gripping enough,
Elizabeth Corley of Allianz Global Investors sifts through the
clues to provide bespoke strategies for clients before settling
down to write her thrillers
Q: What is your investment strategy in the current vola-

tile environment? Which asset classes do you expect
to perform?
A: There is no getting away from the fact that these are

particularly challenging markets in which to protect and
enhance our clients’ wealth. All asset classes at the
moment appear to have their drawbacks. Even the sover-
eign bonds still considered to be safe havens are currently
delivering negative real returns.

/10 Talking Business
As a client-centred investment manager, though, we

don’t think in terms of one strategy for particular market “ The growth of ETFs over the
conditions. Rather, our starting point is the distinct objec-
tives of each investor, which takes into consideration their
last ten years has been nothing
time horizon and risk appetite. short of impressive and should
Increasingly, clients are looking for us to help them
navigate today’s very tricky terrain, to make sense of be considered a positive market
the complexities of today’s capital markets. Rather than
being attracted to a suite of products with good track development.”
records, clients are interested in the quality of an invest
ment manager’s research and market insight, in their The perennial question regarding the sustainability
experience and capabilities across asset classes and an of the euro has always centred on the degree to which
increasingly interconnected globe. Indeed, the provision member countries would be able to maintain differ-
of solutions and risk management services are becoming entiated fiscal policies in bad times as well as good.
an ever more important part of our business. In essence, Until recently, the political will of member states to do
clients are looking for an investment partner. whatever was necessary to make the project work was
without question. More recently, doubts have crept in
Q: Allianz recently announced a reorganisation of its and political risk has become a considerable factor in the
asset management operations, giving Pimco more current debt crisis.
autonomy. How does this relationship work in prac-
tice? Are there synergies to be gained from having two Q: What is your view of the current regulatory environ-
asset managers, Pimco and Allianz Global Investors, ment, specifically Emir and Dodd-Frank, and how do
under one roof? you think regulators can strike a balance between
protection and intervention?
A: Allianz Global Investors (AGI) was established at the start
of the last decade as a family of boutique investment A: The context for and background to these latest regulations
managers. As the businesses have evolved and grown, is fully understandable, and there can be little doubt that
and as client demands have changed, we have consid- the quality of thinking, in particular in relation to systemic
ered how we can better serve our global client base. The issues, has become much more pointed.
reorganisation will recognise two distinct global invest- Just like markets, though, the pendulum of regulation
ment companies, each with global reach and scale, each tends to overshoot in both directions! So, to the extent
contributing to Allianz’s asset management division. While that some regulators became too receptive to certain
Pimco will continue its internationalisation and diversi- financial innovations prior to 2007/8, the risk is that this
fication into other asset classes beyond bonds, we are new environment will impede development of the healthy
bringing together the AGI and RCM-branded businesses as well as the malignant. Through industry bodies such as
to form a globally integrated investment company, which the Forum of European Asset Managers and the European
operates in 19 markets. The aim is to deliver greater client Fund and Asset Management Association, we seek to
focus. AGI and Pimco will operate independently of one make considered and constructive input into various regu-
another, but will continue to co-operate when this is in the latory discussions.
best interests of clients and/or shareholders.
Q: Are ETFs a threat to traditional asset management?
Q: Allianz made a significant contribution to the debate How has AGI responded?
on Europe’s response to the debt crisis. Do you think
the lack of common economic governance in the A: The growth of ETFs over the last ten years has been
eurozone will hinder growth in the future or even nothing short of impressive and should be considered
threaten the currency itself? a positive market development. While some of the more
exotic ETFs that have been developed in recent years have
A: These are clearly very testing times for eurozone coun- the potential to give the product a bad name, the principal
tries and the euro itself. Allianz has rightly been taking a advantage of ETFs to investors is clear: they provide cost-
stand on the pivotal issue of tackling the sovereign debt efficient exposure to an index or other liquid benchmark,
crisis and has made a number of constructive proposals, and do so with a low tracking error.
most notably the use of the European Financial Stability Nevertheless, as an active asset manager, our funda-
Facility as an insurer for the majority of European sover- mental belief is that markets are often inefficient and that
eign debt. following the herd has its limits and can in fact destroy

Talking Business /11
rather than add value. Through a combination of global when others were in retreat. The benefits of this strategy
reach and deep local market insight, we seek to exploit are becoming clearer.
market inefficiencies in order to generate added value for Nevertheless, resource is finite and cost discipline is
our clients’ benefit. Regardless of the growth of ETFs, very important. As we integrate the AGI business, we will
there should always be a place for active investment. need to take decisions as to where we focus our business
development; this may mean disinvestment in other areas,
Q: You have said in the past that stable, durable retire- or reducing overlaps within the business. And as we do
ment income would become an “endangered species”. this we will have a keen eye on our cost/income ratio,
How can pension systems adapt to the problems which we benchmark against our peers.
associated with ageing populations? Where does the
asset management industry come in? Q: There is much discussion of the need to change
corporate governance codes to increase female repre-
A: How we think about retirement planning and pensions is sentation in boardrooms – do you regard this to be
undergoing considerable change in many markets, and is affirmative or tokenistic action?
a significant societal concern in many developed econo-
mies. For a number of years now, AGI has been tracking A: This is an important yet delicate issue. There is clearly
the sustainability of an increasing number of national scope for more females within boardrooms, and there is no
pension systems. While it is not an exact proxy, those doubt in my mind that companies and their shareholders
countries that have done most to move from a Defined could benefit from further development on this front. Targets
Benefit (DB) or Pay As You Go model towards a Defined are certainly a useful way to focus minds, but the type of
Contribution (DC) or funded model are best placed to cope change we need will still take some time to realise fully. And
with the demographic changes that lie at the heart of many it’s change that will not be solved by establishing quotas,
of the problems of the previous system. which could undermine the role of women on boards.
The move from DB to DC, though, in large part shifts Rather, we should be looking at policies that aim to broaden
responsibility for pension provision from the employer the talent pool of female executives throughout organisa-
to the employee. As this change occurs, there are a tions, and to create an inspiring environment for women,
number of roles that an investment management company one in which they aspire to take on those most senior roles.
can fulfil. One of the more esoteric areas that we’re looking
at is the topic of behavioural finance, which studies how Q: You are an acclaimed writer and have had four thrillers
people make financial decisions. Last year, we estab- published – has your literary career influenced your
lished a Center for Behavioral Finance in the US, with work in financial services, or vice versa?
the express intent of developing what we call “actionable
insights” that help people make better financial decisions. A: The novels are a creative outlet and do not draw on experi-
ences at work! Nevertheless, my day job and my novel
writing each benefit from one another to the extent that
“ One of the more esoteric areas they are both activities that I enjoy and find stimulating. I
think this is true of many people that pursue extracurricular
that we’re looking at is the topic activities that they are passionate about. It is important
of behavioural finance, which

that we have balance in our lives.
studies how people make Career in brief
financial decisions.”
Elizabeth Corley is chief executive officer of Allianz Global Investors Europe
and will become CEO of a globally integrated Allianz Global Investors in
January 2012.
Corley joined Allianz in April 2005 and became a member of the
management board of Allianz Global Investors AG, the global management
Q: Swingeing cost cuts are underway at many financial holding company of Allianz’s asset management business, in October that
institutions around the world. Where do you plan to year. In 2008, she also assumed responsibility for Allianz Global Investors
save costs? Germany. Prior to Allianz, she spent 11 years at Merrill Lynch Investment
Managers becoming head of the EMEA APAC mutual fund business.
Corley spent two terms as chairwoman of the Forum of European Asset
A: Our parent company, Allianz, is a supportive shareholder Managers and was named Most Influential Woman in Asset Management
with a long-term, strategic outlook. When it decided to by Financial News in 2009. Most recently, she was named CEO of the Year
develop its asset management capabilities, this was for at the 2011 Financial News Excellence in Institutional Asset Management
the long haul. So, if we look back to 2008 and 2009, we Awards. She is a fellow of the Royal Society of Arts. An acclaimed writer, she
is a published author of four thriller novels.
continued to invest in the asset management business

/12
Source: Corbis Focus: China housing market

Focus: China housing market /13
The property market in China has enjoyed phenomenal growth but
thanks to government attempts to curb price inflation, it now appears
to be at a turning point, writes Haibin Zhu of JPMorgan Chase
A rumble
along China’s
walls
C
hina’s house prices have tions will evolve into a nationwide
risen at an unprece- market collapse either.
dented pace since 2009, We first want to clarify two points
most remarkably in cities that have often been ignored. First,
such as Beijing (+77 per the current turnaround in the housing
cent between January market is largely a consequence of the
2009 and August 2011), Shanghai (+129 tightening measures introduced by the
per cent) and Shenzhen (+154 per cent). Chinese government since late 2009.
The market now seems to be at a turning These measures aimed to contain
point. In major cities, the number of house price inflation and restore afford-
housing transactions has dropped by ability and included stricter mortgage
about 50 per cent from the peak level lending rules and home purchase
and has remained low throughout 2011. restrictions in cities that had seen
House prices have started to decline prices soar. So the current weak-
and inventory-to-sale ratios have more ness in the housing market is a desir-
than doubled. In October, the weakening able outcome for addressing housing
in the housing market seemed to have bubble concerns and to restructure the
spread to smaller cities. This is triggering economy.
talks of a market collapse. So will house Second, China is a large country
prices crash? and regional developments are very
We do not think so. Just as we refute different. A lot of attention has been on
the claim of some economists that the major cities in China, such as Beijing,
house market boom in 2009-10 was Shanghai and Shenzhen, where the
“the biggest bubble in history”, we do housing bubble was most remarkable
not think the ongoing market correc- from the beginning and the housing

/14 Focus: China housing market
Figure 1: House Price Growth and Real Economy exceeds house price increases, afford-
ability can improve over time. Also, given
% OYA % OYA
the high home ownership rate in China,
30 40
the social tension and political pressure
caused by a house price collapse could
25
be much bigger than during a housing
30
20
boom. Last, and most important, the
government not only has the incentive,
15 20 but it also has the capacity to avoid
a house price collapse. Importantly,
10 the ongoing weakness in the housing
10 market is mainly caused by the govern-
Housing Price
5
Real Estate Investment
ment’s tightening measures which have
Retail Sales reduced housing demand to artificially
0 0 low levels. Nonetheless, the demand has
2007 2008 2009 2010 2011
Year
not gone away. Strong income growth, a
rapid urbanisation process, high saving
Source: CEIC, J.P. Morgan estimates rates as well as limited investment
options imply that demand will remain
strong. If the government eases or
market adjustment has also been most these measures. We predict that house removes these tightening measures, the
noticeable. However, the share of major prices will decline by 5 - 10 per cent housing market is very likely to bounce
cities is relatively small in China. For at the national level in the next 12-18 back, just as we have observed several
instance, Beijing, Shanghai and Guang- months, and may drop by up to 20 per times in the past decade.
dong combined accounted for 16 per cent in some main cities. Given downward corrections in house
cent of total property investment, 20 However, house price collapse at prices, what are the implications for the
per cent of buildings sold (in value) and the national level is unlikely to occur. real economy? In the baseline scenario,
10 per cent of floor space sold in the First, the objective of housing market a housing market adjustment will cause
first nine months of this year. Indeed, tightening is to restore affordability. the economy to grow at a slower, but still
housing market dynamics in smaller In a fast-growing economy such as solid pace. A nationwide collapse in the
cities have been quite different from China, achieving this objective does not housing market would very likely cause a
those in major cities; in many small necessarily require house prices to fall hard landing, but the likelihood of such a
cities the initial overvaluation was less dramatically. As long as income growth collapse scenario is very small.
remarkable (or even undervalued in
some cities) and housing market activity
and prices have continued to grow
amid the tightening cycle. Such regional Figure 2: Property Contribution to GDP: International Comparison
differences contributed to a seemingly
% Share of GDP
puzzling phenomenon – the coexistence
20
of weak housing market activity in major
cities and robust national level data for
18
most of this year. For instance, national
data show that, as of September, 16 China
transaction volume increased by 13.4 Hong Kong
per cent over a year ago, new builds by 14 Taiwan
25 per cent (both three-month moving Japan
USA
average) and property investment by 25 12
per cent.
In our view, the house price correc- 10
tion has just started. We think policy-
makers will continue to impose tight- 8
2000 2002 2004 2006 2008 2010
ening measures in the housing market, Year
despite rising uncertainty in the global
economy and calls for an easing of Source: CEIC, J.P. Morgan estimates

Focus: China housing market /15
The most important channel Figure 3: Property Exposure: International Comparison
between the property market and
% Share of Total Loan
the real economy is via investment.
60
Weakness in housing market activity
Mortgage Loan
will reduce property investment and
50 Commercial Real Estate
demand in related industries, and
drag on economic growth. We expect
40
that private property investment is
likely to slow down sharply alongside 30
house prices and new housing starts
in 2012, but the construction of afford- 20
able housing should provide additional
meaningful support. We estimate that 10
total property investment will grow by
a modest 10 per cent (down from the 0 ina
ia
ia
sia
es
re
es
n
current level of 32 per cent), slowing
re
pa
n
an
es
Ind
po
pin
at
Ko
y
Ch
Ko
ail
Ja
ala
on
St
ga
ilip
down economic growth but not causing
Th
ng
Ind
d
Sin
Ph
ite
Ho
Un
a hard landing by itself. Note that this Country
assumption is relatively conservative
based on historical experience (figure Note: As of June 2010, except India (Mar 2009), Philippines (Mar 2010 for construction loans), US (Dec 2006)
and Japan (Dec 1989). Definitions may vary across countries.
1). In early 2009 (the previous round of
tightening in the housing market), new Source: CEIC, J.P. Morgan estimates
housing starts fell at a pace of 15-17
per cent, but total property investment
still rose 8 - 10 per cent, even without per cent). The credit quality of loans to that the government has the time to
offsetting public housing investment. property developers is more sensitive to adjust its policies), but more impor-
Indeed, the contribution of the prop- house price movements, but its rela- tantly, the current stabilisation measures
erty sector to the real economy in China tively small size implies that the impact have not been successful in addressing
seems to have been overstated, at on banks’ balance sheets will be limited. structural problems in the housing
least from an international perspective The second, or indirect, effect relates to market, most notably the demand-
(figure 2). Although the property sector property collateralised loans. However, as supply imbalances and the distorted
has been labelled as a pillar industry long as economic growth remains solid, incentive of local governments in the
in China, the share of the property and this impact can only be of second order. housing market.
construction sectors in GDP was 12.2 Looking ahead, the key to the future
per cent in 2010, which was smaller of the housing market depends to a
than in Japan (19.4 per cent) and the US large extent on government policy.
(16.1 per cent) and only slightly higher When and how to exit from the tight- Haibin Zhu, chief
China economist,
than in Taiwan (11.4 per cent) and Hong ening measures will be a big challenge head of Greater China
Kong (8.3 per cent). for policymakers. In our view, while economic research,
The health of the property market in the near term the downside risk JPMorgan Chase
also has an impact on the real economy (i.e., tightening too strict for too long)
because it affects the quality of bank may increase, in the medium term the
loans. Due to tight loan-to-value restric- upside risk can be larger. This is not Career in brief
tions and low household indebtedness, only because the regional differences Haibin Zhu is chief China economist and head of
delinquency rates of mortgage loans in China imply a window period before Greater China economic research at JPMorgan
Chase. Prior to that, he spent ten years
tend to be low, even if house prices regional housing market stresses would (2001-2011) at the Bank for International
dropped dramatically (for example, by 30 evolve into a nationwide collapse (so Settlements (BIS), covering topics such as the
links between the financial system and the real
economy, risk management and bank regulation,
“ When and how to exit from the tightening

the Chinese economy and real estate cycles. His
work has been published in academic journals
and BIS flagship publications. He has received
measures will be a big challenge for various best paper awards in the areas of
banking, real estate and fixed income. Zhu has a
policymakers.” PhD in economics from Duke University.

/16 Focus: Collateral transformation
Source: Getty Images
The
shape shifters
Regulations on collateral requirements are forcing firms
to seek to transform what they already have into assets
that will work better for them, writes Tracy Alloway
Focus: Collateral transformation /17
I
t’s a year until central counterparty system more secure and bringing addi- repo market participants, at a recent
clearing, the post-crisis financial tional stability to the derivatives market. capital markets event in London. “That
reform mandated by regulators However, in order to make the CCP is probably going to create a situa-
and politicians, begins to take hold itself safe, the clearinghouse will collect tion where people are going to have to
for buy-side users of derivatives. margin on such trades, meaning it will exchange illiquid collateral.”
But already the planned move has take extra collateral to help cushion itself
given birth to a new type of busi- from losses. Initial margin, clipped at the How to transform collateral
ness, with many dealers and custo- start of the trade, can be in the form of Banks that plan to provide collateral
dian banks aiming to offer “collateral liquid securities such as cash or govern- transformation services say the first
transformation” to their large institu- ment bonds. Variation margin, required line of defence for buy-side clients will
tional customers. as the market price of the collateral fluc- be collateral management, or sifting
The idea behind the service is simple. tuates, can only be taken in cash. through their assets to make sure they
With central clearing comes the need “Variation margin is passed through are using them as efficiently as possible.
for trillions of dollars worth of collateral to the profitmaker of the [derivatives] That may involve looking at a fund’s
– high-quality securities which buy-side trade. That’s why it has to be cash,” entire book and figuring out what to
firms might be lacking. Instead of such explains a product manager at a major pledge and to whom.
funds having to purchase new assets clearinghouse. The CCP will keep the However, if buy-side firms find that
or liquidate their portfolios to meet initial margin, either sending it to its own they still lack enough eligible collateral
collateral requirements, some banks custodial account if it is in the form of then they may choose to seek outside
plan on offering to convert the funds’ high-quality securities, or investing it help to convert some of their existing
existing securities into cash or govern- through fully-collateralised overnight inventory– such as equities or high-yield
ment bonds. repos if it comes in the form of cash. bonds – into securities that can be used
“With new regulation and the move to
central clearing, there will be more of a
need for the collateral deemed eligible
by clearinghouses,” says Christopher
“ The push for more high-quality collateral
Coleman, business manager at BNY could even change the mechanics of the
Mellon, the world’s biggest custodian
bank. “We continue to explore the most wider repo market, where banks and buy-
appropriate solution to help clients
source the required collateral.”
side firms lend out trillions of dollars worth
But while the concept may seem
simple, some market participants say
of securities every day.”
collateral transformation obscures a
problem rather than solves it. Moreover, Estimates for the amount of high- to satisfy margin requirements, such as
the push for more high-quality collat- quality collateral needed as part of cash or government bonds.
eral could even change the mechanics upcoming financial reform range from Custodian and dealer banks “trans-
of the wider repo market, where banks $1,000bn to as much as $10,000bn after form” collateral through the vast securi-
and buy-side firms lend out trillions of including liquidity buffers, the war chests ties lending or repo markets.
dollars worth of securities every day. of liquid assets that banks will be required “We look into a client’s portfolio to
As part of Dodd-Frank legislation in to hold under new Basel III rules. see if there’s anything available to meet
the US and new rules in Europe, buy- But either way, it is expected to be a the margin requirement,” says Judson
side users of over-the-counter derivatives significant amount. Baker, product manager at custodian
will eventually be required to run their Derivatives trades are “going to bank Northern Trust. “After determining
trades through central counterparties, or have to be collateralised on a central that there may or may not be anything
CCPs. The idea is for the CCP to stand counterparty or on an exchange”, said available, that’s when we may partner
between the parties in a derivatives Oscar Huettner, global product manager up with our securities lending desk to
trade, making the global financial at BondLend, a technology platform for provide a repo service for our client.”

/18 Focus: Collateral transformation
Securities lending involves loaning Contingent collateral liabilities However, the idea of margining and
an asset into the market and taking in Risk management will also be key for haircuts – fundamental to the concept
cash, then potentially reinvesting that banks providing the service. They too will of central clearing and collateral trans-
money to generate a rate of return. In a have to monitor the daily market moves formation services – are themselves a
repo transaction, an asset may be sold and fluctuations in the collateral given to concern for some.
with an agreement to buy it back at a them. They will have to determine if they “People are going to use balance
later date. need to call for more collateral or return it. sheet in different ways to simply extend
Custodian banks say they are well But even with daily adjustments, credit and collateral transformation
positioned to provide such a service, the proposed service is not is one of those ways,” says Pirrong.
since they routinely help optimise their without controversy. “Because these services can be a
customers’ collateral and help facilitate Some derivatives experts say the contingent liability, during periods of
and settle trillions of dollars’ worth of service undermines the risk-mitigating stress, the banks are going to demand
repo trades. purpose of central clearing; creating higher haircuts to protect themselves.”
That, says Pirrong, can create and
accelerate feedback loops – with buy-
“ The largest three or four exchanges are side firms liquidating their assets to meet
looking very carefully at the quality of

variation margin calls as market prices fall,
creating a further downward spiral.
collateral they can get and how far away Widening the collateral net
from government securities they are Buy-side firms might hope that central
counterparties widen their accepted
prepared to go.” collateral, though the clearinghouses
will have to walk a fine line between flex-
ibility and safety.
But broker-dealers who clear deriva- contingent liabilities for large banks LCH.Clearnet, Europe’s biggest
tives trades on behalf of their clients that could wreak havoc in times of fixed income clearinghouse, recently
may also offer collateral transformation, market volatility. expanded its portfolio of eligible margin
creating a streamlined process for buy- “The original reason behind clearing collateral to include gold and also
side firms. mandates was to reduce systemic risk supranational bonds from KfW, the
Crucial details of such services, but collateral transformation is just likely German development bank. It’s thought
including legal protection for providers to relocate it,” says Dr Craig Pirrong, to be considering expanding that to
and the fees they might charge for professor of finance at the Bauer College include investment-grade corporate
transforming collateral, have yet to of Business at the University of Houston. bonds and more agency debt.
be finalised. “We haven’t really fixed the systemic risk “The largest three or four exchanges
In normal repo or securities trans- problem; we’ve just changed its address.” are looking very carefully at the quality
actions, a custodian bank will share Providers of the service don’t neces- of collateral they can get and how far
the cash that results from lending out sarily disagree that risk has been away from government securities they
a bond. In the case of collateral trans- moved, but say they will be able to are prepared to go,” says Northern
formation, however, that cash will be deal with potential problems through Trust’s Baker. “They have pressure to
needed by their clients, meaning fees careful management. compete in this space, so it will evolve.”
could be charged per transaction or as “What you hear people saying is the But even as the financial industry gears
a percentage of the notional value of CCP won’t accept your equities so why up to deal with one consequence of new
the trade. should someone else? You’re not dealing financial regulation – the need for vast
Market participants are agreed, with the risk, you’re shifting it,” says swathes of high-quality collateral – there
however, that the move towards central David Little, director of Calypso, which may be new challenges on the horizon.
clearing will ultimately increase the cost offers collateral management services. “There could be unintended conse-
of using derivatives for buy-side firms. “The answer to that is the haircut,” quences,” says Baker. “You have what
“There are a number of different adds Little. “If people have priced these could be a pretty big impact on the general
variables that will make derivatives haircuts correctly, then in the event of repo market because you’re taking more
trading more expensive,” notes BNY default they should be able to make quality bonds out of circulation and
Mellon’s Coleman. “That is the price we themselves whole. Everybody who pledging them to exchanges. That’s an
pay as an industry for standardisation needs collateral understands haircuts aspect that will impact the market, though
and transparency.” and the need to get them right.” we’re not sure how just yet.”

/20
Source: Getty Images Focus: Exchange traded funds

Focus: Exchange traded funds /21
A long look
at the short
view
Index-based products such as exchange traded funds certainly
have a place in the investor’s portfolio. But are they reliable enough
for the shorter investment horizon, ask Allan Lane and Irene Bauer
of BlackRock
I
ndex-based products such as ment view by studying the performance
exchange traded funds (ETFs) only of a multi-asset portfolio under a range
benefit investors if the construction of of stress tests by varying the net returns
these indices is such that they result for each ETF. This approach acts as a
in portfolios that allow the manager to proxy for the situation when spreads
deliver robust and acceptable perfor- widen out and tracking errors are higher
mance against the benchmark. than usual.
With the prevalence of a risk on/risk
off attitude to investing, the role played The ETF industry comes of age
by tactical asset allocation has come to Today, more than 20 years after the
the fore. When using ETFs tactically, a introduction of the first ETF product,
portfolio manager needs to be confi- ETF assets have reached nearly
dent that the scope for widening bid/ $1,400bn globally, of which more than
offer spreads and the negative impact $250bn is invested in fixed income
of tracking errors do not outweigh the ETFs. A recent McKinsey study1
attractive returns that a shorter invest-
ment horizon can offer.
We address the viability of using ETFs 1
McKinsey & Company – ‘The Second Act Begins for
to implement one’s shorter term invest- ETFs’ – August 2011

/22 Focus: Exchange traded funds
Figure 1: Net New Assets of ETPs Globally in 2011 whether index providers and ETF fund
managers can design indices that are
Global NNA ($bn)
fit for the ETF market. The main require-
30
Equity ments for an ETF are that it is tradeable
25 Fixed Income on a daily and potentially intraday basis,
Commodities and Other with a reasonable bid-offer spread to its
20
net asset value (NAV) and that it tracks
15 the benchmark index to an accept-
10 able level.
When evaluating ETFs as part of
5
a due diligence exercise2, the invest-
0 ment needs among different types of
-5
portfolio managers will vary. A passive
manager might care most about the
-10
Jan 11 Feb 11 Mar 11 Apr 11 May 11 Jun 11 Jul 11 Aug 11 Sep 11 Oct 11
tracking difference3 of an ETF, whereas
Month/Year
an active manager will most likely
focus on the typical size of the ETF’s
Source: ETF Landscape, BlackRock Investment Institute, end October 2011 tracking error 4. For example, in 2009,
high yield as an asset class saw annual
returns in excess of 50 per cent. As a
tactical investment, however, where
underscores this dynamic growth debt, which were once seen as the less the investment horizon might only
suggesting that the ETF industry has accessible part of the bond markets. range from a few days to a few weeks
reached an important inflection point or months, what level of tracking error
and is entering a new phase. While Act I Designing indices suitable for the becomes unacceptable?
of the ETF story was all about the rapid ETF market It stands to reason that the typical
growth of the ETF market, Act II will be This begs the question whether these tracking error of an instrument is
characterised by significant shifts in asset classes are still liquid enough and dictated by the underlying market
product design, distribution and, poten-
tially, regulation.
What started out as an equity-domi-
nated story now has a fixed income Figure 2: Average Annualised Tracking Error for Different Asset Classes
chapter as well. So much so, that with
Average Annualised Tracking Error on an Asset by Asset Basis (bps)
the heightened risk in markets since
90
the global financial crisis, the alloca-
tion to fixed income ETFs has increased 80 European National Equity
substantially. Figure 1 shows the net International Developed Equity

70
new assets of all exchange traded prod- Pan European Equity
ucts globally in 2011, and fixed income 60 Sector/Speciality Equity
is the only asset class with a perfect 50

International Emerging Equity
track record of inflows for every month Fixed Income

40
up to October.
The evolution of product coverage 30
in the fixed income market is much as
20
one would expect. The first ETFs usually
tracked government bonds, which are 10
liquid instruments, easy to track and 0
allow for daily creations and redemp-
tions of ETF units. The next iteration then Source: BlackRock, as at end June 2011
moved to investment-grade corporate
bonds, denominated mainly in US dollars 2
See http://uk.ishares.com/en/pc/about/due-diligence
and euros. More recently, ETFs have 3
We define the tracking difference of an ETF as the difference in actual returns of the ETF versus the ETF’s benchmark after
been launched based on indices that adjusting for management fees.
track emerging markets and high yield 4
The tracking error of an ETF is the standard deviation of those period by period tracking differences.

microstructure in which the exposures Table 1: Diversified Set of High Income Yielding ETFs
are traded. For developed market
Average Annual Annualised
government bonds, the annualised Total Expense
Ratio (bps)
Tracking Tracking Error
Diference (bps) (bps)
tracking error is usually between 2 and
iShares STOXX Europe Select Dividend 30 (DE) 32 -37 65
15bps. These tracking errors are very
similar to very liquid equity indices, iShares FTSE UK Dividend Plus 40 21 45
sometimes even smaller. Tracking error iShares EURO STOXX Telecommunications (DE) 52 -1 46
is somewhat higher for investment- iShares STOXX 600 Utilities 52 13 36
grade corporate bonds of around 20 to iShares FTSE/EPRA European Property Index Fund 40 -50 60
50bps per annum. iShares Barclays Capital Euro Government Bond 15-30 20 22 12
In Figure 2 we tabulate the size of iShares Markit iBoxx Euro Corporate Bond 20 15 21
the typical tracking errors exhibited for
iShares Markit iBoxx $ Corporate Bond 20 22 72
each of the six main categories of ETF
iShares Markit iBoxx Sterling Corporate Bond 20 8 66
exposures, which on a relative basis
iShares Markit iBoxx Euro High Yield Bond 50 -29 45
is very much in line with the increasing
level of risk associated with each sub- Source: BlackRock, Bloomberg, as at end September 2011
asset class.
Track the errors and avoid eating bid-offer spread to their NAV and are Our approach has been to use a
the alphas they tracking the benchmark index tactical investment strategy to reset
As the ETF industry continues to grow, fairly well? the weights of the portfolio depending
the range of building bricks available to on trading signals, while at the same
a portfolio manager is now very exten- ETFs as a source of income time controlling the risk of the port-
sive. Within Europe, there are more Using the example of an enhanced folio and transaction costs. The signals
than 1,700 ETFs available from which income portfolio, we study the perfor- are a blend of fundamental and tech-
to construct a strategic or tactical mance of a multi-asset ETF solution nical signals and can be interpreted as
portfolio. By their very design, index which has been designed to provide a scorecard as to whether to allocate
products started life as a buy and hold a steady income stream while at the into an asset or not. Part of the trading
proposition, which places quite different same time aiming to preserve the signals is a risk on/risk off strategy based
demands on managers compared to
those arising from tactical asset allo-
cation. An active manager, aiming to
deliver outperformance to a pre-speci-
“ The current market turmoil in Europe and
fied benchmark, will expect the ETF to
track its own benchmark index tightly.
elsewhere has forced many asset managers
The current market turmoil in Europe to follow a risk on/risk off strategy.”
and elsewhere has forced many asset
managers to follow a risk on/risk off
strategy. This strategy demands a original capital. We have selected on volatility indices like the VIX and
tactical allocation between riskier assets a diversified list of the best income VSTOXX Index6. The rationale for using
like equities and alternatives, and lower performing ETFs historically, ranging these signals is to capture the flight to
risk assets like fixed income. A recent from high dividend equity to prop- lower risk assets when volatility spikes.
study by the Investment Management erty to high yielding bonds. Each of Figure 3 shows this negative corre-
Association also found a growing interest these ETFs provides a fairly consistent lation between the Markit iBoxx Euro
from institutional investors in multi-asset income stream of between 4 per cent Liquid High Yield Index and the VSTOXX
strategies5, confirming this view. and 6 per cent, even during different Index very well. When risk in the markets
The most important question for economic regimes. In our tactical is high, an allocation to high-yield bonds
an asset manager looking to design asset allocation we will therefore should be reduced and put back on
a tactical portfolio is whether the focus on our second goal which is to when the risk subsides. We also use
expected “alphas” will persist after one preserve capital. Libor and Euribor to signal whether to
includes all trading costs and accounts
for the tracking errors of the instru-
ments used. Are the indices suitable 5
Asset Management in the UK 2010-2011, The IMA Annual Survey, July 2011
for a tactical play with an acceptable 6
These track the level of implied volatility of the S&P 500 and EURO STOXX 50 indices respectively.

/24 Focus: Exchange traded funds
Figure 3: Correlation Between High-Yield Bonds and Volatility in the Markets allocate into bonds or not. We use the
blended forecasts for each asset as
Markit iBoxx Euro Liquid High Yield VSTOXX
inputs to a mean-variance optimiser from
140 100
which we identify the efficient frontier
Markit iBoxx Euro Liquid High Yield
130
VSTOXX
and rebalance on a monthly basis.
80 The back-tested results show an
120
overall performance of five per cent per
110
60 annum with a consistent income stream
100 of around five per cent each year while
40
preserving capital. Figure 4 shows the
90
overall performance pre- and post-
80 trading costs compared with a multi-
20
asset benchmark. When one talks of
70
multi-asset benchmarks, surprisingly
60 0 there are no industry standards. For that
Dec 06 Jun 07 Dec 07 Jun 08 Dec 08 Jun 09 Dec 09 Jun 10 Dec 10 Jun 11 Dec 11
Month/Year
reason, we have chosen a mix of 60
per cent MSCI World and 40 per cent
Source: BlackRock, Bloomberg, as at end September 2011 Barclays Capital Global Aggregate as
our comparison benchmark.
From the list of ETFs in Table 1, the
Figure 4: Cumulative Returns of the Income Portfolio Compared with a composition of the portfolio starts with
Multi-Asset Benchmark an overweight in the riskier assets like
equities and property. With the onset
Cumulative Returns
of the global financial crisis and, more
140
recently, the euro debt crisis, there is
Portfolio (Pre T-cost)
130 a much higher concentration of fixed
Portfolio (Post T-cost)
Multi-Asset Benchmark
income ETFs in the portfolio.
120
Stress testing the alphas

110
When it comes to getting the atten-
100 tion of an active manager, nothing is
more pertinent than the month-on-
90
month outperformance of the strategy
80 compared with its benchmark. Trading
costs and the tracking errors of the
70 underlying assets must be much smaller
Month/Year
than the alpha of the tactical allocation
for this strategy to be a winner.
Source: BlackRock, Bloomberg, as at end September 2011 The back-test results shown in
Figure 5 have been calculated using
the underlying benchmarks of the ETFs
and subtracting the TER (total expense
ratio) from it. It also includes transaction
costs when rebalancing the portfolio.
To test the robustness of the alphas,
we rerun the model with higher levels
“ When it comes to getting the attention of an of tracking error. Table 1 shows the
active manager, nothing is more pertinent average annual differences between the
fund and the index. For some of these
than the month-on-month outperformance ETFs, for example the iShares STOXX
Europe Select Dividend 30 (DE) ETF,
of the strategy compared with its the fund on average outperforms its
benchmark index. This is often due to
benchmark.” additional income from securities lending

Figure 5: Monthly Excess Returns of the Income Portfolio Conclusion
The performance of the multi-asset
Monthly Excess Returns (%)
income solution is very encouraging as
8
it shows that although there is a tight
6 budget when chasing alpha, the use
of index-based products is well suited
4
as a tool for tactical asset allocation
2 even in the current volatile environ-
0 ment. In fact, being able to benefit
from the flexibility of ETFs allows active
-2
managers to address the issues of
-4 market timing such that the alphas more
than outweigh the size of tracking error,
-6
trading costs and total expense ratios.
-8
Month/Year
Allan Lane, head of EMEA product & investment
consulting and Irene Bauer, director, EMEA
Source: BlackRock, Bloomberg, as at end September 2011 product & investment consulting, BlackRock
Figure 6: Stress Testing the Robustness of the Alphas
Cumulative Returns
140
Index - TER 2-Sigma Event
0-Sigma Event 3-Sigma Event
130 Career in brief
1-Sigma Event Multi-Asset Benchmark
Allan Lane
120
Allan Lane is head of the iShares EMEA product
& investment consulting team at BlackRock,
110
which provides portfolio solutions to clients.
Before joining iShares in 2008, Lane spent three
100
years with Barclays Global Investors (BGI) Fixed
Income Active, focusing on a range of trading
90
strategies and was also responsible for building
out the investment platform.
80
He joined investment banking in the
early 1990s and has since run a number of
70
Dec 06 Jun 07 Dec 07 Jun 08 Dec 08 Jun 09 Dec 09 Jun 10 Dec 10 Jun 11 Dec 11 quant teams at sell-side institutions such
Month/Year as Banque Paribas, J.P. Morgan and Royal
Bank of Scotland, where he was global
head of quantitative research. Lane studied
Source: BlackRock, Bloomberg, as at end September 2011
mathematics at both Oxford and Cambridge
before subsequently gaining a PhD in theoretical
physics at the University of Washington.
or more favourable tax treaties for the to higher trading costs and unfavourable
Irene Bauer
fund compared with the index. The last tracking errors, we subtract an additional Irene Bauer joined iShares in 2009 and is
column in Table 1 shows the annualised amount corresponding to a 1-, 2- and a member of the iShares EMEA product &
tracking error. In this tactical portfolio, it 3-Sigma event of tracking errors. investment consulting team at BlackRock,
is the expected outperformance of an advising clients on ETF products and portfolio
solutions, along with other insights and research
asset compared with its actual tracking on ETF trading strategies. Prior to this, Bauer
difference that matters the most. We In Figure 6, we present the results for worked in asset allocation for the active fixed
ran three additional scenarios to test each of these simulations and notice income business within BGI. She started her
the robustness of the alphas based on that in the worst case scenario (the career at ABN Amro in 2004 where she was
responsible for the modelling of structured
higher levels of tracking differences. One very unlikely 3-sigma event) it loses products specialising in mortgage-backed
would expect the ETF returns to be lower on average 1.1 per cent per annum securities. Bauer has a degree in mathematics
by an amount in line with their historical compared with the original back-test. from the University of Augsburg and completed
tracking differences. To allow for more Nonetheless, it is noteworthy that it still her PhD in numerical mathematics at the
University of Heidelberg.
extreme levels of underperformance due outperforms the multi-asset benchmark.

/26 Focus: Social media
Banks brush up
on their social
skills
I
f there is one thing financial profes- Media – Catching Up with the Banks’
sionals have learned in recent months said that for the majority of banks right
it is that information is no longer now social media is about building
confined to newswires and news- awareness with customers, business
stands. Whether it is MF Global or partners and potential new hires.
The financial world’s the sovereign debt crisis in Europe, Andrew Nicolls, managing director
use of social media is the amount of news and analysis about at MHP, explains that even though
such events coming out on social banks are still behind other industries in
suddenly picking up media is growing with the popularity of the use of social media, mainly due to
pace. From weblogs weblogs, Twitter, business networks concerns about control over content,
to viral videos, financial (such as LinkedIn) and online financial there are now many examples of how
market communities. they can benefit from carefully planned
professionals are not A recent report reveals that more social media engagement programmes.
just talking about social financial institutions are unleashing “These range from improving corporate
media – more are now strategies and developing internal reputation to creating a better customer
guidelines for the use of social media. experience and using platforms as
participating in it. Rachael Released in November 2011 by MHP easily accessible news distribution
Horsewood reports Communications, the report ‘Social channels,” he says.

Focus: Social media /27
Annelie Gullstrom, SEB’s head of about our range of services and corpo-
digital media, says it is a way of life in the rate announcements,” he says.
digital age. “Internet penetration is huge “We are also looking at how best to
in Sweden so it would be bad for our disseminate our economic research
business if we were not active. This time to the financial journalist community
last year we had 10,000 followers. Now in Europe which increasingly relies on
we have over a million,” she comments. Twitter for access to breaking news.
She says that in Sweden social media The idea will be to give reporters access
is already recognised as an impor- to our research as it happens. We
tant public relations tool by banks and already have a blog for this (http://www.
other financial institutions. “It’s a good uk.daiwacm.com/blog), used by the
source of information for us and our likes of the BBC, the Financial Times,
customers,” she asserts. “Networks Bloomberg and a range of financial titles,
such as Twitter and Facebook allow us but we hope to expand our service to
Annelie Gullstrom
to reach out to customers more. We include Twitter. LinkedIn is also good for
can look at their behaviour and how keeping our client network updated on
they consume financial products via the firm-wide developments,” he adds.
internet. We can give them more infor- communications and corporate social MHP says that financial institutions
mation and quicker support,” she adds. responsibility business. Uli Pecher, global with defined strategies and goals are
American Express, Bank of America head of emerging and social media, training employees on how to tweet,
and SEB have all launched successful says the bank plans to expand its social blog and adapt to social media without
online communities. TheBenche. media activities this year. misstating or divulging sensitive infor-
com, SEB’s online community for Still, in its recent report, MHP points mation. More of them decide to use
trade finance, cash management and out that the investment banking side social media together internally first by,
custody professionals, mainly targets of financial services has been slower for example, setting up micro-blogs for
trade finance professionals. At the time to open up to social media, especially teams across the firm.
of writing, it had over 5,000 members when it comes to allowing traders to blog The story is similar on the investment
(growing at about 200 new members or tweet. On the one hand, traders can management side of the market. Karen
per month). It gets 18,000 hits a month engage with and share information with Perrott, a public relations manager at
from around the world with Sweden, clients more readily throughout the day. M&G Investments in London, notes that
Germany, the US, the UK and India But there is also the risk of things being her firm’s fixed-interest team started
being the top five countries. said publicly that are not compliant with tweeting in 2011. M&G is not new to
Gullstrom told Markit that she is financial regulations and that could be social media having launched www.
currently working with SEB’s IT depart- damaging to the firm’s reputation. bondvigilantes.com, a blog providing
ment on TV and mobile phone applica- “Social media platforms are commer- views and commentary on the bond
tions. She says this is an important area cial operations and there is the risk that markets, in 2006. “Our fixed-interest
for the future of retail banking. “Nine out data are misused, misplaced or falsely team already writes blogs on a range of
of ten mobiles in Sweden are smart- allocated. Many banks feel data should topics designed to educate and inform
phones. People are using them for all be stored and transmitted on their own clients, and the team now has a Twitter
sorts of things.” infrastructure to ensure full compliance. following of 1,578 industry experts,
Although firms with large retail busi- At the same time, however, regula- professional investors, commentators
nesses tend to be more proactive users tory bodies such as the UK’s Financial and journalists,” she told Markit.
of social media – and have dedicated Services Authority (FSA) are trying to Martin Forrest, director of asset
roles for overseeing the effort – this make social media more widely user- management at MHP, states in his
does not mean that financial profes- friendly by publishing guidelines and summary of the MHP Asset Manage-
sionals in the institutional markets are recommendations,” the report states. ment Social Media Survey, which
not participating. Deutsche Bank, which Paul Lyon, head of marketing for was released in July 2011, that “asset
has been active on YouTube since 2008, Daiwa Capital Markets in London, managers should take heed of the
Twitter in both German and English points out that more financial profes- words of Eirik Solheim of Norwegian
since 2009 and Facebook since 2010, sionals are being drawn to social media broadcaster, NRK, who said in an
is widely considered as one of the more by the timeliness of the information. At interview about sharing content on new
forward thinking investment banks on the time of writing, Daiwa had some media channels that ‘The only way to
social media. It now has an international 16,000 followers on Twitter. “We use control your content is to be the best
team dedicated to this within its group the service to keep our clients updated provider of it.’”

A social revolution
many bloggers out there – serious or not
– who don’t do much more than aggre-
gate and curate. In other words, if no one
is actually reporting news there’s nothing
Far from banning employees from accessing social media while to blog about. That point of origin, the
first person who wrote the actual story
at work, companies are fast catching on to the power of online
because they got on the phone and
networking and actively encouraging its use. To discuss what further spoke to someone, is so important.
impact social media can have on financial services, Markit gathered At some point, I think old school jour-
together some practitioners nalists will embrace social media and
realize that it’s a better way to tout their
The MF Global story didn’t play out stories as opposed to having the blogger
Zach Seward, editor of outreach and
social media, Wall Street Journal on the web much. It was a behind- community do it for them.
@zseward closed-doors story. Those with valu-
able information were not discussing it In the old days, the source of infor-
Felix Salmon, finance blogger, Reuters
before the bankruptcy filing. However, mation was paramount – the Wall
@felixsalmon
when we reported on the Sunday night Street Journal, CNN and Reuters,
Paul La Monica, assistant managing that a bankruptcy was imminent, it was for example. These days, because
editor, CNNMoney important we made sure the story got content is so open, the personal integ-
@LaMonicaBuzz
out there and that we were credited with rity of who sends you the information
Sean Park, founder, Anthemis Group the scoop. is at least as important as the original
@anthemis news source. What impact does this
Heidi Johnson, Markit Felix Salmon: The bankruptcy court have on social media in the finan-
hearing was tweeted live by most media cial markets?
What are the challenges for tradi- outlets. Court hearings are definitely
tional news organisations? How can well suited to social media. Paul La Monica: In today’s world we
they co-exist with social media? How But I don’t believe social media will can see if a stock is moving strangely
have recent news stories played out replace traditional journalism. Social and track what blog post is influencing
between old and new media? media doesn’t get the big, exclusive its share price. Look at how Boy Genius
scoops in the same way that traditional Report moves tech stocks. Five years
Zach Seward: We are always aware of journalism does. Social media doesn’t ago people never would have thought
what’s on at places like the Huffington break the story. that something called Boy Genius
Post, Daily Beast and StockTwits. It’s Report might have a tangible impact
part of our job to see what nimble Paul La Monica: The disruptive, i.e. inno- on Apple or Motorola stocks. More
competitors are doing and stay abreast vative, areas are where the story origi- people are spreading information and
of what they are covering. nates and how it gets linked. There are a lot of the better bloggers are making
an impact.
Felix Salmon: Historically, many media

Felix Salmon companies have had an umbrella over
the journalists, where the brand is
stronger than the journalists. A classic
example of this is The Economist.
Now, with the dispersal of information
and social media, you’re more likely to
take a story seriously if it’s sent to you
by someone you trust rather than just
because it appears in The Economist.
That is a huge change.
The act of sending good, interesting
information is something that old media
needs to do and most of us have been
bad at this. It’s external linking. In other
words, pointing readers to other stuff

created around instand messaging (IM).
Zach Seward Many financial institutions today try
to centralize around an enterprise IM
network while also trying to gain access
to external networks through their own
domains. We see this as a potential to
build or empower other networks in the
financial services marketplace.
How else are banks and big institu-

tional firms channelling information via
social media?
Heidi Johnson: A couple of years ago

banks were reluctant to recognise social
networks and most blocked Facebook
and LinkedIn. That wasn’t necessarily
because of regulatory concerns. It was
a fear of scrutiny too. But the people
coming up at banks are a decade
that is useful. It’s a crucial part of what terminals because they relied so much younger. They grew up with social
we have to do. If you pretend to be the on instant messaging to do business. media and are likely to be more open
‘be all-and-end-all’ no one is going to That’s when we started joking about minded about the pros and cons.
take you seriously. Bloomberg being a $1,500 per month
instant messaging terminal. The value Felix Salmon: It’s worth noting one
What ‘disruptive’ institutions, individuals of the implicit network built around group of people who are typically over
or technologies are making the biggest this messaging was huge, so when 30 years old – the General Counsels.
impact in the financial markets? Facebook emerged with critical mass, It’s going to be a long time before they
it should have been easy to see that change. A banker recently told me he
Sean Park: They are many and varied. it would become extremely valuable. wasn’t on Twitter because his bank’s
When I left banking one of the things I For the past 20 years Bloomberg has compliance people said that every
worried about as an information junkie shown how powerful the social network single tweet needs to have the phrase
was what I would do without all my really is. ‘Member FDIC’ in it.
subscriptions and terminals. However,
in terms of news and information, I Felix Salmon: You don’t have a choice Sean Park: This mentality is a legacy of
honestly didn’t feel like I was any less with Bloomberg – all of your informa- the industrial age. The mindset of the
informed after I left. The only exception is out there and visible to everyone. digital age is about solving the problem
tion was the arcane, securities-type You can get messaged by anyone with but also making it easy to do. We ran
data and analytical information. A big a Bloomberg which makes it incredibly into a lot of resistance when we set up
chunk of my team’s subscriptions valuable as a messaging platform. wikis and blogs at my former bank. Of
were Bloomberg.
Bloomberg was the world’s first
(highly profitable) social network. As is “ The mindset of the digital age is about
often the case in bear markets, banks
have looked to see if they can cut costs solving the problem but also making it easy
by reducing the number of Bloomberg
terminals they subscribe to. I remember
to do.”
leading a review to do just that around
the time of the first dotcom bust. In Heidi Johnson: The value of networks is course, we considered that someone
the end, we were able to cut around clear. What is interesting is that there are could write something crazy or even
20 per cent but the main commer- many in the marketplace, each catering put pornographic pictures on it, but
cial impediment to doing more was to different user types or communi- objectively who really would do this? We
the instant messaging function. It was ties with a shared interest. One area of launched internally first with the idea of
very difficult to justify people sharing opportunity we see, is in the networks later rolling out externally to collaborate

with customers. Undoubtedly, there

will be risks but that isn’t a reason not Paul La Monica
to move forward and capitalise on the
digital world. Obviously, the crazy person
in the example would be caught imme-
diately – in the digital world everything is
tracked and auditable. If you think your
staff will behave like that, then social
media is the least of your worries.
Back to the question about disrup-
tion, Betfair, the largest online betting
exchange, is a prime example. When it
was created in 2000, the incumbents
argued that it would attract corrupt
gamblers – as if there was no corrup-
tion in the traditional betting world. But
Betfair has proved that by betting on a
platform, you can actually see and police
corruption. The betting is logged and
audited so it’s more secure and efficient.
It’s easier to make insider trades on a Sean Park: It’s not as if rumours have more efficient at dealing with misinforma-
listed company than on a private one but never moved the markets before. The tion because the community does not get
nobody argues that stock exchanges community deals with them at high spooked in the same way traders do.
cause corrupt behaviour. Platforms don’t speeds. Look at StockTwits. In general,
ensure transparency but they offer much you’ve got crowd sourcing and fact Felix Salmon: Rumours hit Twitter but
greater transparency. Then business checking. It’s all about where it comes they get shot down more quickly than in
models are forced to follow. from now and that becomes pretty traditional media.
obvious from the start. I would say that
How are rumours or inaccuracies social media actually facilitates the More analyst research reports are
policed in the social media world? debunking of false rumours more quickly. dispersed via social media now, so
Traditional news organisations have how does this impact the market?
editors and there are laws for them Zach Seward: To me this is more a ques-
to abide by, so how have the markets tion about whether the markets are effi- Paul La Monica: Market participants
coped with crazy comments in the cient at dealing with misinformation. It has know that they have to pay attention to
new media? What kind of effect does nothing to do with Twitter or other social what is coming out via social media. If
this have on markets? media. In fact, social media are probably not, they’ll lose. There’s an audience of
traders out there trying to make money
off every little twist and turn. That’s why
people seem to have this insatiable
Sean Park
need for what the latest tick is.
Felix Salmon: Underneath it all, finan-

cial professionals are human beings.
They have the same appetites for news
as normal people – they like to read
good, interesting stories. They want
instant analysis.
Zach Seward: I see a big information

spectrum spreading from instant news,
so people can get right up close to an
event, to longer in-depth analysis,
so they can sit down at the end of the
week and think about what’s happened.

With over 50 blogs, the WSJ obviously
is involved in it all. But what’s interesting
is that we all are sharing the news more
because of social media.
Both Dow Jones and Reuters have

built services for mining news informa-
tion. They then try to convert that into
resultant data and trading information
products for financial professionals.
Is this mining of information some-
thing other organisations might start
doing? How can financial firms capi-
talise on what is going on in the social
media world?
Felix Salmon: These products and Heidi Johnson

services are for quantitative profes-
sionals and I suspect more organisa-
tions will look into this if they have a lot
of computing power. Exchanges might at the world of trading, people don’t like always been the key value proposition
want to consider this. Reuters has been to pay to trade things. They don’t like in information services and its value is
successful at selling raw data to anyone transaction costs, but they will pay for more accentuated in a world of informa-
who makes a trade. clearing and settlement. We’ve found tion abundance.
that this behaviour is true of almost In terms of what to invest in, if I were
Sean Park: One point to make is that any market, whether B2B or B2C. If CEO of Thomson Reuters, for example,
you can’t profit from something unless transaction costs are too high, you get I’d be taking a Google-type approach
you participate in it. If a firm wants to “leakage”, where people look to match and buying a lot of start-ups to get
profit from a community it needs to their transactions off the platform. technology and, more importantly, their
support it and earn some sort of leader- However, there is much less resistance people to help drive cultural change.
ship within it. That’s where the differ- You need to have a deliberate strategy.
ence between the old and the new
comes in. It’s not about controlling, it’s
“ It’s not about In fact, Markit uses that strategy of
acquiring companies to build up and
about participating. controlling, pump fresh blood and new ideas into
the firm.
Felix Salmon: This is where things it’s about There’s a real opportunity to become
are evolving. For example, sell-side experts in managing large data sets.
research is a marketing function. There participating.” With almost all providers of financial
are a gazillion conversations between information and content, the ability
people in the financial services industry to paying for ancillary services around to combine financial data, analytics,
wanting to talk about social media and the transaction, for example, tools and content and traditional media offer-
these people usually come from the payments. If you look at Google, the ings in ways that allow customers to
marketing side. It’s sort of fundamental transaction search is free. The moneti- quickly derive insight and knowledge
when you compare buying ads on sation comes from services sold around will be key to maintaining a competi-
the back page of The Economist with the search. It’s the difference between tive advantage.
getting more involved in StockTwits. making money “with something” or
“because of something”. Felix Salmon: Back to what Sean was
If you were a consultant what are the Coming back to the context of media saying about curation, the first organisa-
technologies that you would advise us and content validation, the question tion to get it right will be massive. The
all to get immersed in? What will the is what will people pay for. I think the first sell-side research shop to open
successful business models be? main threat to the value-added for large everything up, take down all the ridicu-
players is disruptive technology that lous passwords and put everything on
Sean Park: I think ‘free’ as in ‘open’ is changes the way people do things. the web in HTML rather than in PDF
an extremely important topic. If you look Curation, in the broadest sense, has form is going to be a game changer.

/32
Source: Getty Images Environmental: Nutrient credit trading

Environmental: Nutrient credit trading /33
Liquid water
markets
A nutrient credit trading programme around Chesapeake
Bay aims to dilute contamination in the most cost-effective
manner possible, writes Paul Marchetti, executive director
at PENNVEST
C
hesapeake Bay is the Early steps
US’s largest estuary, yet In 2005, the Pennsylvania Department
it is in extremely poor of Environmental Protection (DEP)
health, with polluted established the nutrient credit trading
water, low populations programme for the Chesapeake Bay
of fish and shellfish watershed in Pennsylvania, which is
and lost and degraded habitats and primarily comprised of the Susque-
landscapes. Although Pennsylvania hanna River basin but also includes
does not geographically touch Chesa- the Potomac River basin. Working
peake Bay, the state is, nonetheless, with the World Resources Institute
intimately involved in its health and (WRI), DEP established a credit registry
water quality: nitrogen and phospho- where potential credit buyers could
rous discharges from rivers enter the find credits being offered for sale by
bay as a direct result of activity in the credit generators. DEP also estab-
state. These discharges encourage lished the protocols for certifying the
the growth of algae in the bay which in credit-generating activities that would
turn depletes the oxygen supply of the reduce either nitrogen or phosphorous
waterways and destroys the habitat discharges into the bay watershed.
for shellfish and other aquatic life. These activities were largely, although
Approximately 50 per cent of the fresh not exclusively, agricultural Best
water flow into the bay comes from the Management Practices (BMPs) imple-
Susquehanna River, which traverses mented on any of the 35,000 farms in
central Pennsylvania. the Chesapeake Bay watershed. DEP
Recognising the significant nega- is also responsible for verifying the
tive impact that nutrients contained actual reduction of nutrient discharges
in this flow have on the bay, Pennsyl- once they have taken place.
vania instituted a trading programme to Subsequent to DEP’s creation of
alleviate this contamination in the most the nutrient credit trading programme,
cost-effective manner possible for the the Pennsylvania Infrastructure Invest-
state’s residents. ment Authority (PENNVEST) became

/34 Environmental: Nutrient credit trading
interested in adding its financial resources anticipated environmental benefits to be environmental compliance obligations.
to help enhance this market further. delivered by the project. Then, at the end This uncertainty is largely responsible
of each compliance year, DEP checks to for PENNVEST entering into the nutrient
Mechanics of trading water quality see if the promised nutrient reductions credit trading business.
A nutrient credit represents the elimina- actually occurred during the year. Asso-
tion of one pound of nutrient discharge, ciated credits are verified and can be Shoring up the market
either nitrogen or phosphorous, into the counted by a compliance buyer, such as The uncertainty among waste water
bay watershed. Credit values depend on: a waste water treatment plant, as a credit treatment operators concerning the
towards meeting its permitted nutrient reliability of certified credits is the main
• The river basin in which the nutrient discharge levels for that year. reason why PENNVEST entered the
reduction occurs: as each basin has There are multiple credit markets. nutrient credit trading market in Pennsyl-
its own nutrient discharge goals, Each combination of nutrient, river basin vania. By acting as intermediary between
a Susquehanna credit cannot be and compliance year constitutes its own credit suppliers and buyers, with the aim
traded for a Potomac credit, even separate market yet they all vary in size, of becoming the buyer to all sellers and
if the nutrient being reduced is the volume, participation and visibility. The the seller to all buyers (who choose to
same in each case. markets for certified and verified credits deal through PENNVEST), PENNVEST
• The compliance year in which the are also separate. mitigates credit buyer concerns
credit is generated: waste water treat- This distinction is critical: verified over future contractual fulfilment. By
ment plants have to meet permitted credits represent actual reductions that purchasing credits through PENNVEST,
limits for nitrogen and phosphorous the buyer can claim for permit compli- a wastewater treatment plant receives
discharges on an annual basis using ance purposes and therefore consti- PENNVEST’s commitment to supply
the water year as the calendar i.e. the tute a compliance tool. Certified credits credits in the future and so does not
period from October 1 to September are more in the nature of a planning have to worry about an individual farmer
30 the following year. Credits are not tool. When deciding on how to meet its going out of business or changing opera-
tradable across compliance years future nutrient reduction permit require- tional planning. Rather, the operator can
and any credit generated during one ments, a waste water treatment plant count on PENNVEST to find credits in the
compliance year ceases to exist when can either install a physical upgrade, future from the sources available.
that year ends. financed by borrowing perhaps, or enter At the moment, PENNVEST’s ability to
find replacement credits stems from two
sources. First, PENNVEST funds nutrient
“ By acting as intermediary between reducing projects in the Bay watershed
credit suppliers and buyers...PENNVEST

and in turn owns a certain portion of
the credits created by these projects.
mitigates credit buyers’ concern over future More specifically, for each of these
projects PENNVEST owns credits up
contractual fulfilment.” to the value of the funding subsidy (low
interest loan or grant) that it provides to
the project owner. At the time of writing,
Additionally, a credit is either a “certi- into a longer-term contract for certi- PENNVEST has funded approximately
fied credit” or a “verified credit”. A certified credits, which will be purchased 50 such projects with an aggregate value
fied credit is a promise on the part of over time. However, there is great of about $70m. At $4 per credit, this
a credit generator, such as a farmer, uncertainty surrounding the purchase translates into a pool of more than 17
to carry out some nutrient reduction of these credits. For example, a waste million credits that PENNVEST could tap
activity. If DEP certifies that the contem- water treatment plant might enter into a to cover shortfalls in its contracts with
plated activity will achieve the stated contract with a farmer for certified credits buyers. In addition, as a second source
nutrient reduction, then the farmer has to be delivered in 2012 and beyond, of replacement credits, should the need
certified credits equal to the number which when delivered, would satisfy occur, PENNVEST is able to spend
of pounds of nutrient reduction that that plant’s environmental compliance $50m in federally-funded Clean Water
will occur. This certification can be for obligations, removing it from any further State Revolving fund dollars to purchase
reductions that will occur in one or more actionable obligations. But, if the farmer credits directly on the open market.
future compliance years. This is similar were to go out of business in 2015 and In its capacity as “market maker”,
to a project being validated in the carbon fail to deliver those credits, the treatment PENNVEST has conducted credit
markets – a validator reviews the project plant could find itself unable to access auctions in both 2010 and 2011. The
and validates the calculation of the other credits and risk breaching its 2010 auctions were “forward” auctions

Environmental: Nutrient credit trading /35
“ Markets are a powerful tool for regulators operators can choose between a long-
run capital intensive solution financed
and policymakers that, when designed and by borrowing, or buying credits. Even
if, as they currently can, the treat-
implemented well, can help play a key role.” ment plants can buy five, ten or even
15-year “strips” of certified credits in
PENNVEST’s forward auction, they
of certified credits to be delivered in destructive credit hoarding and price still do not have the same degree of
compliance years 2011, 2012 and 2013. manipulation is a difficult task. certainty surrounding such a purchase
Conducted for PENNVEST in the fall of • Dealing with auction losers: If a treat- as they do with financing a capital-
2010 by the Chicago Climate Exchange ment plant bids on verified credits intensive solution. Being answerable
they resulted in the sale of 21,000 and in the spot auction but is unsuc- to their customers, plant operators
41,000 certified Susquehanna nitrogen cessful, the regulated entity faces are understandably risk averse when
credits at $3.04 and $2.75 respec- potential regulatory punishment if it it comes to such decisions. Making
tively. PENNVEST has now entered into does not meet its nutrient discharge credits a viable option in their minds
a multi-year contract with Markit who limits. PENNVEST may have credits may be the most significant challenge
will provide credit registry and auction available to sell in order to forestall that this programme faces.
hosting services. The first such auction this outcome, but doing so could
was held on November 2 2011 and was undermine the auction process. It is These challenges will be solved
for verified “spot” credits for the 2011 not clear how best to balance these through practice, leadership, improve-
compliance year. The auction resulted in concerns but other market or intro- ments in trading rules, innovation and
the exchange of 20,859 nitrogen credits ductory platforms may play a role. flexibility of both market participants
at $3.10 per credit, together with 700 • Cross-basin and interstate trading: and regulators. It is critical that they
phosphorous credits at $4.73 per credit. One change that could significantly are overcome to ensure the long-term
PENNVEST and Markit have sched- increase the size of the market would viability of water quality trading in the
uled further forward and spot auctions be for credits generated in one water- bay and in other upcoming US water
for 2012. shed to be applicable in another. This quality trading programmes. Markets
should be possible since all of the are a powerful tool for regulators and
Barriers to be overcome watersheds involved drain into the policymakers that, when designed and
The initiation of PENNVEST’s nutrient Chesapeake Bay and the common implemented well, with clear rules and
credit trading activity has been prom- goal is to improve to the Bay’s water quality infrastructure, can help play
ising, yet it must overcome challenges quality. This approach still faces chal- a key role in helping find lowest-cost
in order to mature successfully. Many lenges, particularly when reconciling abatement and financing innovative
of these challenges stem from the small the various regulatory programmes solutions to improve water quality.
size and early stage of the nutrient in the Bay’s states and their different
credit market. The challenges we face, ways of defining what constitutes a
in no particular order, are: credit. But as Carl Lucero of the U.S.
Department of Agriculture’s (USDA)
• Market manipulation: Given the limited Office of Environmental Markets
number of sellers and buyers in the (OEM) says, “nutrient credit trading Paul Marchetti, executive
director, PENNVEST
market at present, credit hoarding is a promising tool that can help
and price collusion are likely. To some us improve the water quality in the
extent, some “collusive” behaviour is Chesapeake Bay and to be successful Career in brief
also necessary. For example, to the it has to have credible (and cost- Paul Marchetti has served as executive director
of Pennvest since 1988. Prior to this, Marchetti
extent that credits are generated by effective) underpinning. Supported by
was a fiscal policy specialist in the Governor’s
BMPs on some of the 35,000 farms the 2008 USDA Farm Bill and a 2009 Office of the Budget (1988) and, prior to that,
in the Susquehanna watershed, the Chesapeake Bay Restoration Execu- a senior economist for the U.S. Government
individual farms are not likely partici- tive Order, the USDA OEM is also Accountability Office (1976-1987). He is an
adjunct professor in the economics department
pants in PENNVEST’s auctions. playing a central role in market infra-
at Shippensburg University. He holds a BA in
Consequently, there is a legitimate role structure development.” economics from the University of Massachusetts,
to be played by “aggregators” who • Making credits a viable option from a and an MA and PhD in economics from the
contract with farmers to market their planning perspective: When deciding University of Maryland. Marchetti is a previous
president of the Council of Infrastructure
credits in the auctions. Delineating how to meet nitrogen and phospho-
Financing Authorities (1994-1996).
legitimate aggregating activity from rous discharge requirements, plant

/36 In Practice: Consolidated tape
Who wants to
be a CTP?
Just because the European Commission is laying
down the groundwork for a consolidated tape does
not mean that it will happen, writes Marcus Schüler,
head of regulatory affairs at Markit
T
he introduction of Mifid in in European equity markets available,
late 2007 caused fragmen- a fact that reduces the attraction of
tation of data in European European capital markets vis-à-vis
equity markets. Several other regions.
industry and regulatory This might now change. The Euro-
initiatives have tried to pean Commission indicated its desire
address major impediments to data for one or several consolidated tapes
consolidation such as the lack of quality (CT) for the European equity markets
and granularity, inconsistent formatting to operate soon, and designed its
and the higher cost of data. However, Mifir and Mifid II legislative proposals
as of today, there is no high quality, to “set the conditions for the emer-
affordable, consolidated view of activity gence of consolidated tape providers”

In Practice: Consolidated tape /37
Source: Getty Images

/38 In Practice: Consolidated tape
(CTPs), a category of regulated data and cross reference table across securi- outline specific use cases and require
reporting services. Most stakeholders ties exchanges, multi-lateral trading facili- investment firms to publish trade
will welcome requirements such as the ties (MTFs) and OTC reporting venues. reports in a prescribed manner in
need for over-the-counter (OTC) equity This mapping exercise is expected to order to ensure the harmonised inter-
data to be disseminated only through facilitate and support the standardisation pretation and application of the post-
Approved Publication Arrangements of proprietary trade flags. trade transparency requirements.
(APAs), the creation of technical stand- • Further thought should be given to
ards for data by the European Securities APA regime how regulatory authorities would
and Markets Authority (Esma), and the Enabling investment firms to dissemi- ensure compliance with such use
provision of pre- and post-trade data in nate their transactions through various cases. Data quality reports provided
unbundled fashion and at reasonable mechanisms, including proprietary web by APAs should not only address
cost by trading venues. However, while pages, has reduced the quality and measurable errors, such as those
these measures represent necessary accessibility of the data. This issue will that are related to timely reporting,
pre-conditions for the emergence of a now be addressed through the APA but all aspects of the quality of the
European CT, they alone cannot guar- regime where reporting can occur only reporting. To achieve this goal,
antee that it will actually happen. via such regulated entities. While this however, further information would
will help to ensure consistent quality need to be disclosed within a trade
Data quality, standards and formats and formatting of the reported data, a report, including basis and side
Esma will be tasked with drafting number of issues need to be consid- of trade.
technical standards for data standards ered in this context:
and formats across asset classes and Cost of data
venues of execution. While most stake- • The APA criteria are presently framed While it will require some work, one can
holders will support these provisions in as high-level principles and will be expect stakeholders to be able to agree
principle, it will require significant efforts subject to interpretation by venues on data formatting and quality stand-
to decide what these standards should and regulators. Without establishing ards eventually. In contrast, resolving
cover and how specific they should be. a common specification, a level issues related to the cost of data will be
Esma would be well advised to take playing field for regulatory approval more challenging given the diverging
the previous industry efforts on these as an APA will not exist.1 commercial interests of the stake-
issues into account, for example, by the
FPL (FIX Protocol Limited) Trade Data
Standardisation Working Group, which
has been working towards providing
“ Review mechanisms and a joint industry/
guidance around the consistent appli- Esma forum will allow regulatory authorities
cation of trade reporting standards.
Another aim should be to further iden- to develop those standards in a timely
tify and flag OTC equity trade types in a
harmonised manner across all publica-
fashion to reflect industry feedback and
tion venues. This will enhance transpar-
ency and enable the performance of
market evolution.”
several important functions in an accu-
rate and reliable fashion, such as trans- • Due to the lack of information within holders. However, without it, a consoli-
action cost analysis, proof of best execu- a trade report, an APA will not be in a dated view cannot be produced at
tion and effective data consolidation. position to identify with certainty the affordable cost.
Flagging standards should be uniform inconsistent or incorrect interpreta- Legislative proposals require trading
and binding for all publication venues tion of Mifid by an investment firm, venues to unbundle their pre- and
and data vendors, including Regulated which might for example result in the post-trade data, with the Commission
Markets (RM). Review mechanisms and incorrect use of a trade flag or the to specify methods and criteria as well
a joint industry/Esma forum will allow reporting of both legs of a transac- as the level of disaggregation. However,
regulatory authorities to develop those tion. Requirements should therefore it is unclear whether and by how much
standards in a timely fashion to reflect
industry feedback and market evolution.
The Market Model Typology industry
1
For example, while all reporting venues will need to have controls in place to monitor data quality and isolate erroneous
trade reports, the actual results may vary widely as thresholds and tolerance levels are set individually by the various
group, for example, is already tackling venues. Further guidance should therefore specify the controls that would allow a reporting venue to comply with APA
this issue and developing a data model criteria, such as a detailed framework around data validation.

In Practice: Consolidated tape /39
such a requirement will actually reduce APAs and consolidate them into a proposals do little to create a level
the cost of post-trade data in prac- continuous electronic live data stream”. playing field between CTPs and
tice, as some previous “unbundling” by CTPs will have to register with their trading venues for the dissemination
exchanges has reduced data costs only home regulator and will need to estab- of transaction data, in contrast to
to a limited extent. The Commission lish, for example, security mechanisms, some Dodd Frank-related proposals
will therefore need to develop specific back-up facilities and policies to deal in the US.
standards to determine how the overall with conflicts of interest. CTPs have to • Mifid requires all post-trade data to
cost of data should be split between disseminate CT data “as close to real be made available free of charge 15
data sets. They could include the time as is technically possible”, on a minutes after publication. Market
following parameters: reasonable commercial basis and participants for whom the timeliness
• The ratio of pre- and post-trade data

fees relative to each other in the form
of an agreed “value ratio” and the
“ It might be easiest first to set a ‘reasonable’
fees for pre- and post-trade data target price for the overall CT and work
backwards from this to determine
on its own relative to the fee for the
“bundled” package
• The relative market share of a venue
in comparison with venues oper-
appropriate payments to the various data
ating in the same category of venue,
e.g. RM or APA. Comparing venues
providers, based on their contributions to the
with peers will ensure the fairness CT, and for the CTP service respectively.”
of assessing relative market share.
It will also provide sufficient flex-
ibility to define “reasonable cost” for free of charge 15 minutes after publica- of data is less important might there-
each category, depending on typical tion. The CTP also has to ensure fast fore, instead of subscribing to a “real-
operating costs, value of data, addi- access to the information on a non- time” CT, prefer to wait to receive the
tional revenue streams and overall discriminatory basis and in a format that data free of charge.
viability of the business. is easily accessible and usable.
Several companies already provide On this basis, one might expect only
The Commission will also determine consolidation services in the European limited natural demand for a European
“reasonable commercial terms” for equity markets today, albeit with scope equity CT. If the Commission concluded
the provision of the actual CT feed. To and timeliness that differ from the CTP that the creation of a CT was in the
achieve this goal, it might be easiest first requirements. That said, one must public interest, it should try to ensure
to set a “reasonable” target price for the wonder why these providers do not its commercial viability. It could do so,
overall CT and work backwards from already provide a service that is similar for example, a) by extending the time
this to determine appropriate payments to a CTP. Is it because of issues related period before data have to be made
to the various data providers, based to the underlying data, or, perhaps, available free of charge; b) by making
on their contributions to the CT, and to because they do not believe that a CTP the use of a CT mandatory for best
the CTP service respectively. To define service is commercially viable? execution and other purposes, and/or c)
a “reasonable” price for the European In this context, one must realise that by creating a level playing field between
equity CT, one could use the US CT as CTPs will not only be tightly regulated trading venues and CTPs in terms of
a benchmark. by the resulting cost, but they will also timing of data dissemination.
be disadvantaged vis-à-vis “competing”
Who wants to be a CTP? data offerings:
Once all these issues are resolved, one
is left with the question of who will actu- • Transaction data that are dissemi-
ally “emerge” as a CTP. Unfortunately, nated by trading venues themselves
the answer is less than clear. will always be more timely than
A CTP has to collect trade reports CT data. Market participants that
Marcus Schüler, head of
from “at least RMs, MTFs, OTFs2 and focus on speed will thus connect regulatory affairs, Markit
to the most relevant trading venues
directly. One should note that, in
2
organised trading facility this respect, the Commission’s

R&D: Cash equities clearing /41
Choice with
benefits
Interoperability between clearinghouses is a positive
development for the markets, writes Robert Barnes
of UBS
T
he trend towards smaller participants the flexibility to trade the
trade sizes has caused the same instrument anywhere and settle
cost of clearing and settle- in one place. This offers the potential
ment in the cash equities to promote new business for products
markets to soar. Market across geographies.
participants often pay for The concept of clearing interoper-
these services according to the number ability was introduced in Europe and
of trades they execute. In a context has given rise to the much talked-about
where the number of trades is rising, the central counterparty (CCP) clearing-
clearing and settlement cost of trading house “user choice” model. This allows
the same value is going up year-on-year. international users to consolidate
Into this situation comes the concept their clearing across markets in the
of interoperability which, in simple CCP which has the best affinity with
terms, means consolidating clearing their commercial profile and without
and settlement activity to take advan- imposing switching costs on those
tage of volume discounts to reduce domestic members that wish to remain
costs. Interoperability also gives market with the incumbent.

/42 R&D: Cash equities clearing
Reading the European Landscape Map
EU Cash Equities: CCPs as at December 2011

Largest number processed on orderbook smallest 3rd party non-displayed pools Lit Pools not FESE Ranked
FESE orderbook year-to-date July 2009
Securities Lending
Nordic Swe Fin Den et al
OTC Client matching
OTC Client matching
panEU ex Fr Be Ne Po
Swiss, German + Fr Be Ne Po
UK and later panEU

Fr Be Ne Po
panEU inc Nordic

panEU MTF
panEU dark
panEU dark
panEU dark
panEU dark
panEU dark
SIX Swiss Exchange (SIS) choice 2003 Switzerland
Euro Millennium (now NYSE Euronext) panEU dark
Swiss dark
Germany
Norway
Ireland
panEU
panEU
panEU
panEU
panEU
panEU
Nordic
Spain
Italy
UK
(Euroclear)
SIX Swiss Exchange Liquidnet Service

closed 2010
DTCC & Thomson Reuters JV

building CCP Q110(VPS)
29 Jul 2011 100% interoperability

29 Jul 2011 partial interop
SecFinex closed Dec 2011

Deutsche Börse (Clearstream)
SIGMA X MTF Goldman Sachs
TOM MTF 50:50 JV Binc Bank + Optiver

Nordic (VP/Euroclear)
(Euroclear)
(Monte Titoli)
Equiduct Börse Berlin

Turquoise MTF (now LSE JV)
Arca EU MTF
Irish Stock Exchange
Swiss Block closed 30 Jun 2011

Europe MTF
SmartPool
(Settlement CSD)
PLUS-pool
LSE (Euroclear) choice 2008
NYSE Euronext
Burgundy MTF
SWIFT Accord
NX Nomura/Lehman
Borsa Italiana
BATSeu MTF
(Iberclear)
Quote MTF
Chi-X MTF
Oslo Børs
NASDAQ OMX
NASDAQ OMX
UBS MTF
Liquidnet
NYSE Euronext JV
NYSE Euronext JV
Pipeline
NYSE Euronext
Trading
Omgeo
PLUS Markets
BME
SLS
NYFIX
FESE rank by number of trades 1 2 3 4 5 6 7 8 9 10 11 15 18 21
FESE rank by value traded 2 1 5 3 6 8 9 7 4 11 10 15 18 19
FESE orderbook EURk/trade 8 8 6 12 9 10 6 15 28 5 10 4 7 7
Multi-market CCPs
CC&G tbc live tbc
EMCF live live tbc *live live live tbc tbc live live
Eurex Clearing tbc live tbc live
EuroCCP Q112 H112 live *live H112 live tbc live live tbc pilot 2012 live
LCH.Clearnet Ltd live Q112 live live *live tbc tbc live live live 2012 2012 ^ live 2012
LCH.Clearnet SA -13 dpd # live ^ live 2012
Oslo Clearing live
SIX x-clear live tbc Q112 tbc H112 Q112 live *live H112 live live live live live 2012 2012 2012 # live 2012 ^ live 2012
-13 NYSE Euronext gave notice on May 12 2010 to drop LCH.Clearnet as CCP for its core French Dutch Belgian Portuguese names; the notice period = to late 2012. June 16 2011 extended to June 2013 for continental
derivatives and December 2013 for cash equities.
dpd SmartPool dropped LCH.Clearnet from 1 Aug 2010 as CCP for French Dutch Belgian Portuguese names, EuroCCP live also for these panEU names on SmartPool.
2012 prospective, qualified.
* BATSeu: EMCF for panEU ex Ireland + LCH for Ireland; at 29 Jul 2011: preferential clearing = EuroCCP, SIX x-clear, LCH / else default=EMCF; Q409 potential: EMCF + SIX x-clear + EuroCCP for panEU / LCH UK & Swiss.
^ Equiduct: LCH only UK; Clearnet=French Dutch Belgian Portuguese; SIX x-clear German + Swiss names on Equiduct.
# SecFinex: Clearnet=French Dutch Belgian Portuguese: live; SIX x-clear=UK, Austria, Denmark, Finland, Germany, Norway, Sweden and Switzerland on SecFinex. NYSE Euronext closes SecFinex Dec 2011.
live: italicised items represent platforms no longer active but which had live CCP models integrated into the EU landscape.
The left column lists CCPs, the top row lists Exchanges and MTFs. Shaded boxes include live dates, where available, from a functional readiness potential.
Some models may require additional time before launching due to additional regulatory review of new interoperability proposals.
The more shading per CCP horizontal row, the more markets that CCP can consolidate for scale economies.
Irish Stock Exchange uses a separate instance of Eurex Clearing.
Source: AFME, CCPs, Exchanges, FESE, MTFs, SecFinex, public reports. Regulators support interoperability: timings are subject to approval of revised interoperability submissions by CCPs
Benefits of CCP user choice provides clearing access to the rest • Competitive clearing gives firms the
The benefits of full interoperability of oncoming markets for little or opportunity to consolidate their multi-
are multiple: negligible incremental cost. market flows into the CCP of their
• Competitive clearing via the user choice. This means that where a CCP
• Introducing a CCP with netting for choice model encourages CCP offers a volume discount, incremental
bilateral markets saves significant incumbents to offer fee incentives flow across names and markets
central securities depository (CSD) pre-emptively, thereby reducing saves significant CCP fees. Also,
settlement fees. These fees are explicit frictional costs. in a fragmented landscape where
incurred as many times as gross • Different firms may have an affinity the same stock name may trade on
stock trades are executed but for different CCPs based on factors multiple platforms that initially use
only once in the case of a net such as their respective order execu- different CCPs, consolidating all
stock position. tion profiles. Firms are not forced to matched bargains per stock into the
• Plugging in once to a CCP that bear switching costs – they have the single CCP of choice adds a further
serves multi-markets effectively freedom to choose to do so. significant consolidation effect.

R&D: Cash equities clearing /43
For example, if a stock matches on value of matched trades surged such Exchange that feature the interoperating
three platforms which do not share a that the MTF ranking jumped from ninth CCPs of LCH.Clearnet and SIX x-clear,
CCP, the user pays three net settle- since launch to fourth (August), second where users clear through their CCP
ment fees per stock per day, due to one (September), third (October) and second of choice.
net message per CCP. With interoper- (November) in the Thomson Reuters European exchanges and European
ability, a firm that consolidates all trades Equities Market Share report which MTFs are delivering or plan safe imple-
in that stock to its CCP of choice will tracks 16 external venues matching pre- mentations of interoperability within the
reduce its settlement fees by two thirds trade non-displayed or ‘dark’ liquidity prudent revised regulatory framework.
in this case. in Europe. In the US there is one currency, one
A meaningful competitive framework Based on UBS’s experience of clearing and settlement model and one
includes willingness by: switching CCPs in the Swiss and set of rules. Europe is more complex
1. Exchange or multilateral trading London markets (2005 and 2008, but has solved the puzzle of how to
facility (MTF) to provide trade feed to respectively), our views are that a trade the same name in two or more
CCP(s) requesting interoperability. multiple CCP user choice model is countries and settle at home. Asia,
2. CCP incumbent to participate in the safe and simple way to aggregate where exchanges have recorded more
interoperability. matched flows of different stock names orderbook value traded than European
ones since 2009, could also benefit
significantly from adopting the user
“ During the financial crisis, business on choice model.
To promote growth of global liquidity,
exchanges with CCPs performed well.” one opportunity is to extend this model
to equities and equity-related products
like ETFs to allow investors to diver-
Full interoperability of CCP user across venues for immediate single sify their risk by geography. As more
choice is helped by: volume discount benefits of reduced international markets embrace clearing
(i) Tariff comparability where fees can transaction and collateral costs. choice for efficiency, one can envision
be translated into a proportion of UBS MTF also has the capability to global equities evolving towards the
value traded. trade 142 of the most liquid ETFs from way developed currencies can trade 24
(ii) User endorsement as a business filter Switzerland, Germany, France, the hours and settle in one place.
for interoperability to avoid frivo- Netherlands and the UK. The opportu-
lous requests. nity post-Lehman where investors wish
(iii) Faster-moving timetables to allow to mitigate broker counterparty risk is
competitive new entry. to encourage ETFs to match on order-
book and clear safely in a CCP model
Technically, most interoperability with the potential for price improvement.
projects and the act of switching are UBS MTF added depository receipts to
Robert Barnes,
straightforward to implement. Delaying complement this offering and interna- CEO, UBS MTF
the introduction of full interoperability tional user demand.
disadvantages market efficiency by
preventing access to the obvious bene- The global perspective Career in brief
fits of multi-market post-trade consoli- The European Commission’s Competi-
Robert Barnes is chief executive officer of UBS
dation via the user choice model. tion in EU Securities Trading and Post- MTF, a segregated non-displayed MTF with
trading: Issues Paper stated: “CCP CCPs that can settle trades of more than 3000+
UBS MTF case study services could – and probably should securities from 15 countries into their respective
home depositories. He joined the proprietary
On July 29 2011, UBS MTF became the – operate in a competitive environ-
trading team at Swiss Bank Corporation in 1994,
first MTF to offer full interoperability of ment provided issues of interoperability gained experience ‘downstairs’ on the Liffe
CCPs, SIX x-clear and EuroCCP. Full are overcome.” Helpfully, MTFs and derivatives floor and ‘upstairs’ trading special
interoperability allows 100 per cent exchanges are moving this way and situations via brokers. He chaired the Securities
Trading Committee of the London Investment
predictability that a matched order interoperability is set to become the rule
Banking Association from 2004-2009 and
will clear through the trader’s CCP rather than the exception. continues to represent UBS on user advisory
of choice. During the financial crisis, business groups for a number of stock exchanges,
Joining UBS MTF qualifies firms for on exchanges with CCPs performed regulatory committees and pro-competitive
initiatives world-wide. He holds a BA from
immediate clearing fee and collateral well. This included markets like SIX
Harvard and a PhD from Cambridge.
incentives announced by its CCPs. The Swiss Exchange and the London Stock

/44
Source: Shutterstock Kit and Caboodle: Local markets

Kit and Caboodle: Local markets /45
Local
markets:
global
opportunity
Markets outside the major money centers are not just providing good
trading opportunities; they are also a much needed source of capital,
write Chris Zanelli and Jeff Drew of NYSE Technologies
A
s 2011 closes with uncer installing and maintaining trading infra
tainty in Europe, the structure was very high, varying regula
Americas and Asia, it’s tion and technical requirements created
easy to be pessimistic. a steep learning curve and retaining
But amid this global qualified support staff in multiple
gloom, large pockets of markets was a formidable challenge.
opportunity exist. Global trading is not Recent advances, notably NYSE Tech
only increasing in volume, but it is also nologies’ Global Liquidity Centers, have
expanding over a steadily increasing arguably leveled the playing field. With
number of growing economies. simpler, more affordable ways to trade
Maturing local markets throughout the in proximity to growing local markets, a
world are providing new sources of far larger community of global traders
capital for issuers and creating prom is now empowered to seek new
ising opportunities for global traders. growth opportunities.
More investors are dispersing the
capital they manage into local markets, Rapidly growing local markets
rather than just committing it to the While the major markets still garner the
established money centers. lion’s share of global trading volume,
Previously, only the very largest the rest of the world is rapidly catching
market participants had the capital up, providing outstanding new oppor
resources needed to take advantage tunities to find liquidity and deploy new
of these opportunities. The cost of trading strategies.

/46 Kit and Caboodle: Local markets
The Major Markets Still Capture the Greatest Volume Australia both attracts foreign listings
and spawns new companies, creating
$ Billion
new demand for capital. A growing
3,000
2,769 middle class not only fuels consumer
2,500 demand, but also provides a new
source of investment capital that adds
2,000 1,760 liquidity to local markets.
1,500 In some cases, listing on a foreign
exchange can be a first step to listing on
1,000 720
larger exchanges, such as the NYSE or
500 280 241 NASDAQ. The Toronto Stock Exchange
158 52 21 10 (TMX), for example, is attracting an
0
impressive list of natural resources
Q
il
re
ic o
go
SE
ng
az
nt
S
DA
po
companies from outside Canada.
Ko
ia
NY
ex
Br
ro
o
nt
a
S
ky
To
M
ng
ng
Sa
NA
To
Small, but fast-growing firms like Forbes
Si
Ho
Stock Exchange
Energy listed first on the Toronto Venture
Source: Electronic Order Book Value (Jan 1 - Feb 28 2011), World Federation of Exchanges Exchange and then, after growing as a
public company for several years, listed
But Many Smaller, Local Markets are Growing Far Faster on the NASDAQ.
In another trend involving companies
%
50% from mature markets listing in growing
50
markets, US venture-backed firms have
40%
40 chosen to IPO abroad (possibly driven
30 by US corporate regulation and taxa
20
tion policies). Bioniche Life Sciences,
12%
10% 10% GI Dynamics and Reva Medical have
10 7% 5%
-18%
4% all listed on the Australian Securities
0 Exchange (ASX) in the last two years.
-10 As local markets become increasingly
well established, the demand for 24-hour
-20
liquidity adds even further volume. For
AQ
SE
to
il
ico
SE
ng
az
or
iag
n
example, Asian and global hedge funds

Ko
NY
ex
Br
SD
ap
ro
yo
nt
To
M
ng
ng
Sa
NA
To
demand liquidity during the Asian day,

Si
Ho
Stock Exchange
fueling increased volume in many issues.
Source: Electronic Order Book Value (Jan 1 - Feb 28 2011), World Federation of Exchanges According to Richard Murphy, general
manager, Australian Stock Exchange
Equity Markets, companies like Teranga
More fuel for growth exploded over the past decade, fueled Gold or BHP Billiton – that histori
As companies expand their operations primarily by rapidly expanding Canadian cally traded on Toronto, New York or
into more countries, many are starting to and Bric-domiciled companies looking London exchanges – are now listed on
look at these new markets as sources of for capital to expand. the Australian exchange. Some 60 per
capital as well as revenues. For this to be However, the stream of companies cent of BHP Billiton’s volume is now on
a viable strategy, the local market must listing outside their native countries no the ASX.
have sufficient liquidity. Most compa longer flows exclusively from smaller
nies that have listed abroad have been markets to larger. The steady growth of Expanding trading opportunities
those from smaller markets looking for China, India, Brazil and many resource- With rapid increases in volume, markets
capital in bigger markets. This trend has based economies like Canada and outside the major money centers are
already large enough to provide good
trading opportunities. Global investors
“ The greater possibilities spring from the fact are now more able to deploy the capital
they raise, and to hedge their invest
that more listings mean more derivatives, ments using a variety of instruments.
There is more opportunity, increasingly
creating more correlations.” distributed over more global markets, to:

Growth in NYSE Listing of Non-US Companies
A natural growth story
G
Number of Listings
140 rowing economies have a
120 2001 to 2011 large appetite for natural
Up to 2001 resources, providing
100
demand for the companies
80 that sit on top of raw materials. The
60 companies that supply the means
to tap into those resources are also
40
booming, as are the companies
20 that support them, and on down
0 the supply chain. The increase in
commodity prices from this exploding
da
ina
il
ia
UK
ina
ic o
az
li
re
pa
Ind
ra
na
Ch
nt
ex
Ko
Br
Ja
st
demand has arguably fueled invest
ge
Ca
M
Au
Ar
Country ment in exploration and extrac
tion technology, making deposits
Source: NYSE
economically viable to access. This
has radically changed the economic
landscape of countries now able to
• Tap into the rapidly growing invest companies across global exchanges and capitalize on their natural resources.
ment pools in emerging economies. alternative trading venues. While having For example, the world’s deepest (and
• Invest in growing international and the same company listed on two markets most expensive) drilling off the coast
multinational companies and sectors. presents an obvious arbitrage opportu of Brazil will make Brazil the world’s
• Deploy new trading strategies nity, straight arbitrage tends to become fifth largest producer by 20201. Large
leveraging exchange traded funds inefficient quickly. The greater possibili mineral deposits will continue to ener
(ETFs), indices and their constituents. ties spring from the fact that more listings gise a booming Australian economy2.
• Develop new partnerships, mean more derivatives, creating more All this creates a chain of opportu
customers and client relationships. correlations. If that listing is also a compo nity, particularly for traders who can
nent of an ETF or index, even more execute strategies effectively across
Many hedge funds are discovering correlations are created. More correla multiple global markets and multiple
attractive opportunities among interlisted tions, in turn, create greater opportunity asset classes. Among these:
1. The commodity resources them

TMX Oil and Gas Issuers with Global Operations selves – oil, copper, iron, etc.
2. The direct supply chain –
Global Properties • Global Investments • Global Visibility producers and operators of oil rigs,
TSX: Toronto Stock Exchange TSXV: Toronto Venture Exchange
mining equipment, transportation,
UK/Europe:
Russia &
CIS Countries: Canada: and processing plants.
TSX: 19 Companies TSX: 4 Companies TSX: 193 Companies 3. Indirectly influenced sectors –
TSXV: 14 Companies TSXV: 6 Companies TSXV: 237 Companies
environmental monitoring and
US: safety, ports and other infrastruc
Africa:
TSX: 23 Companies
TSX: 39 Companies ture projects.
TSXV: 89 Companies
TSXV: 30 Companies 4. Resource sensitive industries like
Mexico, transportation and housing.
Middle East: Central America &
Caribbean:
5. Natural resource ETFs and indices
TSX: 6 Companies
TSXV: 12 Companies TSX: 4 Companies versus their global constituents.
TSXV: 4 Companies
(ASX ETFs have grown from three
India Asia: Australia/NZ/PNG: South America:
to 60 in the last four years).
TSX: 8 Companies TSX: 1 Company TSX: 16 Companies 6. Interlisting opportunities (between
Toronto and NYSE, for example).
Oil and gas companies from every continent currently list on the Toronto Stock Exchange. 1
Economist, November 5 2011: http://www.
Many of these also list in their native countries, and several list on a third exchange. economist.com/node/21536570.
2
Economist, May 26 2011: http://www.economist.
Source: TMX Group Analysis of Company Websites com/node/18719624
Note: A single company may have operations or assets in multiple countries

“ It’s one thing to recognize the opportunity focus on the business logic of strate
gies as they are transported from
in growing local markets and another to venue to venue.
develop the capability to exploit them.” Advances such as these are a

response to customer requests for a
fast, familiar, and cost-effective way of
in the hands of the talented trader. Fierce farther afield. Rather than having to trading in markets worldwide. With no
competition has eroded the profitability of source and build proprietary infrastruc capital expense and a minimal learning
some of these trading opportunities in the ture in each market, they can access the curve, firms can now trade in new
top three markets, but the opportunities enabling technologies within a global markets using the same software they
remain in the growing global markets. capital markets community – consisting use right now in local markets.
of high-speed global financial networks, By taking part in an ever-expanding
Obstacles to overcome infrastructure services and robust market capital markets community, traders
It’s one thing to recognize the opportu data and transaction services. have greater access to more opportu
nity in growing local markets and another Local exchanges and their members nities around the world, more market
to develop the capability to exploit them. want new relationships with inves participants and liquidity providers,
Many arbitrage and complex trading tors and are seeking to be part of and all with a lower barrier to entry than
strategies require lightning fast execu an ecosystem that brings together ever before.
tion and low-latency, high-quality data. exchanges, investors and financial
Until quite recently, building the infra service providers. NYSE Technologies, Chris Zanelli, director, Global Market Data, and
structure to trade in proximity to multiple for example, is meeting this demand Jeff Drew, program manager, NYSE Technologies
local markets was a costly proposition with a Liquidity Center strategy that
and new territory for most. It generally enables frictionless global trading
required substantial local knowledge, without the heavy investment of
long-term commitments and substantial procuring data center space and hard
capital costs; often a greater investment ware, writing software, connecting to
than volumes can justify: counterparties and sourcing exchange
contracts. Specifically:
• Depending on the market and size of Career in brief
deployment, it can cost $300,000- • Eliminating the capital and opera Chris Zanelli
$800,000 upfront, with a recurring tional expense and risk traditionally Chris Zanelli heads the business management
cost of $400,000 to $1.2m. allocated to “do-it-yourself” solutions of NYSE Technologies’ Global SuperFeed
consolidated market data service in the
• It can take up to six months to be enables cost-effective expansion into
Americas. He joined NYSE Technologies
operational in a new market. new markets. through the acquisition of Wombat Financial
• Every market has its own regulations • Outsourcing ownership in the physical Software in 2008, where he was involved
and tax regime. infrastructure makes it easier to move with custom deployments of ultra-low latency
enterprise market data platforms. Zanelli was
• It can take considerable time and in and out of markets and spread your
responsible for the launch of SuperFeed in
effort to learn the technical ins and capital (and risk) appropriately. 2008, providing the first fully managed market
outs of every new market. • Interconnecting liquidity hubs across data solution offering from NYSE Technologies
the world provide access to financial hosted within a liquidity center.
NYSE Technologies Global Market Data
Such considerable barriers to entry services globally.
division was named the Best Market Data
have kept many market participants from • Strategically co-locating trading strat Provider in the 2011 Inside Market Data Awards.
exploring new trading opportunities, egies among the global exchanges
particularly those in the shorter-term, creates ultra-low latency access to Jeff Drew
Jeff Drew is responsible for the Liquidity
in the fastest growing global markets. It the markets. Center Program at NYSE Technologies. Prior
simply took too much time, money and • Global liquidity providers offer to joining NYSE, he founded Trading Metrics,
effort to see if the new market could the education needed to trade in a provider of real time latency measurement
support profitable strategies. local markets – helping to navigate services. Trading Metrics was acquired in 2008
by Greenline Financial Technology, a division
the labyrinth of policy, regulation of MarketAxess. Another software company
Simplified access through global and taxation. he founded, NetGain, was acquired in 2000 by
liquidity centers • Standardized technologies and Greenwich Technology Partners. Drew started
Recent advances have made it far easier access create a single interface to his career programming network protocols and
also worked at McKinsey and Co, Inc.
for traders to explore more opportunities multiple markets enabling investors to

/44
Source: Shutterstock Kit and Caboodle: Local markets

Local
markets:
global
opportunity
Markets outside the major money centers are not just providing good
trading opportunities; they are also a much needed source of capital,
write Chris Zanelli and Jeff Drew of NYSE Technologies
A
s 2011 closes with uncer installing and maintaining trading infra
tainty in Europe, the structure was very high, varying regula
Americas and Asia, it’s tion and technical requirements created
easy to be pessimistic. a steep learning curve and retaining
But amid this global qualified support staff in multiple
gloom, large pockets of markets was a formidable challenge.
opportunity exist. Global trading is not Recent advances, notably NYSE Tech
only increasing in volume, but it is also nologies’ Global Liquidity Centers, have
expanding over a steadily increasing arguably leveled the playing field. With
number of growing economies. simpler, more affordable ways to trade
Maturing local markets throughout the in proximity to growing local markets, a
world are providing new sources of far larger community of global traders
capital for issuers and creating prom is now empowered to seek new
ising opportunities for global traders. growth opportunities.
More investors are dispersing the
capital they manage into local markets, Rapidly growing local markets
rather than just committing it to the While the major markets still garner the
established money centers. lion’s share of global trading volume,
Previously, only the very largest the rest of the world is rapidly catching
market participants had the capital up, providing outstanding new oppor
resources needed to take advantage tunities to find liquidity and deploy new
of these opportunities. The cost of trading strategies.

The Major Markets Still Capture the Greatest Volume Australia both attracts foreign listings
and spawns new companies, creating
$ Billion
new demand for capital. A growing
3,000
2,769 middle class not only fuels consumer
2,500 demand, but also provides a new
source of investment capital that adds
2,000 1,760 liquidity to local markets.
1,500 In some cases, listing on a foreign
exchange can be a first step to listing on
1,000 720
larger exchanges, such as the NYSE or
500 280 241 NASDAQ. The Toronto Stock Exchange
158 52 21 10 (TMX), for example, is attracting an
0
impressive list of natural resources
Q
il
re
ic o
go
SE
ng
az
nt
S
DA
po
companies from outside Canada.
Ko
ia
NY
ex
Br
ro
o
nt
a
S
ky
To
M
ng
ng
Sa
NA
To
Small, but fast-growing firms like Forbes
Si
Ho
Stock Exchange
Energy listed first on the Toronto Venture
Source: Electronic Order Book Value (Jan 1 - Feb 28 2011), World Federation of Exchanges Exchange and then, after growing as a
public company for several years, listed
But Many Smaller, Local Markets are Growing Far Faster on the NASDAQ.
In another trend involving companies
%
50% from mature markets listing in growing
50
markets, US venture-backed firms have
40%
40 chosen to IPO abroad (possibly driven
30 by US corporate regulation and taxa
20
tion policies). Bioniche Life Sciences,
12%
10% 10% GI Dynamics and Reva Medical have
10 7% 5%
-18%
4% all listed on the Australian Securities
0 Exchange (ASX) in the last two years.
-10 As local markets become increasingly
well established, the demand for 24-hour
-20
liquidity adds even further volume. For
AQ
SE
to
il
ico
SE
ng
az
or
iag
n
example, Asian and global hedge funds

Ko
NY
ex
Br
SD
ap
ro
yo
nt
To
M
ng
ng
Sa
NA
To
demand liquidity during the Asian day,

Si
Ho
Stock Exchange
fueling increased volume in many issues.
Source: Electronic Order Book Value (Jan 1 - Feb 28 2011), World Federation of Exchanges According to Richard Murphy, general
manager, Australian Stock Exchange
Equity Markets, companies like Teranga
More fuel for growth exploded over the past decade, fueled Gold or BHP Billiton – that histori
As companies expand their operations primarily by rapidly expanding Canadian cally traded on Toronto, New York or
into more countries, many are starting to and Bric-domiciled companies looking London exchanges – are now listed on
look at these new markets as sources of for capital to expand. the Australian exchange. Some 60 per
capital as well as revenues. For this to be However, the stream of companies cent of BHP Billiton’s volume is now on
a viable strategy, the local market must listing outside their native countries no the ASX.
have sufficient liquidity. Most compa longer flows exclusively from smaller
nies that have listed abroad have been markets to larger. The steady growth of Expanding trading opportunities
those from smaller markets looking for China, India, Brazil and many resource- With rapid increases in volume, markets
capital in bigger markets. This trend has based economies like Canada and outside the major money centers are
already large enough to provide good
trading opportunities. Global investors
“ The greater possibilities spring from the fact are now more able to deploy the capital
they raise, and to hedge their invest
that more listings mean more derivatives, ments using a variety of instruments.
There is more opportunity, increasingly
creating more correlations.” distributed over more global markets, to:

Growth in NYSE Listing of Non-US Companies
A natural growth story
G
Number of Listings
140 rowing economies have a
120 2001 to 2011 large appetite for natural
Up to 2001 resources, providing
100
demand for the companies
80 that sit on top of raw materials. The
60 companies that supply the means
to tap into those resources are also
40
booming, as are the companies
20 that support them, and on down
0 the supply chain. The increase in
commodity prices from this exploding
da
ina
il
ia
UK
ina
ic o
az
li
re
pa
Ind
ra
na
Ch
nt
ex
Ko
Br
Ja
st
demand has arguably fueled invest
ge
Ca
M
Au
Ar
Country ment in exploration and extrac
tion technology, making deposits
Source: NYSE
economically viable to access. This
has radically changed the economic
landscape of countries now able to
• Tap into the rapidly growing invest companies across global exchanges and capitalize on their natural resources.
ment pools in emerging economies. alternative trading venues. While having For example, the world’s deepest (and
• Invest in growing international and the same company listed on two markets most expensive) drilling off the coast
multinational companies and sectors. presents an obvious arbitrage opportu of Brazil will make Brazil the world’s
• Deploy new trading strategies nity, straight arbitrage tends to become fifth largest producer by 20201. Large
leveraging exchange traded funds inefficient quickly. The greater possibili mineral deposits will continue to ener
(ETFs), indices and their constituents. ties spring from the fact that more listings gise a booming Australian economy2.
• Develop new partnerships, mean more derivatives, creating more All this creates a chain of opportu
customers and client relationships. correlations. If that listing is also a compo nity, particularly for traders who can
nent of an ETF or index, even more execute strategies effectively across
Many hedge funds are discovering correlations are created. More correla multiple global markets and multiple
attractive opportunities among interlisted tions, in turn, create greater opportunity asset classes. Among these:
1. The commodity resources them

TMX Oil and Gas Issuers with Global Operations selves – oil, copper, iron, etc.
2. The direct supply chain –
Global Properties • Global Investments • Global Visibility producers and operators of oil rigs,
TSX: Toronto Stock Exchange TSXV: Toronto Venture Exchange
mining equipment, transportation,
UK/Europe:
Russia &
CIS Countries: Canada: and processing plants.
TSX: 19 Companies TSX: 4 Companies TSX: 193 Companies 3. Indirectly influenced sectors –
environmental monitoring and
US: safety, ports and other infrastruc
Africa:
TSX: 23 Companies
TSX: 39 Companies ture projects.
TSXV: 89 Companies
TSXV: 30 Companies 4. Resource sensitive industries like
Mexico, transportation and housing.
Middle East: Central America &
Caribbean:
5. Natural resource ETFs and indices
TSX: 6 Companies
TSXV: 12 Companies TSX: 4 Companies versus their global constituents.
TSXV: 4 Companies
(ASX ETFs have grown from three
India Asia: Australia/NZ/PNG: South America:
to 60 in the last four years).
TSX: 8 Companies TSX: 1 Company TSX: 16 Companies 6. Interlisting opportunities (between
Toronto and NYSE, for example).
Oil and gas companies from every continent currently list on the Toronto Stock Exchange. 1
Economist, November 5 2011: http://www.
Many of these also list in their native countries, and several list on a third exchange. economist.com/node/21536570.
2
Economist, May 26 2011: http://www.economist.
Source: TMX Group Analysis of Company Websites com/node/18719624
Note: A single company may have operations or assets in multiple countries

“ It’s one thing to recognize the opportunity focus on the business logic of strate
gies as they are transported from
in growing local markets and another to venue to venue.
develop the capability to exploit them.” Advances such as these are a

response to customer requests for a
fast, familiar, and cost-effective way of
in the hands of the talented trader. Fierce farther afield. Rather than having to trading in markets worldwide. With no
competition has eroded the profitability of source and build proprietary infrastruc capital expense and a minimal learning
some of these trading opportunities in the ture in each market, they can access the curve, firms can now trade in new
top three markets, but the opportunities enabling technologies within a global markets using the same software they
remain in the growing global markets. capital markets community – consisting use right now in local markets.
of high-speed global financial networks, By taking part in an ever-expanding
Obstacles to overcome infrastructure services and robust market capital markets community, traders
It’s one thing to recognize the opportu data and transaction services. have greater access to more opportu
nity in growing local markets and another Local exchanges and their members nities around the world, more market
to develop the capability to exploit them. want new relationships with inves participants and liquidity providers,
Many arbitrage and complex trading tors and are seeking to be part of and all with a lower barrier to entry than
strategies require lightning fast execu an ecosystem that brings together ever before.
tion and low-latency, high-quality data. exchanges, investors and financial
Until quite recently, building the infra service providers. NYSE Technologies, Chris Zanelli, director, Global Market Data, and
structure to trade in proximity to multiple for example, is meeting this demand Jeff Drew, program manager, NYSE Technologies
local markets was a costly proposition with a Liquidity Center strategy that
and new territory for most. It generally enables frictionless global trading
required substantial local knowledge, without the heavy investment of
long-term commitments and substantial procuring data center space and hard
capital costs; often a greater investment ware, writing software, connecting to
than volumes can justify: counterparties and sourcing exchange
contracts. Specifically:
• Depending on the market and size of Career in brief
deployment, it can cost $300,000- • Eliminating the capital and opera Chris Zanelli
$800,000 upfront, with a recurring tional expense and risk traditionally Chris Zanelli heads the business management
cost of $400,000 to $1.2m. allocated to “do-it-yourself” solutions of NYSE Technologies’ Global SuperFeed
consolidated market data service in the
• It can take up to six months to be enables cost-effective expansion into
Americas. He joined NYSE Technologies
operational in a new market. new markets. through the acquisition of Wombat Financial
• Every market has its own regulations • Outsourcing ownership in the physical Software in 2008, where he was involved
and tax regime. infrastructure makes it easier to move with custom deployments of ultra-low latency
enterprise market data platforms. Zanelli was
• It can take considerable time and in and out of markets and spread your
responsible for the launch of SuperFeed in
effort to learn the technical ins and capital (and risk) appropriately. 2008, providing the first fully managed market
outs of every new market. • Interconnecting liquidity hubs across data solution offering from NYSE Technologies
the world provide access to financial hosted within a liquidity center.
NYSE Technologies Global Market Data
Such considerable barriers to entry services globally.
division was named the Best Market Data
have kept many market participants from • Strategically co-locating trading strat Provider in the 2011 Inside Market Data Awards.
exploring new trading opportunities, egies among the global exchanges
particularly those in the shorter-term, creates ultra-low latency access to Jeff Drew
Jeff Drew is responsible for the Liquidity
in the fastest growing global markets. It the markets. Center Program at NYSE Technologies. Prior
simply took too much time, money and • Global liquidity providers offer to joining NYSE, he founded Trading Metrics,
effort to see if the new market could the education needed to trade in a provider of real time latency measurement
support profitable strategies. local markets – helping to navigate services. Trading Metrics was acquired in 2008
by Greenline Financial Technology, a division
the labyrinth of policy, regulation of MarketAxess. Another software company
Simplified access through global and taxation. he founded, NetGain, was acquired in 2000 by
liquidity centers • Standardized technologies and Greenwich Technology Partners. Drew started
Recent advances have made it far easier access create a single interface to his career programming network protocols and
also worked at McKinsey and Co, Inc.
for traders to explore more opportunities multiple markets enabling investors to

In the Spotlight: Electronic trading /49
Time to get
right on the
button
In the wake of the financial crisis, banks will have less
choice about whether or not they introduce electronic
trading of credit, writes Simon Boughey
I
f the pioneers of electronic trading But, in the wake of the financial
of credit products foresaw a brave crisis, banks will have less choice about
new world, then they are likely to be whether or not they introduce electronic
very disappointed today. Indeed, it trading of credit. Regulators on both
would be fair to say that electronic sides of the Atlantic have highlighted
trading of credit products, both cash the full automation of trading from
and synthetic, has not, over the past execution to clearing as a key prophy-
decade or so, proceeded as quickly or lactic to avoid a repeat of the events of
as comprehensively as could have been 2007-2008.
the case. A certain amount of institu- In particular, the Dodd-Frank Act in
tional reluctance has barred its path, the US specified the use of so-called
for fear of surrendering a competitive swap execution facilities (SEFs) for over-
advantage. Moreover, banks claim, with the-counter (OTC) derivatives, which in
occasional justification, that not every the case of the credit markets means
product is suited to the exigencies of credit default swaps (CDS). However,
electronic dealing. Dodd-Frank provided little helpful

/50 In the Spotlight: Electronic trading
guidance as to what it meant by SEFs: it although Tradeweb – which is the major

has been left to the Commodity Futures player in the electronic trading of US
Trading Commission (CFTC) to fill in Treasuries – has a CDS platform as well.
the gaps. This has not yet been widely adopted,
In January 2011, the CFTC said that but “We are currently redesigning the
the Dodd-Frank definition required “at platform and adding liquidity and new
a minimum the existence of a trading functionality, including additional trading
system or platform”. Perhaps realising protocols,” says Rupert Warmington,
that this is not particularly specific either, director and head of European credit at
the CFTC went on to say: “In order for an Tradeweb in London.
entity to meet the definition of a SEF and While there has been more progress
satisfy SEF registration requirements, in dealer-to-dealer trading, it is also
multiple parties must have the ability to concentrated chiefly in the dealing of
execute or trade swaps by accepting the Markit iTraxx index products. No
bids and offers made by multiple partici- more than perhaps 20 to 25 per cent of
pants.” This seems to suggest that elec- dealer-to-dealer single-name volume Rupert Warmington,
tronic trading is required for CDS. is electronic, while at least 90 per cent director and head of
European credit, Tradeweb
The European Market Infrastructure of all index volume is now automated,
Regulation (Emir), introduced by the suggest market participants. However,
European Commission in September activity is likely to have shrunk in the trading into its business model. Cred-
2010, takes a similar line and states: “All second half of 2011 due to the turmoil itex now offers a hybrid approach,
standardised OTC derivative contracts caused by the eurozone debt crisis. promoting electronic dealing when
products are sufficiently liquid for
dealers to have comfort with just
“ In order for an entity to meet the definition on-screen clicking but enabling them to
execute by voice when these variables
of a SEF and satisfy SEF registration do not apply.
Unfortunately, CDS volumes have
requirements, multiple parties must have declined sharply since the heyday of the
the ability to execute or trade swaps by market just before the crisis. The struc-
tured credit market has atrophied and
accepting bids and offers made by multiple the hedging of these once extensive
positions accounted for a great deal of
participants.” interbank business. In its absence, day-
to-day trading volume is now perhaps
only 25 per cent of what it was in 2007,
should be traded on exchanges or Over ten years ago, the broker say dealers. This collapse in volumes
electronic trading platforms, where Creditex, now part of ICE, was formed has not made acceptance of electronic
appropriate, and cleared through by two ex-Deutsche Bank traders with dealing any easier.
central counterparties by end-2012 at the sole intent to bring dealer-to-dealer Brokerage GFI is a relative latecomer
the latest.” Though, as with Dodd-Frank, electronic trading to the CDS market. It to the CDS market but it has carved
there is some looseness in these terms, launched its RealTime platform in 2004 out an enviable niche in the product.
it seems that the writing is on the wall and is widely acknowledged as having At the end of the 2011 third quarter,
for CDS dealers. pioneered the electronic trading of the firm reported that revenues from
However, at the moment, there is CDS. But it was too much too soon: the derivative fixed income products, of
only limited electronic trading of CDS, market was not ready for the electronic- which CDS is the largest component,
particularly between dealer and client. only approach and Creditex encoun- represented 51 per cent of total fixed
It is estimated that in Europe around 65 tered considerable institutional opposi- income revenues.
per cent of dealer-to-client flow in the tion, particularly in the US. The firm says it now handles between
index market is electronic, while there Over a decade on, Creditex has a a third and half of all European CDS
is still “virtually zero” in the single-name somewhat lower profile in the dealer-to- trading, and has perhaps a 50 per cent
market, comments a market expert. dealer CDS market. It long ago aban- share of Markit iTraxx index volume.
The dealer-to-client CDS market in doned its zeal with regard to electronic Important to the success of its CDS
Europe is dominated by Bloomberg, dealing and has now incorporated voice business has been its CreditMatch

In the Spotlight: Electronic trading /51
online trading platform, introduced online, we’d lose more than 15 per cent positioned for this,” says Biggar. Dealers
in 2003. In the European market, of our business if we took the brokers and clients might not have embraced
perhaps 50 per cent of GFI’s single- away,” says Woodhams. e-trading of CDS fully, but they are
name volume is now conducted online Creditex echoes these sentiments. It going to have less choice about it in the
through CreditMatch while between 80 once had a considerable technological years ahead.
and 90 per cent of its index volume is advantage, but other firms have caught Although cash products are not
traded electronically. up. More to the point, the collapse in specified by Dodd-Frank and Emir in
The volumes traded online by GFI in market volume has made e-trading of the same way that derivatives are, they
the US market are less impressive, as CDS less appropriate. “The market has have not escaped the attention of Mifid
e-trading has always been slower to become considerably less liquid and II. This legislative proposal is far from
gain a foothold in New York. However, the trader decision of when to deal is complete and will now be subject to
volumes are now catching up. Matt increasingly driven by broker feedback many hours of debate and horsetrading.
Woodhams, head of e-commerce at and colour,” says Biggar. It is not difficult to see which way the
GFI in London, estimates that up to
80 per cent of all Markit CDX index
volume is now executed electronically
after a sharp increase this year. “The
“ It is fairly clear that there will be a regulatory
US market looks a lot more like Europe push for CDS products, both single-name
and index, to be traded on electronic
these days,” adds Grant Biggar, presi-
dent of Creditex in New York.
However, the proportion of US
dollar single-name business traded
platforms.”
on an automated platform is consider-
ably smaller than CDX index volumes GFI says its biggest competitor in the wind is blowing. One of the key notes of
and also much smaller than European European single-name market is Tullett Mifid II is transparency, and the Euro-
single-name volumes. Prebon while its biggest competitors pean Commission wishes to see the
The success of GFI’s CreditMatch in the index market are Creditex. And, same conditions that surround equity
suggests it has found the secret of to a lesser extent Icap. The latter has trading extended to other products,
CDS e-trading. Like Creditex, it adopts provided fully electronic dealing of including cash credit. Moreover, the
a hybrid approach. When markets index and single-name CDS through its crux of the original Mifid documentation
are choppy and price action variable, BrokerTec platform since 2004. Though was the concept of “best execution”.
dealers still prefer to speak to a broker it is an established force in cash credit Although this remains disputed and ill-
on the telephone. The screen and the markets, it has not achieved the pene- defined, it would be naïve to expect the
voice now form a symbiotic and indis- tration into the CDS market it would like cash credit market to escape the drive
soluble combination. “Although 85 per but it is a market leader in emerging toward greater automation.
cent of index trading might be done market credits. Like the others, it also In fact, there has been reasonable
provides a hybrid solution alongside the progress made already in the electronic
BrokerTec platform. trading of some cash credit products.
All this suggests that while e-trading MarketAxess, for example, was formed
of CDS has come a long way, the in 2000 and provides an automated
market is still not ready for a fully elec- platform for multi-dealer competitive
tronic solution. Indeed, its readiness pricing in a range of credit products,
for pure e-trading has receded with the including high-grade US corporate
sharp diminution of volume. Whether bonds, high-yield bonds, emerging
this status quo will satisfy regulators market bonds, US agencies and CDS.
seems unlikely. “It is fairly clear that At the time, it provided the first multi-
there will be a regulatory push for CDS dealer-to-client platform for the trading
products, both single-name and index, of high-grade US corporate bonds.
to be traded on electronic platforms,” It is particularly dominant in US
says Tradeweb’s Warmington. corporate bonds and it currently
Creditex agrees, and says that the handles around 12 per cent of all Trace
regulatory impetus will aid its cause. volume, compared with 5 per cent in the
Grant Biggar, “There is going to be mandatory elec- first quarter of 2009. Although electronic
president, Creditex
tronic trading and we are very well platforms provided by Bloomberg and

/52 In the Spotlight: Electronic trading
TradeWeb account for some volume, there has been a 36 per cent year-on- following the crisis of 2008 (now sadly
MarketAxess believes that most of the year increase. “We see that investors evaporated) gave automated dealing
remaining 88 per cent is still largely are continuing to demand new and a shot in the arm. About one third of
voice-traded. This means it accounts for alternative sources of liquidity, and all European corporate credit is now
around 90 per cent of all US high-grade using technology to meet these goals is traded online, though it has slipped from
corporate e-trading. a priority for them,” says McVey. the middle of 2011 due to the eurozone
MarketAxess Europe was opened in In the European market, the buy-side debt crisis; this compares with no more
2001 and initially traded US dollar and can contact 24 different broker dealers, than 10 to 12 per cent in the first quarter
euro-denominated eurobonds, but has and full straight-through processing and of 2009.
since added trading of European credit a clear audit trail gives clients the tools The frenetic pace of issuance and
products denominated in sterling and they need to conform to the demands trading volume in 2009 and for much
has more recently expanded into the of Mifid. Eurobond volumes are far less of 2010, when buyers that had never
trading of sovereigns, supranationals, impressive however: in the third quarter, bought bonds before crowded into
agencies and covered bonds. It was the only $7.6bn was traded via MarketAxess the asset class, showed the virtues of
first platform in Europe to offer corpo- platforms, which represented a 29 per electronic trading: bloc trades of 20
rate bond trading. cent year-on-year decline. or more bonds could be completed
Around 800 institutional clients of
MarketAxess in the US have access
to 81 broker-dealers, and in the last “ We see that investors are continuing to
decade total trading volume has
exceeded $2,000bn. Chief executive demand new and alternative sources of
Rick McVey is keen to point out that
before 2008 there were only 35 dealers liquidity, and using technology to meet
on the platform but that this has since
opened up to a larger group including
these goals is a priority for them.”
international names.
Volumes traded on the product have One of its chief rivals in the provision simultaneously, for example. “To cope
diminished a little over the past two of electronic dealer-to-client trading in with the resulting increase in buy
quarters, in line with the general decline European corporate bonds is Tradeweb. orders, institutional execution desks
in bond dealing, but by the end of the The latter has been around since 1998 were pushed into executing elec-
third quarter, there was still a 31 per and was the pioneer of automated tronically, taking advantage of the time
cent year-on-year increase in global US Treasury trading, in which it still efficiencies offered by trading this
volumes to around $132bn. possesses clear leadership. way, and they found that they liked it,”
Of this, the US high-grade supplied While MarketAxess has a dominant says Warmington.
$82bn, and though the numbers are share of the US corporate bond market, But, as soon as liquidity fled the
also a little down from the first quarter, Tradeweb, which unveiled its cash credit markets as the eurozone crisis
platform in 2006, has made very steady reached fever pitch, so the enthu-
progress in the European credit market siasm among dealers and clients for
and now handles between one third and electronic trading began to fizzle out.
a half of all institutional business that is There is a certain threshold beyond
processed electronically. Between June which electronic dealing will not now
2009 and this year, volumes have quad- slip, but its widespread and compre-
rupled, says Warmington. hensive acceptance depends on liquid
Its strength is institutional business markets, without which the reas-
and around 80 per cent of all its volume suring voice of a dealer or broker is
is conducted with asset managers, with still preferred.
the remainder split between pension It seems likely that illiquid and volatile
funds, insurance companies and central markets are here to stay for some time,
banks. In contrast, Bloomberg, which but whether the regulators will allow
also provides a multi-dealer platform participants to adopt automated trading
for cash credit, is more evenly split when they are good and ready seems
between retail and institutional clients. unlikely. Large portions of the market
Rick McVey, chief executive, According to Tradeweb, the sudden will be dragged somewhat reluctantly
MarketAxess
burst of liquidity in cash credit markets along the path of greater automation.

/53
Markit Commentary & Data

Commentary
and Data
T
he economic situation has credible plan to reduce its deficit in the thrived to such an extent that yields have
worsened dramatically since long run and eurozone politicians finding become unattractive.
the last edition of the Markit a way to resolve their differences. Failure With correlation remaining elevated
Magazine. Back then, we to achieve these, according to the OECD, among asset classes, few hiding places
noted how the economic would result in a global recession. appear available to shelter from the debt
data had started to signal a It’s no surprise then, that recent crisis. Even the loan market has been hit,
steep easing in many countries’ rates of months have seen risk aversion grow with price returns see-sawing, bid-ask
growth. But more recently the data have to a degree not seen since early 2009. spreads widening and liquidity falling.
indicated a return to recession in the euro- The FTSE All-World equity index is down Returns have plunged since the summer
zone, which is having a far-reaching 22 per cent since its peak in May. This (see page 61). Corporate bonds have also
impact around the globe, even infecting fall has been accompanied by higher- suffered (see Markit iBoxx indices), and
emerging markets (see economics). than-usual trading volumes, according the European ABS market’s gains from
The weaker-than-expected economic to Markit BOAT data, which track over- earlier in the year have been wiped out in
growth has brought with it worries about the-counter equity trading volumes. recent months (see structured finance).
countries’ abilities to reduce their budget Volumes are 34 per cent higher than a Bright spots still persist for those prepared
deficits. A lack of decisive policymaking year ago (see page 65) led, of course, to seek them out. For example, Markit is
and political agreement in the US and by financials. forecasting 6 per cent dividend growth in
eurozone has exacerbated the problem. Bond yields and credit default swap Brazil in 2011 (see dividends). However,
Forecasters such as the Organisation for spreads blew out for the eurozone’s at the moment those bright spots seem
Economic Co-operation and Development periphery (see European CDS) to levels to be few and far between.
(OECD) have been revising down their that threaten the existence of the euro.
forecasts. The European Union’s economy, Credit markets have also been on ten-
sitting at the epicentre of the current crisis, terhooks not only in the US, due to the
is now expected to grow just 0.2 per cent super committee’s inability to set out a
in 2012 compared with a forecast of 2 per seemingly simple roadmap for tackling
cent back in May. The OECD countries the debt mountain (see US CDS), but
are now expected to grow just 1.6 per also even in Germany.
cent next year. Meanwhile “safe-havens” such as gold, Chris Williamson
However, even these downbeat fore- the dollar, yen, Swiss franc and US, chief economist
casts are reliant on the US agreeing a German and UK government bonds have Markit

/54
Economics
I
n the last edition of the Markit Magazine, we noted how the Purchasing Managers’ Index (PMI) surveys
had turned down sharply, signalling a steep easing in rates of economic growth in many countries. In
Europe, the survey data had descended to levels that were historically consistent with a loosening of
monetary policy to prop up stalling recoveries in many countries. Policy is indeed now being loosened
again, but unfortunately the situation has continued to deteriorate since the summer.
Global Growth Slowdown

PMI GDP Annual % Change
65 6
60 4
55
3
Chris Williamson 50
0
chief economist 45
chris.williamson@markit.com -2
40
@WilliamsonChris
Global PMI Output Index -4
35
Global GDP
Economic forecasts revised down in
30 -6
light of the eurozone crisis 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
The PMIs are now indicating an almost Year
inevitable recession in Europe and far
weaker global economic growth than Sources: Markit, J.P. Morgan, ISM, HSBC
most had been anticipating earlier in the
year. Even emerging markets are seeing manufacturing sector. The UK’s recovery in contrast, has shown some surprising
a slowdown due to weakened demand is showing signs of stalling due to the resilience so far in the fourth quarter, with
from the developed world. combination of domestic austerity meas- the ISM survey data picking up, the unem-
ures and falling exports. The US economy, ployment rate falling and consumer
Eurozone the epicentre of
global slowdown US Consumer Confidence
The October PMIs signalled the weakest
US (Conference Board Index, 1985 = 100)
month of global economic growth since
the recovery began in August 2009. Their 160
failure to pick up to any noteworthy extent 140

in November suggests that global GDP
is likely to have risen at an annual rate of 120
no more than 1.5 per cent in the fourth 100

quarter, down from 4 per cent a year ago.
By comparison, the average rate of global 80
economic growth seen in the six years
60
prior to the recession was 3.3 per cent.
The global slowdown has the eurozone 40
as its epicentre. The surveys suggest that
20
the region is almost certain to contract in
1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011
the fourth quarter. Even Germany’s previ- Year
ously surging recovery has now stalled,
led by a renewed deterioration of its Source: Conference Board, Ecowin

/55

confidence improving. However, unem- Economic Growth in Emerging Markets

ployment remains stubbornly high and
despite a rise in November, consumer PMI Output Index (Manufacturing & Services)
65
pessimism is at levels not seen prior to
the recession since the 1960s.
60
Weak demand in the developed world
is affecting emerging markets. PMI data
55
for November showed China’s economic
growth rate may have slowed to a politi- 50
cally-sensitive level of 8 per cent, below China
which economists worry that resulting 45 India
weak job creation could lead to civil Brazil
unrest. Asian exports as a whole have 40 Russia
been falling continually since June. Rates
of economic growth in Russia, India and 35
Brazil are subdued by historical standards

(see chart). 30
2007 2008 2009 2010 2011
Year
Inflation starts to ease
Higher-than-expected inflation prevented Source: Markit
a loosening of monetary policy earlier this
year, and even caused two hikes in euro- Global Manufacturing Supply Chain Price Indicators
zone interest rates. However, the signs
PMI Input Prices Index PMI Suppliers' Delivery Times Index
are that lower inflation rates will provide
policymakers with scope to boost stimu- 90 38
More Delays/Higher Prices
lus measures. One piece of brighter news
from recent PMI surveys has been a 80 41
marked easing of manufacturing price
pressures. Measured across all worldwide 70 44
manufacturing PMI surveys, industrial
input prices fell in November, contrasting 60 47
markedly with the near-record rate of
increase seen earlier in the year. It is rare 50 50
for producer prices to fall. October’s
decline was the first since July 2009. Prior Input Prices
40 53
to the collapse of Lehman Brothers, the Delivery Times
last time that producer input prices fell
30 56
was a modest (one-month) decline during
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
the Iraq War in 2003. Year
A further benefit is that any easing in
the producer price data should feed Source: Markit, ISM
through to consumer prices, meaning
household incomes will face less of a Uncertainty reigns crisis at an EU summit on December 9.
squeeze in 2012, helping to buoy consump- Anecdotal information provided on the The outcome of that summit will almost
tion. This could provide a much-needed PMI survey questionnaires also reveals the certainly affect the depth and length of
lift to economic growth. extent to which businesses and house- a second eurozone recession. It will also
However, we need to bear in mind that holds have grown nervous about the therefore affect growth of the global
the steep easing in price pressures is itself outlook. The eurozone crisis is often at economy in 2012. Until the extraordinary
a sign of just how weak global demand the heart of their concerns, meaning hiring degree of uncertainty that the euro area’s
is at the moment. Suppliers are already and investment has suffered. At the time woes have created is removed, almost
starting to offer discounts to reduce inven- of writing, expectations are running high all economic forecasts for 2012 are
tories in China, the US and all of the major that European leaders will be able to somewhat academic. They will inevitably
eurozone countries. Profit margins will be at least agree a credible roadmap to be revised up or down depending on
under pressure as a result. resolve the eurozone’s sovereign debt the result.

/56
European CDS
T
he credit markets in 2011 were under attack from an aggressive triple pincer movement. A stagnant
US economy, still struggling from a depressed housing market and anaemic demand, has made
a major contribution to current market valuations.
No Country Has Escaped

Spread (bps)
140
UK
120
Germany
USA
100
80
Gavan Nolan
60
director, credit research
gavan.nolan@markit.com 40
@GavanNolan
20
The world’s other growth engine, China, 0

has also been a significant influence on 2 Jan 2 Mar 2 May 2 Jul 2 Sep 2 Nov
2011 2011 2011 2011 2011 2011
credit spreads. Fears of a bubble in the Date
property market and a consequent hard
landing for the Chinese economy caused Source: Markit
shockwaves in the latter half of the year.
But economic data in the US has improved So that leaves one prong of the pincer, crisis drags on. Bailouts have been
and the Chinese government may well an altogether more dangerous and potent announced, plans have been unveiled and
have the tools to stop the rot in property. claw in the attack. The eurozone debt governments have come and gone. But
the crisis is still here, and what’s more it
Sovereigns and Financials Widen has got worse. If evidence was needed it
can be found in the Markit indices.
Spread (bps)
The Markit iTraxx SovX Western
400
Europe, an index comprising the 15 most
350 Markit iTraxx Senior Financials liquid sovereigns in the region, widened
Markit iTraxx SovX Western Europe by more than 170bps over the year to
300
close at 380bps on November 23, a new
250 record. It was a similar story with the
Markit iTraxx Senior Financials, which hit
200
a record 342bps on the same day after
150 widening by 165bps through 2011. Vola-
100
tility has soared: the Markit VolX Europe,
a measure of volatility on the main index,
50 has reached 89 per cent, the highest
0 level since the first Greek bailout in
28 Sep 28 Jan 28 May 28 Sep 28 Jan 28 May 28 Sep May 2010.
09 10 10 10 11 11 11
Why has the crisis got worse? Eco-
Date
nomics is always inextricably linked with
Source: Markit politics and it is the latter dictating events

/57

Daily CDS Notionals
Millions
9,000
7,000
6,000 Markit iTraxx Senior Financials

Markit iTraxx SovX Western Europe
5,000
4,000
3,000
2,000
1,000
0
20 Sep 27 Sep 4 Oct 11 Oct 18 Oct 25 Oct 1 Nov 8 Nov 15 Nov 22 Nov
11 11 11 11 11 11 11 11 11 11
Date
Source: MarkitSERV
to the detriment of risky assets. A com- leaves the ECB as the only credible source clear that, since its roll in September, there
bination of procrastination and cold- of funding. Perhaps the EFSF will be suf- has been a drop in activity. The SovX may
blooded calculation has resulted in ficient after it is leveraged but Bric coun- also have been affected by the questions
European policymakers delivering an tries have shown little interest in contrib- surrounding the Greece CDS trigger and
insufficient response to the debt trauma. uting capital and the amount of leverage also the forthcoming ban on naked sover-
Procrastination led to Italy and Spain may not be enough. eign CDS.
getting caught in the maelstrom, perhaps In such uncertain times, German gov- It is apparent, then, that the direction
unnecessarily; politicians paying closer ernment bonds often benefit from their of credit spreads across world markets
attention to domestic audiences rather safe haven status. But a “failed” bund will be determined largely by political deci-
than the greater good of the eurozone auction in November – just €3.64bn of a sions in Europe. In particular, the future
has meant that the response so far has targeted €6bn was sold – showed that of the euro could hinge on whether
been insufficient. the fragility of the eurozone was affecting Germany can jettison its obsession with
The result is that what was a relatively even its strongest member. It shocked sound money and accept a traditional
contained crisis among systemically unim- the markets, even if allowances for the central banking role for the ECB.
portant countries has developed into full- very low yield of 2 per cent were taken But it is not all about Europe. It is hard
blown contagion across the eurozone. into consideration. But the CDS market to imagine a sustained rally in risky assets
No country has escaped, even the AAA has been flagging warning signals since without a US economy that is back to its
creditor countries such as Austria, the summer, when Germany’s spreads vibrant best. There has been precious
Finland, the Netherlands and Germany. started to widen sharply. The chart shows little sign of this happening, notwithstand-
The latter sovereign is by far the most that it has underperformed the UK and ing the recent improvement in some
important as it is the bulwark of the cur- US by some margin – two countries that indicators. President Obama and the
rency club. But it has failed so far to live have worse fiscal positions than Germany Federal Reserve have few tools left at
up to its responsibilities. but crucially have their own currencies. their disposal, especially in an election
At the time of writing Germany has It is perhaps worth noting that the uncer- year. And let’s not forget China. It is far
refused to countenance changing the tainty emanating from the debt crisis has from certain that the Beijing government
ECB’s mandate so it can act as a lender almost certainly had an impact on credit can deliver a soft landing for the economy,
of last resort, much to the consternation market liquidity. The chart shows daily CDS with a potential property bubble and
of France and others. Given that the Euro- notionals traded for the Markit iTraxx Senior waning demand for exports bound to
pean Financial Stability Facility (EFSF) Financials and the Markit iTraxx SovX impact growth. The credit markets are
lacks the firepower to act as a firewall Western Europe indices – two of the most likely to remain locked in a pincer grip for
against Italian and Spanish debt, that liquid instruments in the CDS market. It is the foreseeable future.

/58
US CDS
T
he movement in five-year US CDS spreads in the run-up to the super committee’s deadline to
present a plan to Congress was subdued. In the days prior to the debt ceiling deadline, the short
end of the US CDS curve inverted with one-year spreads trading wider than five-year and ten-year
spreads; that did not happen this time. Also, five-year spreads did not widen in recent weeks to
the same extent as they had leading up to August. However, like August, the potentially negative credit
implication for the US ended up ironically benefiting US Treasuries as a $35bn auction of five-year notes
priced at a record low yield of 0.937 per cent.
US Treasury 10-Year Benchmark Yields

%
4
3.5
Otis Casey 2.5

director, credit research
2
otis.casey@markit.com
@OtisCasey 1.5
3 Jan 14 Feb 28 Mar 9 May 20 Jun 1 Aug 12 Sep 7 Nov
11 11 11 11 11 11 11 11
Some might argue that the experience of Date
the downgrade in August meant that
investors had a better sense of what to Source: Markit
expect were there to be any ratings impli-
cations from a super committee failure. reduction over the next ten years, while downgrade is not expected from Fitch
However, the best explanation was simply unfortunate, had little near-term risk. but the agency lowered the US outlook
that there was a lot less on the line this Rating agency action, while possible, was to negative after it completed its review
time. Reaching the debt ceiling raised the not widely expected. Thus far, S&P and in late November.
question of a possible technical default; Moody’s both have announced that there Furthermore, policymakers and market
a lack of a plan to find $1,200bn in deficit will be no imminent rating impact. A participants expected that there would
be no plan. For example, Senator Charles
CDS Spreads for US Government (One-Year and Five-Year Tenors) Schumer predicted that the committee
would fail as early as two weeks before
Spread (bps) the deadline. Sceptics all along believed
90
1Y that the committee’s deliberations were
80
5Y simply an exercise to define the issues
70
and campaign themes for next year’s
60
election. Even if the committee had come
50
up with a plan, the chances of its passage
40
in the House may not have been strong.
30
20
After all, the plan would have merely
10
reduced the deficit (rate of growth in the
0 debt) rather than the actual debt outstand-
3 Jan 14 Feb 28 Mar 9 May 20 Jun 1 Aug 12 Sep 7 Nov ing itself. Conservative elements would
11 11 11 11 11 11 11 11
Date have likely balked at any tax or revenue
increases without much more in the way
Source: Markit of spending cuts.

/59

Even though the failure had little or no difficult. Both House Speaker John as 1.5 per cent (at 2.5-3.0 per cent at the
near-term rating consequences does not Boehner and Senate Majority Leader time of this article). If such a slowdown
mean that there are no consequences Harry Reid hinted that they would be materialises, that could give ratings agen-
however. The likelihood of the Bush-era inclined to observe the pledge to allow cies cause for review. S&P indicated spe-
tax cuts and extended unemployment the triggers to take place. cifically that the lack of a rating action
benefits expiring at the end of this year is The expiration of those programmes or assumed that the automatic spending
significantly increased. Furthermore, auto- setting aside the triggers represents poten- triggers will be allowed to take place in
matic spending cut triggers are set to tial downgrade risk. Some economists are 2013. Perhaps this hints that setting aside
begin in 2013. Whether those cuts will be stating that without the tax cuts and unem- the triggers without a concurrent plan to
maintained by the future Congress is ployment benefits, they may lower their slow spending growth could lead to
uncertain, but setting them aside may be estimates of GDP growth down to as low another one-notch downgrade.
Markit iBoxx Indices

C
orporate bond markets and risky assets in general have seen a lot of volatility as the markets
recovered from the broad sell-off inspired by the US sovereign credit rating downgrade in October.
The rally stemmed from a wave of optimism that EU policymakers were finally working cooperatively
towards a comprehensive and effective solution to prevent contagion from spreading through the
financial system and to other nations. However, that optimism was short-lived as investors realised that
there were significant execution risks to the plan announced at the October 26 EU leaders’ summit. The
resulting uncertainty has prompted significant risk aversion. While investors have been sitting on hoards of
cash, the extent to which they have put some of that money to work has been in the primary markets.
Recent weakness in the bond markets is figures demonstrate how little help the outperformed other sectors recently and
clearly evident from month-to-date total equity markets have provided the option on a year-to-date basis. Of course this
return performance. Year-to-date total component in general. is not unexpected given the sovereign
return performance has been weak for The clear bright spots for performance debt woes in the eurozone; these seg-
most segments of the corporate bond have been in investment-grade non- ments of the credit markets are a bit
markets as well. Financials have led the financials for the UK and US which have more insulated from the headline
weakness in many recent sessions as
concerns over sovereign debt exposure Annual Spreads Over Benchmark (Markit iBoxx USD Domestic Corporates)
and dollar funding challenges have hit
Spread (bps)
European banks. US banks have not
400
escaped capital adequacy concerns
Financials
despite their more limited exposure to
350 Consumer Goods
eurozone sovereign debt. Ongoing litiga- Consumer Services
tion risk over mortgages and a new round
of stress tests to be conducted by the 300
Fed which will now test for a “2008-type

shock” and has investors anxious and 250
trimming their exposure to the sector.
Risk aversion is also in evidence by 200
the performance figures for high yield
and emerging markets. Both have 150
shown significant losses so far in
November with only US high yield and 100
Latin America showing moderate pos- 3 Jan 3 Feb 3 Mar 3 Apr 3 May 3 Jun 3 Jul 3 Aug 3 Sep 3 Oct 3 Nov
11 11 11 11 11 11 11 11 11 11 11
itive year-to-date returns. While con- Date
vertibles have outperformed equities
recently, the negative performance Source: Markit

/60
risk of the sovereign debt crisis simply solution, fund flows are likely to continue deadlocked and would be unable to
because they are a few steps removed. to favour investment-grade non-finan- present a plan to Congress, the failure
Consumer goods and services compa- cials in the US and UK as well as US increases the odds that certain Bush-era
nies in the US and UK have done par- Treasuries. The recent failure of the US tax cuts and extended unemployment
ticularly well this year as investors have Congress Joint Select Committee on benefits will expire at the end of the year
sought incremental yield improvement Deficit Reduction is also likely without being renewed. While the
where they can find it, despite their to keep investors thinking defensively markets did not see the kind of broad
risk aversion. for the remainder of the year as well. sell-off that it saw in August following
With the pressures continuing to Despite the lack of a downgrade the downgrade of the US sovereign
mount in the eurozone and policy imple- action by any of the three major rating credit rating from AAA by S&P, the failure
mentation slow to catch up to increasing agencies following the announcement did nothing to boost investor confidence
market expectations for an immediate that the committee had hopelessly in risky assets.
Total Return Performance – Government

Total Return Performance
Index Month-to-date Year-to-date 1 Year 3 Year
Government
US Treasuries 0.71% 9.04% 7.49% 17.82%
UK Gilts 1.84% 14.20% 15.51% 31.37%
Europe Sovereigns -1.94% -0.10% -1.44% 8.39%
Source: Markit
Total Return Performance – Investment Grade Total Return Performance – High Yield
Total Return Performance Total Return Performance
Index Month-to-date Year-to-date 1 Year 3 Year Index Month-to-date Year-to-date 1 Year 3 Year
Investment Grade High Yield
USD Overall 0.31% 7.70% 6.40% 25.40% USD -2.57% 2.64% 3.37% 70.49%
Financials -1.33% 2.56% 1.95% 38.05% EUR -2.64% -3.24% -3.81% 73.41%
Non-Financials 0.18% 9.44% 8.37% 49.78% Source: Markit

Consumer Goods 0.18% 8.72% 7.53% 45.21%
Consumer Service -0.20% 10.07% 9.20% 53.26%
Industrial 0.71% 8.84% 7.53% 42.85%
Utilities 1.51% 11.68% 10.47% 51.27%

Total Return Performance – Convertibles

GBP Overall 1.06% 11.25% 12.02% 31.85%
Convertibles
Financials -1.78% 0.22% -1.14% 25.93%
-0.97% -1.96% 0.10%
Non-Financials 0.05% 8.39% 8.85% 47.62%
Consumer Goods 0.84% 9.68% 10.01% 49.88% Source: Markit
Consumer Service 0.89% 10.38% 11.06% 48.17%
Industrial -0.29% 6.04% 6.33% 52.02%
Utilities -0.29% 7.37% 8.04% 44.44%

Total Return Performance – Global Emerging Markets
EUR Overall -1.67% 0.76% -0.39% 12.56%
Financials -2.36% -1.52% -3.07% 19.98% Global Emerging Markets
Non-Financials -0.65% 2.99% 2.68% 28.50% Global -2.58% -1.85% -1.69% -1.69%
Industrial -1.18% 2.26% 1.51% 29.68% Asia -2.00% 0.96% 1.95% 1.95%
Retail -0.09% 2.40% 2.16% 29.11% EMEA -2.88% -7.00% -7.54% -7.54%
Utilities -0.75% 2.89% 2.22% 24.93% Latin America -2.84% 3.83% 3.98% 3.98%
Source: Markit Source: Markit

/61

Loans
2
011 has been a troublesome year for the loan market. A series of structural changes combined
with the effect of the European sovereign debt crisis joined forces to bring increased volatility and
correlation with other asset classes.
Markit iBoxx USD Leveraged Loans Index and Markit iBoxx

USD Liquid 100 Leveraged Loans Index Total Return, 2011
%
4
Colin Brunton -2
Markit iBoxx USD Leveraged Loans Index
assistant vice president, loan pricing -4 Markit iBoxx USD Liquid 100 Leveraged Loans Index
colin.brunton@markit.com
-6
The leveraged loan market in 2011

-8
Participants had actually started the year 31 Dec 31 Jan 28 Feb 31 Mar 30 Apr 31 May 30 Jun 31 Jul 31 Aug 30 Sep 31 Oct
with high hopes. 2010 had seen relatively 10 11 11 11 11 11 11 11 11 11 11
Date
normal market conditions after the out-
sized price volatility in 2008 and 2009. Source: Markit
Indeed, the first half of 2011 was com-
paratively subdued, with the Markit iBoxx no wonder that liquidity has fallen, as volatility and a higher correlation with
USD Leveraged Loans Index (MiLLI) measured by Markit’s Loan Liquidity Scores. equity. Despite the seniority, security and
averaging just over a 2 per cent total The percentage of the priced loan universe tight covenant restrictions that character-
return through July. But the sovereign in the top two liquidity score buckets (out ise loan assets, structural changes in the
debt crisis worsened in August, causing of five) fell from 12 per cent prior to August loan market’s institutional investor base
the MiLLI to plunge to -3.5 per cent to under 7 per cent thereafter. Liquidity have forced a sustained change in the price
before rebounding in October. The index has recovered to an
is only just now returning to positive ter- extent, but again it Average Loan Bid-Ask Spread and Relative Liquidity, 2011
ritory for the year. The Markit iBoxx USD is clear the market
Liquid 100 Leveraged Loans Index (LLLI), has a way to go. Bid-Ask Spread %
200 14
a new index launched in October repre-
180
senting the 100 most liquid loans of the Changing 12
160
broader index, tumbled even further to investor base 140 10
a -6 per cent return. The syndicated lev- 120 8
100
The average bid-ask spread for the eraged loan market, 6
80
constituents of the MiLLI widened con- once thought to be 60 4
siderably during 2011 from around 100bps a bastion of outper- 40
2
through July to a peak of 180bps at the formance given its 20
0 0
end of August. Spreads have since tight- characteristics of Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
ened to roughly 140bps and continue to low volatility, low 11 11 11 11 11 11 11 11 11 11 11
Month/Year
tighten, but have yet to return to pre-crisis nominal and high
% of Loans in Top Two Liquidity Score Buckets
levels suggesting that the loan market has risk-adjusted return, Markit iBoxx USD Leveraged Loans Index Average Bid-Ask Spread
yet to fully recover from the debt crisis. has in recent years
With bid-ask spreads widening, it is exhibited greater Source: Markit

/62
Rolling 200-day Correlation Between Loans US sovereign debt 40 per cent of the institutional investor
and Bonds, and Loans and Equity downgrade crisis, a base of the loan market, the largest single
figure completely share of the market of any one investor
Correlation
unfathomable a few class. Some market participants have
1
Loan-HY Bond Correlation years ago. Likewise, opined that this changing investor base
Loan-Equity Correlation
0.8 though there has has contributed to the increased volatility
always been a of the loan market of late.
0.6
degree of correla- CLOs are largely restricted to invest-
0.4 tion between the ments in the leveraged loan asset class
leveraged loan and restricted in the types and amounts
0.2 market and the high of loans in which they can invest. Many
0
yield bond market positions are held for long periods of time
(generally between throughout the life of the CLO (particularly
-0.2 0.5 and 0.6), this after the reinvestment period ends).
2007 2008 2009 2010 2011 association has Hedge funds and other new market
Year
steadily increased players on the other hand are generally
Source: Markit, S&P to a now unsur- free to trade in and out of loans, hold
passed 0.88. different position sizes, put on capital
behaviour of the asset class. The loan What is causing an asset class char- structure plays between loans and other
market has finally “grown up” and come acteristically senior in the capital structure, asset classes, and other somewhat more
to resemble a real asset class. secured by assets, with restrictive cov- esoteric strategies. This group is more
Historically, the loan asset class has enants to suddenly behave in a manner likely to showcase investment strategies
been defined by its low correlation to other inconsistent with the observed historical that favour increased frequency of trading.
asset classes, particularly equities. Prior nature of the loan market? With the dearth This investor group is not limited to the
to 2008, loan total returns typically exhib- of new collateralised loan obligation (CLO) loan asset class and can enter and exit
ited between 0 and 0.2 correlation to issuance, the share of the institutional the space as opportunities arise. Some
equity returns. Since then, loan and equity loan market held by CLOs has fallen to have come to think that the flexibility
returns have become increasingly cor- levels not seen over the last ten years afforded to hedge funds has promulgated
related, with a noted increase over the (Source: S&P/Capital IQ/LCD). In its place, a sustained structural increase in volatility
course of 2011. In August, correlations hit hedge funds and distressed debt funds and asset class correlation for the lever-
an all-time high of 0.7 in the midst of the have filled the void and now make up over aged loan market.
Structured Finance
T
he European ABS market has had a difficult third and fourth quarter, much like in 2007 and 2008.
Most of the gains since the beginning of the year have been cancelled out in September and
October. This time, though, the ABS market is not responsible for its own downfall but is being
dragged down by the sovereign crisis which is affecting all debt markets.
Furthermore, most of the downgrades affect- the EFSF to €1,000bn is a perfect example
ing Greece, Ireland, Italy, Portugal and Spain of this. It started to look more and more
(GIIPS, soon to be FGGIIPS) ABS transac- like a CDO since it mixes distressed and
tions were made during the first half of the investment grade assets and could offer
year when the market was still bullish. Per- interesting arbitrage opportunities in the
formance of the underlying assets has future. The ABS market saw a huge rally
remained the same or has sometimes following the announcement. For example,
improved, demonstrating that this price drop Granite levels jumped massively com-
Philippe Pagnotta
is mainly due to macroeconomic factors. pared with mid-October levels: the AAA
director, European structured finance The action plan announced shortly tranches were seeing bids as high as
philippe.pagnotta@markit.com before the G20 on October 27 to leverage 95.95 (up almost 1.5 points on last month),

/63

European AAA RMBS (3-5yr WAL) European BBB RMBS (3-5yr WAL)
Spread (bps) Spread (bps)
1,600 UK SPRMBS UK PRMBS 9,000
Spanish RMBS Dutch RMBS
1,400 8,000 UK SPRMBS
Italian RMBS Irish RMBS
7,000 UK PRMBS
1,200 Portuguese RMBS French RMBS
Spanish RMBS
Australian RMBS 6,000 Dutch RMBS
1,000
5,000
800
4,000
600
3,000
400 2,000
200 1,000
0 0
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct
09 09 09 09 10 10 10 10 11 11 11 11 09 09 09 09 10 10 10 10 11 11 11 11
Month/Year Month/Year
AA tranches were at 81.75 ( +2pts), single Barclays’ Grace- AAA Total Return Jan 2009
A tranches were at 69.5 (+4pts) and BBB church Card Pro-
Spread (bps)
tranches were edging over 48 (+3pts). gramme Funding
130
However, poor communication from the PLC issued the UK PRMBS AAA
125 Dutch RMBS AAA
Greek and Italian prime ministers dashed series 2011-4 in Spanish RMBS AAA
120
all this effort and prices dropped just two September and has Global European ABS AAA
115 Irish RMBS AAA
days later. They are now back to the returned with the
110
levels mentioned above, despite very 2011-5. Denomi-
105
limited liquidity. nated in US dollars,
100
All other sectors including CMBS have the 2011-5 senior
95
widened. The only ones showing resist- tranche is smaller
90
ance remain the UK and Dutch triple A (€741m vs. €1.1bn) Jan May Sep Jan May Sep Jan May Sep
09 09 09 10 10 10 11 11 11
Prime RMBS and Auto ABS. and priced 20bps
Month/Year
Primary market activity picked up sig- tighter than the
nificantly during the third quarter with close 2011-4 equivalent, Source: Markit
to €17.5bn worth of notes being placed which was denom-
across seven new deals, compared with inated in euros. index showed a smaller increase of 0.4
€4.5bn across three deals in September. The UK housing market continued to per cent. The Halifax index showed a 1.8
Unsurprisingly, the majority of new issu- trend sideways with a slight downward per cent drop year-on-year compared to
ance was in prime RMBS (Arena 2011-2, slant. The Halifax House Price index Nationwide which reported a 0.8 per cent
Arran Residential 2011-2 and Silverstone showed an important price increase of increase. Meanwhile the Markit/CIPS UK
2011-1) accounting for over €15bn. 1.2 per cent in October, while Nationwide’s Construction PMI posted 53.9 in October,
BBB Total Return Jan 2009 House Prices

Spread (bps) PMI Housing Index Halifax HPI (Annual % Chg)
500 80 35
Granite Master Issuer 07-1 3C1
UK SPRMBS BBB 70 25
400
Global European CMBS BBB
60 15
300
50 5
200 40 -5
30 -15
100
UK Construction PMI Housing Activity Index
20 -25
Halifax House Price Index, All Houses
0
Jan May Sep Jan May Sep Jan May Sep 10 -35
09 09 09 10 10 10 11 11 11 1998 2000 2002 2004 2006 2008 2010
Month/Year Year
Source: Markit Source: Markit, Halifax

/64
essentially signalling no change in UK Property market news from the periph- or restructured, the debates around debt
construction activity. PMI data indicate ery, namely Greece and Ireland, has also forgiveness are unnerving for noteholders
that growth in the sector was mainly driven been mixed. The Greek property tax of Irish RMBS. Reassuringly, for those
by activity in the commercial segment as announced by the country’s government invested in the RMBS transactions, recent
it continued to show improvement at 54.6 is likely to put increasing pressure on the comments from senior political figures
this month. Housing activity contracted Greek RMBS cashflows as borrowers’ seem to indicate that blanket debt forgive-
for a fifth consecutive month to 49.3, while available funds are reduced further. Uncer- ness is not on the cards, and that a case-
the non-seasonally adjusted figure tainty also remains over the Irish mortgage by-case approach with limited debt forgive-
reached 41.9, one of its lowest points in loan workout approach. With over 15 per ness based on specific criteria is likely to
over two years. cent of all mortgage loans either in arrears be the preferred route.
Dividends
B
razil’s growth and maturing stock market have made Brazilian companies increasingly attractive
to investors seeking stable returns through dividends. Payouts from companies included in the
Ibovespa index grew 8 per cent between 2009 and 2010 and Markit expects total payouts to grow
by 6 per cent in 2011.
with social improve- Average Year-on-Year Dividend Growth by Sector*

ments. Phase II of
Growth %
the Growth Accel-
1
eration Program, a 2009
strategic investment 0.8 2010

2011F
program led by the 0.6
federal government,
0.4
will see approxi-
mately $548bn 0.2
Francisco Troula
injected into socio- 0
associate, equities economic projects
-0.2
francisco.troula@markit.com between 2011 and
2014. Fifty per cent -0.4
Financials Energy Mining
of these funds have
*These amounts are current as of November 16 2011, all amounts are derived from payment distribution date
been earmarked for
the energy sector Source: BM&F Bovespa, Markit
(oil/gas and electric
utilities) and 6 per cent for the metals and management intends to distribute 100 per
mining sector. cent adjusted NOI (net operating income)
This is good news for investors. In for 2011. CEMIG’s bylaws require it to
Brazil, companies are required by law to distribute a minimum of 50 per cent of
distribute at least 25 per cent of adjusted adjusted NOI. We expect Eletropaulo and
Mario Rojas
net income to shareholders. So any gov- Transmissao Paulista to yield 20 per cent
associate, equities ernment policies which have a positive and 12 per cent respectively for 2011.
mario.rojas@markit.com effect on a sector will automatically gen- Companies in the metals and mining
erate higher dividends for investors. sector have maintained consistent payout
To understand where the investment Sectors benefiting from these investment ratios despite declining dividend yield
opportunities are, it is important to under- programmes include energy, banking and growth rates during the global financial
stand what lies behind Brazil’s success metals/mining sectors. crisis. Expansion and investment through-
story. In recent years, the Brazilian govern- Notable dividend payers in the energy out the production chain will benefit these
ment has focused on the promotion of sector include Tractebel, CEMIG, Eletro- companies further and lead to higher
economic growth and stability in tandem paulo and Transmissao Paulista. Tractebel’s dividends. Notable dividend payers

/65

Ibovespa Dividend Yield Participation by Sector* Average Dividend vs. IOC*, 2009-2011**
Total Cash Distribution Per Share
30
Dividend
15% 25
IOC
32% 20
15
28%
10
Electric Utilities
Metals & Mining
25% 5
Financials
Other 0
2009 2010 2011 2009 2010 2011 2009 2010 2011
Financials Energy Metals & Mining
*These amounts are current as of November 16 2011, all amounts are derived from payment * Interest on capital
distribution date **These amounts are current as of November 16 2011, all amounts are derived from payment distribution date
Source: BM&F Bovespa, Markit Source: BM&F Bovespa, Markit
include Vale, Gerdau, Usiminas and CSN. stable dividends during the financial rates and loose monetary policies. The
Gerdau has consistently distributed quar- crisis thanks to strict regulatory oversight biggest payers within the sector include
terly dividends exceeding 30 per cent and conservative practices including Banco do Brazil, Bradesco and Itaú.
adjusted NOI since 2006. Thus far in 2011, exceeding the 11 per cent minimum Since 2008, payout ratios have approx-
Vale has delivered record shareholder Basel capital requirement. The average imated 30-40 per cent of adjusted NOI.
return through $9bn in distributions, a 200 capital ratio at the top 25 Brazilian banks Itau and Bradesco distribute fixed
per cent increase from 2010. was 16 per cent as of June 2011. This monthly dividends and two semi-annual
Unlike their US and European counter- sector has enjoyed steady growth thanks interest on capital/dividend payments.
parts, Brazilian banks have maintained to easy access to funding, low interest Banco do Brazil distributes quarterly.
Markit BOAT
M
arket uncertainty in Europe resulted in a frenzy of activity in the European equity markets in
Q3 2011. Volumes reported to Markit BOAT were up 35 per cent in August and September as
compared to the same period in 2010. October volumes were in line with those seen during
the same month last year. The number of trades mirrored this increase with over 27m reported
between August and November this year and 9.3m in the same period in 2010. Sectors such as financials,
oil and gas, and telecommunications saw volumes rise by 43 per cent, 25 per cent and 15 per cent
respectively between August and November.
Trading activity in financial stocks con- banks is likely to continue into the short
tributed 38 per cent of all volume reported term as the European community tackles
to Markit BOAT in September and the debt crisis. On the day that news of
October. UniCredit, one of Italy’s biggest the UBS rogue trader broke, volumes
banks, saw volatile trading on its stock, traded in UBS went up to over 85m,
a consequence perhaps of its exposure almost 10 times larger than the bank’s
to Italian government debt. Published average of 8.6m. The shares also saw
volumes for this security were 65 per a 78 per cent increase in trading volumes
cent higher between August and Novem- over 2010 levels between September
Thomas Axup
ber than activity seen during the same and November as investors may have
associate, Markit BOAT months in 2010. This sort of volatility seen weighed up the value of the Swiss
thomas.axup@markit.com for UniCredit and Europe’s other big banking giant.

/66
Markit BOAT Turnover and Volume UBS Markit BOAT Volumes

Markit BOAT Volume (Millions) Markit BOAT Turnover (Millions) Markit BOAT Volume (Millions) Number of Trades
45,000 6,000 90 8,000
Volume Turnover UBS
40,000 80 7,000
5,000 Number of Trades
35,000 70 6,000
30,000 4,000 60
5,000
25,000 50
3,000 4,000
20,000 40
3,000
15,000 2,000 30
10,000 20 2,000
1,000
5,000 10 1,000
0 0 0 0
Aug 11 Sep 11 Oct 11 Nov 11 Aug 11 Sep 11 Oct 11 Nov 11
In the oil and gas sector, traded Madrid-based company also published is seen as very important to the European
volumes for BP stocks were up 25 per its first quarterly loss in nine years follow- travel sector.
cent in Q3 2011 compared to Q3 2010. ing poor results from Spain. Volumes of Between August and October, firms in
This can possibly be attributed to the trading activity on its shares increased by the technology sector saw trading volumes
company’s restructuring following last nineteen fold in October and November on their shares 40 per cent higher than in
year’s oil spill in the Gulf of Mexico. as compared to the same period last year. the same period last year. One firm which
Although the jury is still out over BP’s The holiday tour operating company stood out was Nokia, which has lost con-
ability to make good on its plans, BP’s Thomas Cook Group saw high levels of siderable market share in recent years. The
sale of $45bn worth of assets has caught activity on its shares in November with Swedish multinational saw trading on its
the eye of investors. Trades on the com- volumes of over 105m in comparison to stocks increase by 46.5 per cent in August
pany’s stocks contributed to over 37 per the 21.8m seen in the same month in 2010. through to November compared to the
cent of all Markit BOAT’s volumes reported This large increase came after Europe’s same period in 2010. The mobile phone
for the oil and gas sector. second biggest tour operator admitted company has put its full weight behind the
Telefónica, the large Spanish telecom- that it would have to renegotiate the terms Windows operating system in an effort to
munications provider, saw an increase in of its gross debt burden for the second win back customers who have been cap-
trading activity on its stock towards the time in two months, which helped end tured by Apple, RIM and HTC. The move
end of October and early November. Fol- speculation that it may breach its banking could be ‘make-or-break’ for Nokia, whose
lowing the announcement that it was covenants. The Peterborough based firm aggressive pricing strategy will allow them
restructuring its standalone Spanish divi- which employs 31,000 people across to address the lower-end smartphone
sion as part of a major overhaul, the Europe and has revenues of almost £9bn market aimed at emerging markets.
Financial Sector Markit BOAT Volume Telefónica Markit BOAT Volume

Markit BOAT Volume (Millions) BOAT Volume (Millions)
1,200 250
2010 2011 BOAT Volume
1,000
200
800
150
600
100
400
50
200
0 0
Aug 11 Sep 11 Oct 11 Nov 11 Aug 11 Sep 11 Oct 11 Nov 11

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/6 Markit News

Markit acquires quantitative

Northern Trust chooses The Markit TRX II indices, a

Markit iBoxx commercial mortgage-backed secu-

the markit magazine – Winter 2011

MarkitSERV acquires Markit Desktop

Logicscope CDS/bond basis

Markit wins two To display CDS/bond basis for

Winter 2011 – the markit magazine

Q: What is your investment strategy in the current vola-

A: There is no getting away from the fact that these are

Winter 2011 – the markit magazine

As a client-centred investment manager, though, we

the markit magazine – Winter 2011

of behavioural finance, which

studies how people make Career in brief

Winter 2011 – the markit magazine

the markit magazine – Winter 2011

Winter 2011 – the markit magazine

the markit magazine – Winter 2011

“ When and how to exit from the tightening

policymakers.” PhD in economics from Duke University.

Winter 2011 – the markit magazine

Source: Getty Images

Winter 2011 – the markit magazine

looking very carefully at the quality of

the markit magazine – Winter 2011

the markit magazine – Winter 2011

Winter 2011 – the markit magazine

substantially. Figure 1 shows the net International Developed Equity

ucts globally in 2011, and fixed income 60 Sector/Speciality Equity

is the only asset class with a perfect 50

track record of inflows for every month Fixed Income

the markit magazine – Winter 2011

is somewhat higher for investment- iShares STOXX 600 Utilities 52 13 36

Winter 2011 – the markit magazine

Stress testing the alphas

the markit magazine – Winter 2011

Figure 6: Stress Testing the Robustness of the Alphas

Winter 2011 – the markit magazine

the markit magazine – Winter 2011

Winter 2011 – the markit magazine

Felix Salmon: Historically, many media

the markit magazine – Winter 2011

How else are banks and big institu-

Heidi Johnson: A couple of years ago

Winter 2011 – the markit magazine

with customers. Undoubtedly, there

Felix Salmon: Underneath it all, finan-

Zach Seward: I see a big information

the markit magazine – Winter 2011

Both Dow Jones and Reuters have

Felix Salmon: These products and Heidi Johnson

Winter 2011 – the markit magazine

the markit magazine – Winter 2011

Winter 2011 – the markit magazine

credit suppliers and buyers...PENNVEST

the markit magazine – Winter 2011

Winter 2011 – the markit magazine

the markit magazine – Winter 2011

1. The commodity resources them

1. The commodity resources them