Section 1 - FTSE

SECURITIES LENDING: THE CUSTODIANS FIGHT BACK 

ISSUE SEVEN • MAY/JUNE 2005 

Euroclear leads 

on strategy 

Pharmaceuticals 

at the crossroads 

The glory–glory days 

of portfolio trading 

DOES TRANSITION MANAGEMENT NEED A CODE OF PRACTICE?

SECURITIES LENDING: THE CUSTODIANS FIGHT BACK 

ISSUE SEVEN • MAY/JUNE 2005 

Euroclear leads 

on strategy 

Pharmaceuticals 

at the crossroads 

The glory–glory days 

of portfolio trading 

DOES TRANSITION MANAGEMENT NEED A CODE OF PRACTICE?

EDITORIAL DIRECTOR: 

Francesca Carnevale, Tel + 44 [0] 20 7074 0008, 

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CONTRIBUTING EDITORS: 

Karen Jones, Neil O’Hara, David Simons. 

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Andrew Cavenagh, Rekha Menon, Tim Steele, 

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Ian Williams, Benedict Mander 

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FTSE GLOBAL MARKETS • MAY/JUNE 2005 

Outlook 

As part of our growing focus on the provision of investment 

services, we take an in-depth look at a number of key product 

areas in this issue – namely securities lending, sub-custody 

services and portfolio trading. The market in many areas of investment 

services is becoming increasingly crowded, diverse and complex. That 

complexity is also beginning to have consequences. The 

implementation of Basel II, for example, will have a long term impact 

on the provision of securities lending services and may encourage 

custodian lenders to fight back for market share lost to the successful 

and growing army of third party agency lenders and specialist auction 

services, such as ESecLending. 

In similar vein, our opening market leader feature focuses on a new 

initiative, promoted by Credit Suisse First Boston, that transition 

management providers adopt a code of practice, or T-Charter, as it is 

becoming increasingly known. As the transition management market 

becomes more competitive and diversified, clients reportedly find it 

difficult to make proper assessments of the services on offer. Some 

providers would have it that the time is ripe for clarity as to the proper 

definition of modern day transition management services and a 

requirement that transition managers provide basic performance 

guarantees. Others think a charter unworkable. We canvass the rising 

debate as to its value. 

There are myriad reasons why portfolio trading is gaining in 

prominence. Not least is a trend towards quantitative ‘top down’portfolio 

management and a growing requirement for asset managers to respond 

quickly to market movements. But even while portfolio trading grows 

apace, the sector is itself in flux. We take a long and detailed look at the 

opportunities and challenges facing this increasingly arcane business. 

Andrew Cavenagh meanwhile reviews the vicarious fortunes of the 

pharmaceuticals industry. The sector is undergoing a critically testing 

period. The share prices of leading US and European companies are in 

the doldrums, even while profits remain robust. Can they cope with the 

pressures of radical change demanded by today’s healthcare industry? 

Our cover story however belongs to Chris Gorog, chairman and chief 

executive officer of digital-music service Napster. Gorog says the 

company’s newly launched Napster To Go portable subscription service 

will revolutionise the way we all listen to music and that he is willing and 

able to take on the mighty Apple Computer and its galactically popular 

iPod digital-music player. Dave Simons explains why Gorog thinks he 

has more than a fighting chance of success. 

Francesca Carnevale, 

Editorial Director 

May 2005 

1

2 

Contents 

COVER STORY 

REGULARS 

MARKET LEADER 

IN THE MARKETS 

REGIONAL REVIEW 

EQUITY REPORT 

INDEX REVIEW 

NAPSTER ..................................................................................................................Page 36 

Flush with $100m in available cash, in February of this year Napster chairman and 

CEO Christopher Gorog finally unveiled Napster To Go, a portable subscription music 

service that very well may revolutionise the way we listen to music. Dave Simons 

finds out about the man and the company that made one of the music industry’s most 

dramatic comebacks. 

TEETH AND THE T-CHARTER ..............................................................Page 6 

Does the transition management market really need a code of practice? 

We tell you why it does and why it doesn’t. 

SYNDICATED LENDING AT THE MARGINS ........................Page 14 

Pricing, structure, documentation and covenant packages are all under pressure. 

LIFETIME SUPPORT ......................................................................................Page 17 

Neil O’Hara reports on the mounting demand for annuities. 

THE IMPORTANCE OF BEING ICB ................................................Page 18 

The battle to provide a seminal industry classification benchmark 

TIMED IN, TIMED OUT ............................................................................Page 20 

Neil O’Hara explains why investors should consider their voting rights. 

IS MEXICO LOSING IT’S APPEAL? ................................................Page 22 

Benedict Mander explains why investors are chary of Mexico. 

TAIWAN’S GLOBAL ROADSHOW ................................................Page 25 

Ian Williams outlines the island’s key selling points. 

INVESTING IN SOUTH AFRICA ........................................................Page 28 

Ian Williams assesses the market’s appeal. 

AXA’S BENDAHAN TOPS FUNDS IN EUROPE ..................Page 32 

New fund manager performance league table is launched. 

CUKUROVA SETS THE PACE ..............................................................Page 34 

How four big sell-offs will affect investor appetite for Turkish risk. 

SUB-CUSTODY: A RACE TO THE FINISH................................Page 46 

Tim Steele reports on the outlook for sub-custodian services in Europe. 

REITS FIND A HOME IN EUROPE ..................................................Page 80 

The growing appeal of REITs as an investment vehicle. 

Market Reports by FTSE Research ................................................................................Page 86 

Companies in this issue ..................................................................................................Page 85 

Calendar ............................................................................................................................Page 96 

MAY/JUNE 2005 • FTSE GLOBAL MARKETS

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6 421.6 115 422.6 

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121 421.9 112 422.4 

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©2005 Board of Trade of the City of Chicago, Inc. 

All Rights Reserved 

www.cbot.com

4 

Contents 

FEATURES 

EUROCLEAR ON THE FAST TRACK ............................................Page 41 

Armed with a new corporate structure Euroclear is quietly confident of the 

applicability and efficacy of its two-pronged forward business strategy. At its heart, the 

plan calls for a single platform for all five markets in Euroclear, plus Euroclear Bank. 

Francesca Carnevale talks to Pierre Francotte, CEO of Euroclear. 

STP’s NEW FOCUS ........................................................................................Page 50 

These days firms now focus on the business objectives underlying STP, such as 

increasing efficiency between trade counterparties, improving margins, reducing 

transaction costs and minimising failed trades. By Rekha Menon 

PORTFOLIO TRADING: UPSIDE ALL THE WAY ..............Page 54 

These are golden days for portfolio traders, backed by better technology, a solid business 

pipeline supplied by transition managers and the growing popularity of ‘top down’ 

portfolio management. Trading strategies, benchmarks and the market structure are all 

set to become even more sophisticated and competitive. 

SECURITIES LENDING ..................................................................................Page 60 

The big changes in the securities lending market have already happened. Competition 

from new lenders cut the ties that bound securities lending to custodians and now the 

market is living with the consequences. But custodians are fighting back. Francesca 

Carnevale explains how and why. 

PHARMACEUTICALS ....................................................................................Page 67 

The pharmaceutical industry is facing a crisis of confidence. Following a spectacular 

bull run between 1994 and 2001, US and European pharmaceutical company share 

prices have stagnated as investor confidence has fallen away. Even so, profits remain 

high. What’s the answer? Andrew Cavenagh reports. 

LIFESTYLE FUNDS ............................................................................................Page 71 

Only a few years ago, 401(k) plan participants were clamouring for more investment 

choice. Plan sponsors then added more products, but too quickly everyone 

complained they had so many choices they could not decide what to do. Enter the life 

cycle fund, a product that is taking the 401(k) world by storm. Neil A. O'Hara reports. 

HEDGE FUNDS REPORT ............................................................................Page 74 

So far small but constantly growing institutional investor allocations, proposed 

Securities and Exchange Commission regulations and new management strategies are 

subtlety changing the $480bn US hedge fund industry. By Karen Jones 


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and regulated by FSA.

TRANSITION MANAGEMENT 

6 

Market Leader 

TEETH & THE 

T-CHARTER 

Enjoying boom times, the transition management 

(TM) market is increasingly crowded and complex. 

While competition has increased service levels and 

choice (and helped push down fees), the selection 

process for transition management has become more 

difficult. In the search for consistency, the elimination 

of conflicts of interest and even double charging, 

leading providers have come up with the idea of 

launching a code of practice, or ‘T-Charter’ as it is 

becoming known. Is it a force for good? Francesca 

Carnevale tries to find some answers. 

IN DECEMBER 2004, at a 

Euromoney conference on The 

Future of Transition Management an 

end-of-session discussion panel 

delivered rather more than the 

conference delegates had bargained 

for. The panel – chaired by Tim 

Wilkinson, managing director, 

transition management at Citigroup – 

included TM doyen Graham Dixon, 

managing director, transition services 

at Credit Suisse First Boston (CSFB) 

and Andrew Williams, investment 

consultant at Mercer Investment 

Consulting. Dixon boldly threw aside 

the anodyne discussion topic and 

invited everyone to get down to a more 

meaningful discussion. There was an 

important question facing TM, he said. 

“Is it time for the market to finally 

agree standards of practice?”he asked. 

From that spur of the moment talkshop, 

a comprehensive market 

consultation exercise on the need for 

a code of practice [the so-called 

T-Charter] was kick-started that could 

have significant repercussions for the 

transition management sector. Dixon, 

like many other transition managers, 

Graham Dixon, 

managing director, 

transition services 

at Credit Suisse 

First Boston 

believes the time is ripe for the 

charter. And, he thinks, it is imperative 

for market practitioners themselves to 

lead the effort towards self-regulation. 

“Many users of TM services do not 

have the weapon of withholding 

repeat business,” explains Dixon, “we 

would like a charter to protect the 

non-expert user, for example, a 

corporate pension fund which does 

not have the technology and means to 

monitor and measure portfolio 

transactions. Professional users, for 

example a fund management dealing 

desk, do not need this protection. 

They already have a level battleground 

for business and weapons of mass 

destruction if required.” 

The debate over the usefulness of a 

T-Charter hangs on the mounting 

complexity of the TM offering. A big 

change has occurred as investment 

banks, such as Lehman Brothers and 

specialist brokers, such as Instinet and 

ITG, as well as integrated offerings 

from JP Morgan and Citigroup have 

taken on the big custodian houses, 

such as Bank of New York, State 

Street, Mellon and Northern Trust.The 

result is a patchwork of service 

providers, often with differing 

definitions of TM itself. In the context 

of the United Kingdom market, says 

Mercer’s Williams, “five years ago 

when we started researching 

transition managers we were looking 

at six or seven firms, now it involves at 

least 16 major players and the 

different approaches to the business 

mean different business models on 

offer. It is harder for clients and 

consultants to choose the right 

transition manager.” 

It is not an issue of competition, 

expands Citigroup’s Wilkinson,“it is a 

question of competence and 

delivering an efficient solution to the 

client. Even looking at the most 

simplistic scenario of moving $100m 

from one manager to another, the 

Fund could lose between 100 and 150 

basis points of performance if the 

portfolio transition is not managed 

properly; versus typically 25 to 30 

basis points if it is.” 

Jody Windmiller, director of transition 

management at UBS stresses: “If it is 

implemented, the T-Charter will go a 


home 

Wherever you settle should feel like 

Demands for a single European 

capital market have set 

harmonisation in motion. 

We are convinced of the benefits 

of harmonised financial markets 

in Europe and are committed to 

removing barriers to cross-border 

securities settlement. 

DELIVERING A DOMESTIC 

MARKET FOR EUROPE


8 

Market Leader 

Tim Wilkinson, managing director, transition 

management at Citigroup 

long way to raising awareness of the 

services and processes involved in 

transitions. That includes knowing the 

right questions to ask of your transition 

service provider. It is an assurance of a 

baseline level of integrity.” 

Since the publication of seminal 

research, undertaken by Bob Werner, 

at Frank Russell Securities, Inc. back 

in 1999 revealed a surprisingly wide 

gap between promised cost estimates 

and delivered performance in the 

portfolio transition management 

business, there has been a simmering 

and unresolved tension in the 

market. Werner conducted a study of 

more than 100 pension funds in the 

United States, Canada, Australia and 

Europe between 1999 and the first 

quarter of 2001 to see if low-cost 

estimates resulted in low cost 

transitions for clients. 

Werner found that “they do not, and 

clients generally were unaware that 

such a substantial gap exists.” The 

research also raised other issues, such 

as the supply of unreasonable estimates 

by providers simply to win business. It 

also highlighted the mis-selling of 

services where so-called TM specialists, 

or what Dixon refers to dismissively as 

“part-time transition managers,” who 

in practice provide portfolio trading 

services instead of the distinctive and 

specialist portfolio TM offering. 

Werner claimed he also found 

conflicts of interest rife in the business, 

with some large investment banks 

bidding low on TM project fees, only to 

make up the revenue shortfall through 

trading activity via their proprietary 

accounts. As Citibank’s Wilkinson 

posits: “it is the ultimate conflict. Can 

you act for the client and the bank at 

the same time?” Index funds, Werner 

continued, also have a strong incentive 

to maximise crosses with their internal 

funds, regardless of the impact on the 

transition client’s destination portfolio. 

That would imply therefore that while 

many transition managers play fair – 

some do not and it is harming business. 

“The very fact that one of the stated 

objectives of the T-Charter is to ‘protect 

clients from poor or questionable 

practices’ indicates that implication to 

be correct,”says Windmiller. 

In January this year, Dixon invited 

10 or so major providers in the market 

to a meeting where he set out his 

ideas and where he asked them to 

help him thrash out a draft code of 

practice, or T-Charter which could, in 

the words of State Street’s European 

TM team “have teeth,” be widely 

adopted by the market and at the 

same time give a large degree of 

comfort to clients. 

Perhaps it was the time of the 

month with little business to transit, 

or perhaps it was the fact that 

frustration with certain market 

practices had built up to boiling 

point. Whatever the reason, the kickoff 

meeting was packed, according to 

attendees. It included Dixon, 

Wilkinson, Williams and Windmiller, 

Paul Samuel of Barclays Global 

Investors, Julie Dickson from Mellon, 

Josephine Defty of Russell 

Investment Group, Rakesh Manani 

from Goldman Sachs, Peter Walker 

from Merrill Lynch Investment 

Managers (MLIM), Rick Di Mascio 

from Inalytics, John Minderides from 

JP Morgan, Lachlan French from 

State Street, Alex Johnstone from 

Bank of New York and Tony Nash 

from Deutsche Bank. The meeting 

was chaired by another doyen of the 

TM market Nigel Foster, who built 

up his market reputation at 

ECrossnet and MLIM. Foster was 

brought on board as a sort of 

“respected elder statesman” says 

Dixon, “who is ensuring the market 

is properly lobbied and canvassed for 

input and opinions.” 

A number of people and 

institutions came under fire at the 

meeting. With the first flush of 

frustration articulated, people at the 

meeting soon found a more proper 

direction and some 12 marketcritical 

issues were hammered out 

into a draft charter that would be the 

basis of extensive market 

consultation. Comprehensive 

meeting notes were sent out to 

participant and non-participating 

firms, asking for comment and 

suggestions. A second meeting was 

arranged for February, and while 

fewer institutions turned up to that 

follow-up meeting, a more 

substantive form to the elements of a 

possible charter began to emerge 

and the “twelve points were reduced 

to a more manageable eight,” says 

Dixon (please refer to Box 1: What 

the T-Charter might contain). 

The market reaction to the 

proposed charter is mixed. As 

Wilkinson says, “all non-investment 

banks are likely to be very 

supportive of this charter.” 

Meanwhile Simon Hutchinson, head 

of European transition management 

at Northern Trust says “Realistically, 


it is not too controversial and we are 

not massively surprised about what 

is in there.” 

Questions about the efficacy of the 

charter rest on various points. First 

that it might be too prescriptive and 

“create a rod for our own backs,” 

according to one leading transition 

manager. Dixon counters with “if the 

charter is causing you to do 

something not in the interests of the 

client, then we will change it. We are 

deliberately trying not to be too 

prescriptive. It is the spirit of what we 

are trying to do that is important.” 

UBS’s Windmiller concurs.“It is a fine 

balance though,” she warns. “The 


initial draft was certainly too 

prescriptive. There are so many 

different types of transition managers 

and it was important that the charter 

be seen not to favour one business 

model over another. A key 

consideration behind the initiative 

was that clients had more choice, 

rather than less.” 

John Minderides, managing 

director, transition management at JP 

Morgan acknowledges that the draft 

charter is, “more constructive than I 

thought it might be.”He explains that 

TM specialists already work in a highly 

regulated environment. “Pre-hedging, 

for instance, is already covered by the 

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rules anyway. It not an issue unique to 

transitions in a primary way.” 

A third element is that it is too UK 

centric. Again, Dixon counters with 

the fact that the principles of the 

charter have a global application.“We 

weren’t thinking of anything other 

than immediate market concerns 

when this came up. However we are 

seeing interest from the US about its 

applicability.” UBS’s Windmiller 

acknowledges that the charter is 

“probably UK-centric at the 

moment.” However, she points out 

that there are more transitions 

undertaken in the UK than elsewhere 

9


10 

Market Leader 

in Europe, although, “we are seeing 

more interest from European clients 

and eventually the charter will 

become a global phenomenon.” 

“Off the record” transition 

managers mention other concerns 

such as one broker TM specialist who 

says “I doubt many transition 

managers will be able to get their 

signature on the charter without some 

substantial input from their firm’s 

compliance people, and that may 

ultimately take the teeth out of the 

initiative.”“I worry about that,” says 

Dixon, who explains that that 

particular requirement flows from the 

consensus view that the T- Charter 

“has teeth.” He also points out that 

the FSA, which may be supportive of 

the self-regulatory element in the 

draft charter, is the natural institution 

with which compliance officers can 

have a productive dialogue. 

Others point out that while there is 

a strong belief that some houses are 

winning business falsely “there is no 

WHAT THE T-CHARTER MIGHT CONTAIN 

connection between that and post 

event performance,” although the 

same transition manager concurs 

that “people should be more honest 

about measuring post trade. 

Guarantees about crossing, for 

instance, are nonsense [sic].” Others 

question the need for a separate 

team saying,“How can you possibly 

leverage the broader expertise of 

your bank by ring-fencing transition 

management?” Then again says 

another provider,“given that a lot of 

the issues are aimed at pension fund 

trustees, it may be that the National 

Association of Pension Funds (NAPF) 

should also be involved, rather than 

the FSA, which covers even market 

professionals who do not actually 

need this charter.” 

Some critics see the charter as an 

indirect marketing exercise by the 

people who raised the issue “giving 

added credibility to the people who 

are associated with it”; others say it 

that in important essentials, it still 

AT THIS STAGE of the market consultation process eight guiding 

principles have been suggested as the basis for a workable T-charter. 

Transition managers: 

• Must disclose any potential conflicts of interest when they submit bids to 

clients and explain how those conflicts will be managed. 

• Should guarantee confidentiality to the client and show or prove how 

they will keep confidentiality. 

• Should confirm that the required experience, resources and processes 

are in place for each transition assignment. 

• Should specify the performance benchmark that reflects the objectives 

of the transition and track records carefully. 

• Should confirm that systems are accurate and timely. 

• Should present cost estimates in the same way. The layout of specific 

costings should be common to all TM bids, so that clients can 

compare bids side by side. 

• Must disclose all fees ahead of the transition and provide detailed 

calculations of fees after the transition has taken place. 

• Should follow appropriate dealing practices on pre-hedging, crossing and 

foreign exchange. 

Simon Hutchinson, head 

of European transition 

management at Northern Trust 

remains light.“In some ways it brings 

the lowest common denominator of 

capability to the fore,” says another 

transition manager. TM providers 

should be accountable not only for 

their performance in safeguarding 

portfolio profitability but also, where 

relevant, the activities of third party 

agents, that are trading out the 

portfolio.” Windmiller jumps to the 

defence. “I understand the concern 

about the charter achieving the 

lowest common denominator, but 

that can still be a very high standard 

indeed. In addition clients will be 

assured of this baseline level of 

integrity. That’s a really good thing. It 

has to be said that if a TM manager 

does not sign up, there should be a 

compelling reason why.” 

According to Mercer’s Williams, 

where the T-Charter really breaks new 

ground is in the area of cost 

estimation. There is a real drive to 

formulate a standard template, where 

every assumption made in a bid is 

stated “so that when you receive bids 

from a request for proposal they can 

be compared on a like basis or, at least 

you should know where all the 

assumptions have originated,”he says. 

Northern Trust’s Hutchinson thinks 

that as the nature of the business 

changes, and client’s grow in 

sophistication and they themselves set 

the level of demand for more 



12 

Market Leader 

transparency and better practice. 

“Increasingly clients are looking for 

deeper service relationships with 

transition managers. The fact that the 

business is much more complex than 

simply trading out of one portfolio 

structure into another, means that 

clients are looking for a much 

deeper understanding of their 

strategies and preference and are 

looking for a relationship which 

covers regular assignments.” 

The latest draft charter is currently 

with the FSA for guidance and 

feedback. So far, reports Dixon, the 

feedback is extremely positive. “The 

FSA is interested and supportive and 

have asked to be kept informed of 

progress. The syndication to the 

investment consultants has uncovered 

100% support, and three firms have 

agreed to collaborate on the T-Charter 

Who’s leading the Investment Pack? 

cost estimation template,” he states. 

The next round of talks with transition 

management providers is scheduled 

for May. 

Dixon is also waiting on further 

input from clients, investment 

consultants and transition managers 

on the latest draft. The most valuable 

element of the consultation so far 

adds Mercer’s Williams is “having 

the majority of transition managers 

in a single room, discussing 

important market issues. It’s been 

pretty powerful.” 

It is still too early to say whether 

the charter will undergo further 

modification and streamlining and 

whether it will come into formal 

existence some time soon. 

“Something that makes the industry 

more transparent for everyone can 

only be a good thing,” says JP 

Morgan’s Minderides. 

Windmiller at UBS is sure that 

“bidding for business will become 

more standardised,” if the T-charter is 

adopted. She cautions, however, 

against the charter putting too much 

emphasis on costs.“Teamwork, clarity 

of process, reporting capability and 

depth of resources across asset classes 

are equally important considerations. 

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SYNDICATED LOANS 

14 

In the Markets 

Bumper syndicated 

lending extracts its price 

Investor appetite is allowing borrowers to procure competitive terms 

across the debt markets, with public and private bond spreads also 

narrowing during 2004 and the beginning of this year. For syndicated 

loans, however, it is not only pricing that is under pressure but also 

structure, documentation and covenant packages. Ian Fitzgerald, 

director and head of loan syndication at Lloyds TSB Capital Markets, 

looks at the market’s prospects for the rest of this year. 

BUMPER LENDING VOLUME 

in 2004, including substantial 

increases in leveraged loans, has 

left the syndicated loan market finely 

balanced. But it has failed to stem 

growing competition between banks 

and that continues to drive down 

pricing. Given that balance-sheet 

lending decisions – both for 

investment-grade and loans further 

down the credit curve – are now 

supported by sophisticated riskengagement 

mechanisms, (including 

a new generation of credit risk 

instruments) it is not clear how this 

pricing cycle will compare with 

previous cycles. Neither is it clear 

which banks will manage to stay in 

the market when pricing finally 

bottoms out. 

Investor appetite is allowing 

borrowers to procure competitive 

terms across the debt markets, with 

public and private bond spreads 

narrowing – a trend begun last year. It 

is not only pricing that is under 

pressure but also the structure, 

documentation and covenant 

packages attached to transactions.This 

is especially true for more creditworthy 

borrowers in the market and 

particularly the continental markets. 

Veolia and RWE, for example, tapped 

the French and German markets 

respectively with few or weakened 

financial covenants. Although some 

bankers argue that such lending is 

evidence instead of unusually strong 

banking relationships. 

There is also a wider trend in the 

European market to leverage deal 

structure against credit quality. In the 

more conservative United Kingdom 

market this has manifested itself in 

efforts to fix financial covenants 

against a single criterion – rather than 

the traditional two or three – for some 

investment-grade borrowers. But 

pricing, covenants and structure are all 

ultimately factors within the 

relationship between the borrowing 

company and the lending banks. As 

such, lending decisions will remain a 

response to the credit strength of the 

1999 

1st half 

1999 

2nd half 

2000 

1st half 

2000 

2nd half 

2001 

1st half 

2001 

2nd half 

company and its need for wider 

banking support. 

The combined effect of both this 

structural compression and the 

pressure on margins is a narrowing in 

pricing differentiation between 

stronger and weaker credits. This is 

partly why banks are putting 

resources into widening their 

marketing franchises to focus more 

closely on mid-cap and regionallybased 

companies. Another area that is 

benefiting substantially from the 

depressed major M&A market is, of 

course, the private equity-led 

acquisition finance business. The level 

of LBO/MBO loan transactions was 

up by 78% across Europe last year – 

again, encouraged by fierce 

competition between banks taking 

place against a relatively stable 

economic background. 

In the longer run, this combination 

may mean the market will contract to 

the extent that only the strongest 

international banks can compete in the 

investment-grade lending market. By 

Figure 1: Transaction volumes in European syndicated lending 1999-2004 

Volume ($bn) 

600 

500 

400 

300 

200 

100 

0 

Source: Dealogic 

2002 

1st half 

2002 

2nd half 

2003 

1st half 

2003 

2nd half 

2004 

1st half 

2004 

2nd half 

Volume $bn No. of transactions 

800 

700 

600 

500 

400 

300 

200 

100 

MAY/JUNE 2005 • FTSE GLOBAL MARKETS 

0 

Number of transactions

the same token, smaller regional banks 

are being forced to refocus on their 

home or preferred markets. It is clear 

that banks without a certain critical 

mass in their balance sheet are finding 

it harder to compete with those that 

have built a strong franchise, 

underpinned by the support structures 

and products to sustain volumes. 

Indeed, a consolidation is now 

underway that has resulted in most 

UK investment-grade market liquidity 

being provided by the top 12 banks. 

And in the western European market 

as a whole, a similar proportion is 

provided by a mere 20 top tier banks. 

But even as this polarisation takes 


Figure 2: Refinancings dominate European syndicated lending 


France Germany UK 

place, a question mark still hovers 

above pricing. How long will lenders 

continue to fund at what are 

increasingly tight rates? With pricing 

approaching its cyclical low point – 

and given that such a high percentage 

Refinancing M&A LBO/MBO Other 

We set the standard. Now we’re raising the bar. 

of borrowers have completed or are 

completing recent refinancings – one 

has to wonder where the market is 

headed. While uncertainty lingers 

over a possible resurgence in big ticket 

M&A, the market could remain 

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15

SYNDICATED LOANS 

16 


vulnerable to pricing shocks. And, as 

pricing begins to bottom out, 

relationship histories are becoming an 

increasingly vital consideration for 

banks. They are also becoming more 

important for companies as they 

consider where they might raise funds 

to participate in a potential M&A 

surge. As such, companies are likely to 

benefit by selecting their core liquidity 

providers with care. 

Exactly what will happen for the 

rest of 2005 is difficult to predict. 

Generally speaking, UK corporate 

balance-sheets are in good shape – so 

the big questions remain whether 

cash rich large-cap companies will 

indeed approach an amenable loan 

market for more aggressive M&Arelated 

purposes and where the bulk 

of that demand will rest – in 

continental Europe or, as in the past, 

firmly in the UK. 

It is also clear, however, that loan 

market pricing has not yet reached the 

low levels that the market suffered 

during 1995 and 1996 – or even 

RECORD LENDING IN 2004 

throughout the years of 1987 and 

1988. And while banks continue to 

voice their concerns over returns and 

relationship profitability, there is 

substantial liquidity embedded within 

the system and no real signs of a 

change in current market trends. 

History tells us that these trends do at 

some point reverse, but what will be 

the trigger? Ultimately the market is 

being driven by a seemingly robust 

global economy. This is augmented by 

the steady release of strong corporate 

sector results, continued bank 

liquidity and a stable geopolitical 

outlook. For this situation to change 

dramatically will, I believe, require a 

major shift in at least one or more of 

these factors. And in the absence of 

these shifts, current market dynamics 

make this an excellent time for 

borrowers to raise debt finance. 

European syndicated loan volume by country 1999 to 2004 

Volume ($bn) 

600 

500 

400 

300 

200 

100 

0 


1999 

1st half 

1999 

2nd half 

Had anyone said in January last year that a new record in syndicated lending would be set by the end of 2004 

they would have received short shrift. Back then bank liquidity far exceeded demand and margins continued to 

narrow even as deal volume and numbers remained largely flat. By mid summer however, that changed. The French 

and German markets led the pack, with demand driven by industrial and utility refinancing and they even seemed 

ready challenge the UK’s historical dominance. In France, for example, 39 of the CAC 40 companies refinanced, 

while in the UK only 38 of the FTSE 100 refinanced or restructured. The £2bn Land Securities transaction – itself for 

a restructuring and notable for its innovative securitisation structure – was a high-profile exception to this. 

In a late rally however, a substantial number of UK borrowers finally began to come to market, taking advantage of 

competitive conditions. Another area that provided a rich appetite for new loans – both in the UK and on the 

continent – was sponsor-driven leveraged buyouts. The largest of the leveraged transactions in the market was to 

support the acquisition of the AA by CVC Capital Partners and Permira Europe. These trends also exposed a greater 

degree of investor appetite than many previously assumed. Equally, it highlighted the fact that market conditions had 

expanded further than expected to accommodate the demand. In the UK for instance, expansion came via a 

substantial increase in mid-market, rather than big-ticket corporate borrowing. The average transaction size in the UK 

was $550m, compared to the average combined deal size in France and Germany of $950m. Larger transaction 

sizes on the continent reflected deeper demand for new money and ultimately pushed up overall volumes. European 

lending volumes rose to $887.7bn–up 44% on 2003, while volume was up in France by a whopping 139%, in 

Germany by 39%, and in the UK by 42%. 

2000 

1st half 

2000 

2nd half 

2001 

1st half 

United Kingdom 

2001 

2nd half 

2002 

1st half 

2002 

2nd half 

2003 

1st half 

2003 

2nd half 

2004 

1st half 

2004 

2nd half 

France Germany Italy Netherlands Spain Others 


Lifetime support 

Demand is expected to rise for immediate annuities, which convert 

lump sums into income streams guaranteed for life – though sales 

to date remain meagre. Neil A. O'Hara investigates a product that 

may finally be about to realise its potential in the US market. 

TRADITIONAL PENSION 

INCOME annuities may soon be 

an endangered species. Recent 

US Department of Labor figures, show 

the number of private sector employees 

covered by defined benefit plans 

dropped from 30.1m in 1980 to 22.6m in 

1999, while defined contribution plan 

coverage rose from 14.4m to 46.9m over 

the same period. In addition, many 

defined benefit plan participants now 

can and do, choose a lump sum 

distribution at retirement. “There is an 

increasing need for guaranteed lifetime 

income because of fewer defined benefit 

pension plans, the uncertainty of social 

security, earlier retirements and longer 

life spans,” says Jac Herschler, vice 

president of Prudential Annuities, a unit 

of Prudential Financial, Inc., “To date, 

the solutions have not been the 

annuitisation of those assets.” 

Shared risk lies at the heart of any 

annuity pool. An insurance company 

will make higher payments to 

survivors because life expectancy for 

the group is more predictable than for 

individual participants. Yet research 

conducted by Prudential shows that 

Americans prefer to retain control over 

their retirement savings.“It’s a visceral 

negative reaction to sharing risk when 

it comes to payout,” says Herschler, 

“People have an aversion to the idea 

that those who die early make lifetime 

payments to the ones who live 

longer.”In contrast, consumers readily 

accept shared risk when they buy life 

insurance, which has opposite cash 

flows: the long-lived fund lump sum 


payments to those who die young. 

Unlike immediate annuities, 

deferred annuities, which are primarily 

used for tax-sheltered accumulation, 

do not participate in a risk pool unless 

the holders elect to do so when 

withdrawals start. Until then, the assets 

remain under the holders' control. 

Some insurers now permit deferred 

variable annuity holders to make 

regular withdrawals without joining a 

pool. Those contracts retain the 

liquidity of a deferred annuity while 

generating income similar to an 

immediate annuity – but there is a 

catch. “It falls short of the immediate 

annuity because once you are out of 

money, you are out of money,” says 

John Meyer, a senior vice president in 

charge of the individual annuity 

department at New York Life Insurance 

Company, “That is the beauty of 

immediate annuities. Once you make 

the bet, you are guaranteed to get that 

payment for the rest of your life.” 

Herschler does not believe 

consumers are ready to embrace 

annuitisation yet. “The breakthrough 

for the industry in addressing longevity 

risk is going to come from an 

accumulation vehicle from which you 

can take withdrawals,” he says. 

Prudential now offers an optional 

guarantee on its deferred variable 

annuities that will continue minimum 

payments for life even if poor 

investment performance and 

withdrawals deplete the account and 

the holder never chose to annuitise. 

The company charges a fee for the 

insurance, but upon death the account 

balance – if any – passes to a 

designated beneficiary or the holder's 

estate. If Prudential’s guarantee catches 

on, it will attract more money to 

deferred variable annuities. These 

flexible vehicles allow investors to 

select among asset classes in subaccounts 

that operate like mutual 

funds. Without a guarantee, payouts 

under a variable annuity reflect the 

investment performance of the chosen 

sub-accounts, which are typically 

managed by mutual fund advisers. 

Immediate annuities with terms 

similar to Prudential's guaranteed 

contract offer higher income in 

exchange for ceding control of the 

assets. That should be a powerful 

selling point, but annuity providers 

have failed to get the message across to 

consumers. Financial advisers, through 

whom annuities are sold, resist the 

idea. Advisers who charge a percentage 

of assets face a drop in revenue if clients 

buy immediate annuities; some refer to 

it as “annuicide”, according to Michael 

Henkel, president of Ibbotson 

Associates, a research and consulting 

firm that focuses on asset management. 

Annuity providers who spy an 

opportunity in the guaranteed income 

market are trying to storm the 

barricades. In August 2003, New York 

Life introduced its latest immediate 

annuity, which gives consumers more 

flexibility and allows advisers to 

choose a lower commission rate that 

lasts 10 years instead of a one-time 

payment. The product attracted 

$292m in 2004, about 5% of New York 

Life’s total annuity sales compared 

with 2% to 3% for most providers.“We 

see that growing pretty rapidly over 

the next 5 to10 years,”says Meyer. 

A recent NASD rule change could 

jump start immediate annuity sales: for 

the first time, broker-dealers may use 

statistical simulations as well as straight 

line projections in sales materials. 

17

INDUSTRIAL CLASSIFICATION BENCHMARKS 

18 


ICB builds up 

market share 

It is often stated that the benchmark used to describe an asset 

class or investment opportunity is one of the most basic 

assumptions in the creation of an investment programme, from 

asset allocation decisions to performance evaluation. Inevitably 

then, competition to provide the investment market’s preferred 

industry classification system is heating up. 

IN EARLY MARCH, Thomson 

Financial (TF), an operating unit of 

the Thomson Corporation 

announced it would adopt the recently 

launched Industry Classification 

Benchmark (ICB) as its standard 

classification tool across a range of its 

global data products and services. 

Thomson Financial is the first global 

data provider to adopt the new 

classification system from FTSE Group 

and Dow Jones Indexes. Launched 

jointly in January 2005 by Dow Jones 

Indexes and FTSE Group, ICB is 

beginning to establish itself as a 

seminal classification system, 

classifying some 40,000 companies 

and 45,000 securities around the 

world. “It represents a truly global 

solution to our clients’ classification 

needs,”said Sarah Dunn, chief content 

officer at Thomson Financial in March. 

The desire to provide a 

comprehensive industry classification 

system has been underway for 

decades, since the US government 

established industry classification 

systems to organise industries into 

more definable categories back in the 

1930s. In the US the Census Bureau 

traditionally used the Standard 

Industrial Classification (SIC) system. 

That changed when Congress passed 

the North American Free Trade 

Agreement (NAFTA), and the US, 

Canada and Mexico jointly developed 

a newer system called the North 

American Industry Classification 

System (NAICS). Regardless of the 

system type, industry classifications 

can be an effective method for 

extracting industry information and 

generating prospect lists. Today index 

providers have joined the search for 

optimal industry classification by 

providing accurate and transparent 

sector definitions. 

FTSE Group originally developed its 

Global Classification System in the 

spring of 1999 and was quickly taken 

up by stock exchanges in Athens, 

Cyprus, Egypt, Johannesburg, London 

and Madrid, as well as Goldman 

Sachs, Hang Seng, HSBC, ING 

Barings, Nicholas Applegate Capital 

Management, Reuters and US-based 

investment consultants Frank Russell. 

This original classification allocated 

companies to an industrial sub sector 

that most closely defines the nature of 

its business. In its first iteration, this 

was determined by the proportion of 

overall profit arising from each 

business area within a company. The 

system comprised 10 economic 

groups, 39 industrial sectors and 102 

industry sub-sectors. 

Over time the investment industry 

has witnessed a growing requirement 

for an internationally accepted 

industry classification system. One 

that allocates a clear economic activity 

description to one and only one class. 

It is necessary to achieve this, so that 

economic activity can be accurately 

measured, without fear of duplication. 

Without such a classification and a 

complementary integrated statistical 

infrastructure some economic activity 

could be double-counted or not 

counted at all. It is also useful for interindustry 

comparisons of key economic 

performance measures. More 

pertinently for the investment 

industry, classifications aim to enhance 

the investment research and asset 

management process for financial 

professionals worldwide. In response, 

leading index providers have worked 

hard to develop an optimal industrial 

classification system. 

In an effort to provide a superior 

classification system, FTSE Group 

and Dow Jones Indexes announced 

that they would merge their industry 

classification systems in February last 

year and created ICB. The system was 

fully operational by January 2005. 

Major index providers including the 

Hang Seng (HSI) in Hong Kong, the 

Russell 3000 Index family in the US 

and the FTSE Xinhua (FXI) in China, 

have already adopted the industry 

classification system, and STOXX Ltd 

uses ICB for its indices across Europe. 

The Financial Times, The Wall Street 

Journal, CNBC, SmartMoney Magazine 

and Dow Jones Newswires also use 

the classification system, while 

exchanges such as NASDAQ, the 


James Cemprola, 

managing director, ICB 

New York Stock Exchange (NYSE), 

Euronext, the Swiss Exchange and 

the Johannesburg Stock Exchange 

are expected to take up the 

classification imminently. 

Not everyone uses the same system 

and competition is rising between ICB 

and the Global Industry Classification 

System (GICS). GICS was developed 

by Morgan Stanley Capital 

International (MSCI) and Standard & 

Poor’s (S&P). The GICS structure 

consists of 10 sectors, 24 industry 

groups, 64 industries and 139 subindustries 

and which are reviewed 

annually. Most notably perhaps, 

NOREX, the strategic alliance of eight 

Northern European securities 

exchanges, implemented GICS as the 

official standard for the classification of 

listed securities a couple of years ago. 

Transparent and Rules-Driven 

ICB represents a Global Industry 

Classification solution for the 

investment community, says James 

Cemprola, Managing Director, ICB, 

“our role is to bring a market leading 

product to bear, that accurately and 

comprehensively classifies companies 

and securities.”The main benefit is the 

sheer reach of the system, which 


incorporates 40,000 companies and 

45,000 securities (equity based), 

explains Cemprola. It allows speed in 

delivery. He adds,“if you are planning 

an IPO for example, we can deliver the 

appropriate classification within 48 

hours.” The applicability is also 

appreciated by the custodians, “who 

require a strong standardised product, 

and which allows consistent reporting 

within industrial sectors.” 

The merger of FTSE Group’s and 

Dow Jones’s systems resulted in a 

“dramatic increase in coverage,” 

continues Cemprola. It is a 

development firmly in line with 

market requirements, he says as “for 

global investment services providers, 

such as Goldman Sachs, State Street 

and Northern Trust, for example, you 

need to provide an extensive and 

global system that more than matches 

their operational scale, while for 

exchanges such as the London Stock 

Exchange, or the Athens Stock 

Exchange, there is the benefit that 

everyone is utilising the same system.” 

Thomson Financial deciding to use 

ICB was an important strategic step for 

the classification system, explains 

Cemprola. “ICB will be utilised across 

a broad range of TF products including 

Thomson One, Datastream, 

Worldscope and First Call, and TF 

clients also have the opportunity to 

sign up for the full ICB universe 

product on a pass through basis.” 

What makes ICB interesting, says 

Cemprola is that it contains four 

classification levels, which includes 

10 separate industries to help 

investors monitor broad industry 

trends, 18 special Supersectors that 

can be used for trading, 39 sectors 

and 104 sub sectors which “if you 

utilise a bottom up investment 

strategy, you can screen using the 

granular sub sector classification,”he 

adds. Companies within sectors are 

assigned on a primary revenue basis, 

rather than the old methodology 

which determined a company’s 

classification by the proportion of 

overall profit arising from each 

business area within a company. 

“ICB is an important development for 

both Dow Jones Indexes and FTSE 

Group and the marketplace. Many of 

our clients are adopting and organising 

around the new system, and ICB 

represents a comprehensive and global 

industry classification solution for use 

throughout the investment community,” 

adds Cemprola. 

19

NORTH AMERICA 

20 

Regional Review 

AN SEC PROPOSAL to 

enforce a 16.00 hour 

deadline for mutual 

fund orders has drawn flak 

from the industry because, in 

practice, it would impose a 

much earlier deadline for 

investors in 401(k) plans. 

“Many investors use 

intermediaries to receive the 

orders,” says SEC 

Commissioner Roel C. 

Campos, “I think it is safe to 

say we will have a hard close 

4pm rule. It is a matter of to 

whom does the order run?”He 

appears to favour a clearing 

house that collects all orders 

over an audit trail to verify that 

investors entered orders before 

the market close. 

Next day pricing of mutual 

funds would be a cheaper and 

more effective alternative, 

according to Richard Herring, 

Jacob Safra Professor of 

International Banking at 

Wharton Business School. “It 

makes market timing harder, 

day trading becomes hopeless, 

and it is easier to avoid late 

trading as well,”he said. Funds 

that welcome market timers, 

such as some Rydex funds 

(which are index and sector 

funds that are designed to 

match a specific benchmark with no 

trading costs) could opt out as long as 

they disclosed their policies and 

applied them to all investors alike. 

Ken Griffin, founder and CEO of 

Citadel Investment Group, believes 

state-of-the-art technology can 

eliminate market timing. “The ability 

to create same day straight through 

processing of mutual fund trades is a 

matter of will,” he says, “It is a much 

simpler solution, which does not 

require people to understand that they 

bought at tomorrow's price. That is 

very confusing to retail investors.” He 

JUSTICE 

DELAYED 

Eighteen months after the market timing 

scandal broke, the Securities and Exchange 

Commission (SEC) is still debating how best 

to curb the practice. Neil A. O'Hara reports. 

expressed strong support for a hard 

4pm close. The SEC softened another 

deterrent to market timing when it 

backed away from mandatory 2% 

redemption fees on short-term mutual 

fund trades; the final rule leaves 

redemption fees to the fund board's 

discretion. “We were concerned 

mandatory redemption fees might 

make retail investors feel this was 

somehow a more costly way to invest,” 

said Commissioner Campos at a recent 

Harvard Business School seminar, who 

felt the change reflected the agency’s 

rulemaking flexibility. 

That cuts no ice with 

Brandon Becker, a partner at 

Wilmer Cutler Pickering Hale 

& Dorr, who argues that SEC 

enforcement actions affect the 

outcome. “If you do your 

rulemaking after you have 

already sewn up the leading 

firms with settlement orders 

you have chilled that 

conversation going forward,” 

he said. Firms that have 

already committed to new 

procedures in settlements 

have no reason to oppose a 

rule extending those 

procedures to other players 

who might otherwise gain a 

competitive edge. 

Market timing arbitrage 

opportunities would vanish if 

mutual fund prices reflected 

fair value, the “ultimate 

solution” according to 

Commissioner Campos, 

although he acknowledges it 

has practical limitations. 

“That is an art,” he says, “We 

have asked the industry to 

price at fair value where 

appropriate.” Portfolios with 

large positions in Asian and 

European securities are 

particularly vulnerable to 

stale prices from different 

time zones, Griffin notes. 

“Those funds should look at 

appropriate countermeasures for 

short term traders,” he adds, “US 

equity portfolios are not an efficient 

vehicle for market timing.” 

“Fair value pricing is a scary place 

to go,” says Herring, “It is very 

subjective.” Only half in jest, he 

suggests the SEC should have 

required hedge funds caught in the 

market timing scandal to disclose 

their models.“Funds could then turn 

market timers’ weapons against 

them to protect long term 

investors,”he concludes. 


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NORTH AMERICA 

22 

“ 


Investors in Mexico have been dancing salsa all the way to the 

bank. For the last two years Mexico’s stock market has been 

sizzling hot. In March it reached its highest level for 10 years and 

came close to regaining ground lost in the devastating Tequila 

crisis of 1994-95, reaching a value of $183.4bn compared to 

$195.8bn before the devaluation. Mexico’s Indice de Precios y 

Cotizaciones (IPC), the general equities index has soared more 

than 40% in each of the past two years, but following United 

States Federal Reserve chairman Alan Greenspan’s comments in 

mid-March, is market sentiment turning? Benedict Mander 

reports from Mexico City. 

IF IT ISN’T already, the party will 

very soon be over for Mexican 

equities, as the US Federal Reserve 

has taken the path of raising interest 

rates at a faster pace than it has 

probably wanted to do. The latest 

inflation data suggest that it would be 

somewhat heroic to keep its promise 

of ‘measured’ increases. Therefore the 

market in Mexico remains very 

exposed to any change of speed by the 

Fed,” says Dr Rogelio Ramirez de La 

O, an economist with Mexico Citybased 

research firm Ecanal. 

Bond Snodgrass, an analyst at 

Mexico City-based boutique Vera 

WILL THE 

SALSA SOUR 

IN MEXICO? 

Research agrees,“We are moving into a 

phase of less enthusiasm in Mexican 

markets than we have seen over last 

few years,” he explains. “People are 

concerned about what is going on with 

the US budget deficit, as the only way 

for it to be funded is for interest rates to 

go up.” This is hurting stock markets, 

“although Mexico is in a good shape to 

weather this: domestic interest rates 

are way too high, so high that this will 

act as a shock absorber,”he adds. 

Ricardo Amorim, head of Latin 

America research for WestLB, thinks 

that the strength of the Mexican peso 

is an issue, saying it is “one of the only 

currencies in Latin America that is 

overvalued as compared to historical 

standards – in 2004 the Mexican 

economy was the second slowest 

growing among the nine largest Latin 

American economies and it may be 

the slowest growing one in 2005.” 

Competition with China is costing 

Mexico part of its US market share 

and political uncertainty may cause 

capital outflows, he adds, “in short, I 

believe that the peso will depreciate 

and that the Mexican stock market is 

unattractive for foreign investors”. 

Tim Heyman, president of Heyman 

and Associates, explains that most 

Mexican assets “in terms of price to 

book valuation are the third highest 

after the US and India. The Mexican 

market doesn’t look cheap,” he says. 

However, he also has an issue with the 

definition of the Mexican stock 

market, observing that it needs to be 

viewed in a wider context.“People are 

beginning to ask what we really mean 

when we talk about the ‘Mexican’stock 

market,”says Heyman.“With so many 

de-listings and acquisitions by foreign 


t 

 

 

 

 

 

 

 

 

 

t

NORTH AMERICA 

24 


companies recently, there are many 

fewer stocks now – in fact there are 

only really ten major stocks, and they 

are not necessarily very Mexican any 

more.”He pointed out that companies 

such as America Movil, Telmex, 

Cemex, Bimbo and Grupo Mexico all 

have major operations outside Mexico 

– in the case of Cemex some 55% of its 

operations are abroad. 

Even though many may believe 

that, overall, Mexican stock markets 

are fully valued, global investors have 

not lost interest in individual Mexican 

stocks. As Heyman points out, “The 

leading companies here are good 

dividend payers and a lot of analysts 

are recommending them this year 

given an environment of rising 

interest rates.” 

Three of Mexico’s four largest 

companies, which together dominate 

almost half of the stock market, 

performed so well last year that they 

carried out stock splits in March to 

allow greater liquidity for investors. 

Telmex's shares gained about 16% in 

2004, while Cemex shares climbed 

33%; and investors in America Movil 

reaped a return of nearly 100%. Latin 

America's biggest mobile phone 

company America Movil split each 

share into three, while fixed-line 

market leader Telmex swapped two 

new shares for every current 

one. The two companies, 

controlled by the fourth 

richest man in the world 

Carlos Slim, account for 

about a quarter of Mexico's 

stock market and are 

among the businesses best 

known to Latin American 

investors. They were soon 

joined by Cemex, the third 

largest cement company in 

the world, which split its 

shares in two. 

America Movil also 

boosted its annual dividend 

by 75%, while Telmex is raising its 

dividend by 12% from last year. Both 

companies are also increasing the 

amount of money set aside to buy back 

their shares, with America Movil 

increasing its buyback fund by 

US$455m and Telmex by US$546m. 

Carlos Hermosillo, an equities 

analyst for Vector Casa de Bolsa, 

pointed out that the rise of the stock 

market has meant that while last 

year dividends were at around 3%, 

they have now fallen to 1-2% this 

year. But he remains more optimistic 

than others: “Although asset prices in 

Mexico have reached historic highs it 

is not the case for PE ratios which are 

below their historic average. I do not 

see Mexican stocks as expensive 

right now, especially with a decline 

of some 10% during March. And if 

you compare them to US stocks, 

Mexican PE ratios are about 20% 

lower. The average on the IPC is 

currently 16.5 times.” 

Also, a new law governing the stock 

markets, which is currently awaiting 

approval from the Senate, is intended 

to increase investment, improve rights 

for minority shareholders and boost 

the number of companies quoted on 

the exchange. Mexico only has 150 

listed companies, while there are 

some 1,500 in South Korea, which is a 

Also, a new law governing the stock 

markets, which is currently awaiting 

approval from the Senate, is intended 

to increase investment, improve rights 

for minority shareholders and boost the 

number of companies quoted on the 

exchange. Mexico only has 150 listed 

companies, while there are some 

1,500 in South Korea, which is a 

similar-sized economy. 

Ricardo Amorim, head of Latin America 

research for WestLB 

similar-sized economy. According to 

the finance minister Francisco Gil 

Diaz, the new law should contribute 

“to better capitalising Mexican 

companies, to their growth, to less 

economic volatility, to the access of 

medium-sized companies to the 

exchange, to job creation and to a 

democratisation of capital.” 

But one negative factor that has 

historically harmed the Mexican stock 

markets – political risk – has hitherto 

remained in the wings. “With such 

good and stable macro variables in 

Mexico, until recently the markets 

seemed impervious to political risk. 

But it is plausible to claim that some of 

the recent correction – although it was 

mostly matched by other emerging 

markets so it is difficult to say with any 

certainty – is explained by the fact that 

this Lopez Obrador business is 

beginning to creep in,”says Heyman. 

Mexico has recently been in political 

turmoil owing to moves to 

impeach Mexico City’s mayor 

Andres Manuel Lopez 

Obrador – who is also leading 

the polls to win the 

forthcoming elections in 2006. 

Many interpret the 

impeachment process as an 

attempt by his political 

adversaries to knock out their 

most dangerous competitor 

from the presidential race. 

One thing is for sure: the 

troubles the elections may 

cause can only increase as they 

draw closer, say local analysts. 


TAIWAN’S ROADSHOW BANGS THE 

DRUM FOR NEW INVESTMENT DOLLARS 

IT IS “PROBABLY better 

to be the leader in the 

emerging market world 

than to be just one of the 

crowd in developed 

markets!” wryly exclaims 

Leon Ku. While Taiwan’s 

expansion of economic 

growth to 4.6% this year 

may look almost sluggish 

by standards set by China 

(currently 9.5%) or 

Malaysia, it is more than 

enough to go round by 

anyone else’s reckoning. 

The currency, backed by 

massive reserves, is not tied 

to the US dollar, so while it 

has appreciated relatively, 

it has not done so to the 

extent of pricing the island 

out of the global markets. 

It is government policy 

to develop the island as a 

much more important 

financial centre than it is 

now, and it has been 

passing legislation and 

encouraging reforms to that end. 

Ku suggests, dispassionately, that 

“the securities industry is now in the 

hands of a government that has no 

historical connections or burden, so 

they are able to carry out reforms that to 

their mind are in the best interests of the 

economy and industry.” He is referring 

to the victory of the Democratic 

Progressive Party that ended the fifty 

year old domination of the Nationalist 

Party with its bureaucratic, intricate and 

intimate linkages with the business 

establishment. 


At the beginning of May the Taiwan Stock 

Exchange mounts its global road show to attract 

more investors to the island, beginning in the 

neighbourhood with Hong Kong and Singapore. 

When they see how that works, says Leon Ku, 

senior executive vice president of the Taiwan Stock 

Exchange, the show will move within weeks to 

London, Edinburgh, New York and Boston. 

Doubtless investors will be impressed with the 

progress the island’s markets have made – but they 

will need convincing that the progress will 

continue. Ian Williams reports. 

The Battle for Investment – FTSE Taiwan vs. a Selection 

of Asian Markets 

200 

180 

160 

140 

120 

100 

80 

60 

40 

20 

0 

Dec-93 

Dec-94 

Dec-95 

Dec-96 

Dec-97 

Dec-98 

Dec-99 

Dec-00 

Dec-01 

Dec-02 

Steve Champion is head of the New 

York listed Taiwan Greater China Fund 

and author of “The Taiwanese Bubble” 

about more volatile days of the market 

in the 1980’s. He says that “In the 

early days it was illegal for non- 

Taiwan residents without ID cards to 

open an account in a brokerage house, 

and even if you managed to open an 

account and made money in the stock 

market there were foreign exchange 

controls so you could not take the 

money legally out of the country. And 

all of that has disappeared. Now there 

Dec-03 

Dec-04 

FTSE China FTSE Hong Kong FTSE South Korea FTSE Singapore FTSE Taiwan 

Data as at 31 March 2005. Source: FTSE Group 

is a very reasonable 

regime both in terms of 

money exchange, money 

flows in and out of the 

country from institutional 

investors – it’s a complete 

180 degree change.” 

However, not everyone 

is so impressed, and the 

consensus has it that the 

Taiwan market still has 

some distance to travel. In 

the 2004 IMD World 

Competitiveness Report, the 

reliability of Taiwan's stock 

market information 

ranked only 34th, 

compared with Singapore 

(ranked 3rd) and Hong 

Kong’s 22nd position. 

Problems with English 

language skills, and 

bureaucratic attitudes in 

both private and public 

life still dog business. 

Most investors would 

also be happier with a less 

confrontational attitude to 

mainland China, not just because of 

the volatility it puts in the market but 

because restrictions on direct travel 

and trade inhibit Taiwan from being 

part of the regional market, which is 

where it would have a real 

comparative advantage. For example 

Europeans are concerned that several 

thousand “European” company 

products made in the mainland are 

banned from entry to the island. 

In fact, in addition to the 

government’s own moves to reform, 

Ku has presided over a series of 

25 

ASIA

ASIA 

26 


changes to the regulations of the 

Taiwan Stock Exchange, many of 

which are targeted at foreign 

investors, one of the more visible 

being an extension to three days for 

them to settle on deals, allowing them 

to bring in funds from abroad with 

fewer chances of hiccups. 

While he admits there is more to 

come, he does credit outside pressure 

from investors for many of the reforms 

that have opened up the markets, and 

helped position the island so that it 

can seriously consider the transition 

to being a regional centre. 

Assisted by the opening, currently 

foreign participation in the Taiwan 

Stock Exchange is now about 25%, 

up from single digits a decade ago. 

“We know that there is European and 

US money, and our list shows who. 

There is also money from Hong Kong 

and Singapore, but some of them 

represent US/European interests,” 

comments Ku.“The local institutions 

have about 10 to 15% market 

capitalisation but they have a buy 

and hold strategy, so from a turnover 

point of view they are a small 

proportion.” Indeed, many pension 

and investment funds are held in low 

interest bank accounts, and some 

international investment banks are 

looking hungrily at the opportunity 

to use the funds more profitably. 

The list of industries in which foreign 

ownership is restricted has been 

progressively shrinking. Kong Jawsheng, 

the Taiwan Finance Minister, led 

a road show earlier this year to 

persuade foreign investors to buy 

stakes in the state-owned industries. 

With a loud-talking Beijing, some 

Taiwanese are worried at People’s 

Republic of China money infiltrating 

the island, but as Ku points out,“From 

the regulatory side, it is not that easy to 

monitor the ultimate source of capital, 

whether it has PRC roots or not.” 

Indeed at a recent investment forum, 

an advisor to Taiwan’s President, 

urbanely pointed out “If Chinese 

missiles pose no threat to the Taiwan 

markets, why should Chinese money?” 

Several money managers agree with 

Ku that the political risk has already 

been factored into prices so “the value 

and the market dynamics offers very 

little downside risk while the market 

reforms make an attractive opportunity 

from a market viewpoint.” 

In contrast, the PRC has been very 

eager to allow Taiwanese capital and 

companies to set up on the 

mainland. It is a key reason why, 

despite the occasional hair raising 

missile rattling standoffs across the 

Taiwan Straits with the mainland, 

Western investors have seen 

potential not only in Taiwan’s own 

resilient and maturing economy, but 

also from Taiwan businesses’ deep 

involvement in the mainland. 

Western investors in Taiwanese 

companies can get a stake in the 

Chinese boom, but with the benefits 

of the island’s legal and regulatory 

system protecting them from 

capricious mainland officials. This is 

the explicit strategy of Steve 

Champion’s Taiwan Greater China 

Fund, which had been investing for 

a long time in Taiwanese domestic 

but switched strategy at the 

beginning of last year. 

The idea was to have a play in 

China through Taiwan since “in 

Taiwan, the corporate governance, 

market regulations, transparency, 

accounting standards, legal systems 

all those good things are better and 

well developed.” An additional 

advantage is the freedom of 

information based on very lively 

local press. 

While playing the China card, 

Champion comments, that Taiwan is 

now “a value market: it has relatively 

high dividend yields, relatively low 

price book ratio, its volatility is way 

Taiwanese Bronze Dragon Sculpture. 

Photo courtesy of istockphoto.com 

down – it’s a market where a 

reasonable person sitting in whatever 

country could allocate a portion of 

their capital, because what you have 

there are very high quality companies, 

currently selling at low prices.” 

Driehaus Emerging Markets fund 

portfolio manager Emery Brewer 

affirms, “In the first quarter of 2004 

the Taiwan market did extremely well 

and it was really tech sector, but 

primarily local plays. And the real 

estate sector, which went up there. 

We saw interest rates come down. We 

saw people buying up real estate, the 

banking sector did really well, 

particularly we saw big boom in 

consumer landing and credit card 

growth, mortgage growth.” 

He also confirms the degree of 

market maturity and finds the 

companies he deals with “very open, 

very transparent. Most of the stocks 

we cover we can get research reports. 

They are very open to people coming 

talk to them. In fact, on the tech side, 

they report monthly, so you get 

monthly sales data, you see the 

pricing data. It’s very transparent. 

The management is very keen in 

supplying as much information and 

data so that people can make 

judgments if the cycle is going to 

turn and the company is well 

positioned to take advantage of the 

cycle.”He is also impressed with the 

reporting standards of the local 

banks, which are also now branching 

out onto the mainland. 


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AFRICA & THE MIDDLE EAST 

28 


IN MARCH AN an International 

Monetary Fund report on the 

composition of capital flows into 

South Africa found an interesting 

anomaly; a pattern of capital inflows 

that are the inverse of typical inflows 

into emerging markets. While 

comparable countries, such as Poland, 

Malaysia and Mexico, generally 

experience direct foreign investment 

(FDI) inflows of around 2.5% to 2.6% of 

GDP and portfolio inflows around 1.5% 

of GDP, in South Africa, it is the other 

way around. FDI accounts for only 1.5% 

of GDP, while less stable portfolio 

inflows now account for 3.5% of GDP. 

The openness of the South African 

economy, the degree of exchange rate 

volatility, exchange controls and 

inflation are key ingredients of the 

local investment environment. 

Although currency volatility ups the 

uncertainty of demand for exporting 

companies and may reduce the 

profitability of FDI, its impact on 

portfolio inflows into the country is 

less clear. After all, portfolio investors 

can always hedge currency risk and 

continued volatility invariably attracts 

portfolio investors with a higher risk 

tolerance. What is emerging however 

is that the Rand/dollar 

exchange rate is proving 

central to the debate over 

currency stability, with an 

attendant knock on effect 

on US investor appetite for 

South African risk. 

After the US Federal 

Reserve took interest rates 

up to 2.75% in March there 

was a rise in expectation 

that US interest rates will 

move up to 3.75% by year 

end. The obvious result was 

that investors are switching heavily into 

dollar assets, at the expense of global 

emerging market equities and bonds. 

Commodities and metals have also 

been sold sharply down.With the dollar 

14 

13 

12 

11 

10 

9 

8 

7 

6 

5 

Rand impacts 

investment inflows 

Currency volatility accounts for relatively low levels of FDI, but not for 

the country’s high levels of portfolio investments, according to a recent 

IMF report on South Africa’s capital flows. Ian Williams reports. 

at R6.38, the rand has depreciated by 

about 14% from the high of 

R5.6175/$1.00 at the end of last year. 

But there are other anomalies 

impacting on investment inflows. 

South Africa’s isolation in the 1970s 

resulted in a highly developed financial 

infrastructure and industry, which in 

some ways was shielded from 

competition by international sanctions. 

The result is a strong infrastructure on 

the one hand but a third world gross 

national income level for the majority 

of the population, which has a chronic 

28% unemployment. 

The new majority elected 

government has tried to harmonise the 

two by building on the economic base, 

and South African companies, once the 

South African Rand vs. US Dollar – March 2000 to 2005 

15 

Mar-00 

Sep-00 

Mar-01 

Sep-01 

Mar-02 

Sep-02 

Mar-03 

Sep-03 

Mar-04 

world was opened up to them, took to 

the global economy with alacrity. 

South African Breweries’ acquisition of 

Millers in the US and other assets in 

Europe turned the traditional tables. 

London had always been more 

involved in South Africa than New 

York, so Old Mutual, the insurance 

company, Anglo-American and South 

African Breweries all listed in London, 

although they maintained their listing 

on the Johannesburg Stock Exchange 

as well. Since then, gold, platinum, 

coal, diamonds and other commodity 

prices have risen in the face of global 

demand and South African 

manufacturing has proven very 

competitive on the world stage, 

making up over a third of exports, 

Julie Pfeffer, emerging markets 

equity analyst with DuPont Capital 

says “For better or worse the Rand is 

still to a great extent influenced by 

commodity prices. And if you look at 

Sep-04 

Mar-05 


the prices of big 

commodity exports, for 

example, gold, platinum 

and coal, they have all 

gone up so much in dollar 

terms [and even in Euro 

terms] that the Rand has 

been buoyed up by that.” 

Additionally, “we still 

have quite high interest 

rates in South Africa 

relative to the rest of the 

world,” says Pfeffer, “so 

there is still a pretty 

substantial fair trade in the interest rate 

differential between its rates and 

everywhere else.” She also points to 

continuing and favourable macroeconomic 

trends in the country. 


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AFRICA & THE MIDDLE EAST 

30 


Inflation is low, “and the government 

budget is quite strong,”she says 

Taking all this together with a well 

developed and active local market 

(with a lot of liquidity), it is not 

surprising that South Africa looks 

increasingly attractive to American 

investors. Indeed, in a 

perverse way, the legacy of 

Apartheid has enhanced 

its attractiveness, since it is 

now the only politically 

correct and financially 

sound African play. For 

example the New York 

State employee’s pension 

fund announced that it 

was putting $300m into 

the country last year for 

just those reasons. 

While American funds 

often invest in South 

Africa through London, 

Mar-03 

there are increasing opportunities 

through New York where half a dozen 

companies have American Depository 

Receipts (ADRs) on the New York 

Stock Exchange (NYSE). Three gold 

miners, SAPPI, Telkom, and SASOL 

long had a NASDAQ listing. They 

witnessed a large burst of turnover in 

investor interest when they shifted to 

the NYSE, although the reasons for 

that squarely rest with soaring oil 

prices. Buying SASOL, however, also 

gets you a global energy stock, having 

recently opened a new gas to liquid 

plant in Qatar. SASOL also enjoys the 

added benefit of technology it 

developed(under the old and now 

long defunct sanctions regime) to 

make synthetic oil products. 

Although SASOL still makes up a 

significant part of the value of the 

Johannesburg Securities Exchange 

(JSE), Pfeffer notes that, in the last 

year or so, her fund has shifted its 

centre of gravity from resources 

towards more domestically oriented, 

consumer oriented stocks in South 

Jun-03 

Africa.“As income levels have gone up 

there are a lot more people that are 

brought into the formal economy in 

South Africa and that helps. If you 

look at the regional retailers, for 

instance, they have had a massive run 

in retail revenues and profits have 

FTSE/JSE All-Share General Retailers Index vs. FTSE/JSE 

All-Share Index 

350 

300 

250 

200 

150 

100 

50 

Sep-03 

Dec-03 

Mar-04 

Jun-04 

Sep-04 

Dec-04 

skyrocketed.” She stresses the 

potential for the banking sector 

“orderly and growing,” and sees the 

banks as “criminally cheap”. 

Driehaus’s emerging markets fund 

manager Emery Brewer hit upon a 

tangential but successful way to tap 

the profits from the booming real 

estate markets “For the last couple of 

years, we have been buying some of 

the local retailers that sell furniture. 

So, we have seen extremely strong 

sales growth, double digit 20+% 

coming out of retail sector and a lot of 

these stocks in the last two years had 

a tremendous run.”And, of course, as 

the dollar falls, for US investors it has 

been double your money even before 

the local growth. 

Although the rising Rand may hurt 

competitiveness eventually, the 

economic upswing is based both on a 

rising domestic economy and the 

commodity surge fuelled by East 

Asia’s insatiable appetites. As a 

consequence South Africa is on a 

firmer footing than it has been. To 

maintain that growth will entail 

coping with two distinctively South 

African challenges: one is the 

appalling casualty rate of HIV/AIDS, 

which takes its toll on both the formal 

and informal sectors. There, the 

government is better equipped than 

Mar-05 

FTSE/JSE All-Share General Retailers Index FTSE/JSE All-Share Index 


most in the continent to 

rise to the challenge. 

The other challenge is 

how to bring together the 

parallel universes of the 

developed economy in 

South Africa with the 

underdevelopment, poverty 

and unemployment of 

much of the population. It is 

here that the government’s 

project of Black Economic 

Empowerment, although 

provoking one or two 

grumbles, seems to be 

accepted by the business 

establishment as a reasonable 

exchange for government cooperation 

on broader economic issues. 

To help maintain all foreign interest, 

and to keep the economy growing, the 

government, the JSE and the 

corporate sector have been engaged in 

a revamping of their listing rules, their 

governance guidelines and issues 

such as exchange controls, which 

despite a government pledge to 

abolish them eventually, still linger. 

The effect of the regulation and the 

overseas listings has been to untangle 

the cross shareholdings and some of 

the clubby atmosphere that the 

financial sector had, and to enhance 

the concept of accountability to 

shareholders. Julie Pfeffer concludes 

“It is quite easy to invest in the 

market. There are no restrictions on 

foreign investors that you see in many 

other emerging market countries. This 

market has a long history and is very 

well developed and through the time I 

have been there I have never had a 

problem of trading there.” 


There’s the old 

fashioned way... 

...and then there’s 

our way 

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EUROPE 

32 


AXA’s Bendahan tops funds in Europe 

ERIC BENDAHAN, PARIS-based 

manager of the Europe du Sud 

fund, and who works for AXA 

Investment Managers, has emerged as 

Europe’s best performing retail fund 

manager in a new survey by Citywire, 

the financial information group. 

Bendahan tops a list of Europe’s top 

100 fund managers which have been 

drawn by Citywire from the 

performance records of more than 

2,500 fund managers over a three year 

period ending in December 2004. 

Altogether the managers run some 

3,700 funds that are available for sale 

to retail investors in one or more 

European markets. 

The funds included in the survey 

invest in 12 principal sectors, ranging 

from global and European equities to 

global and emerging markets bonds. 

Some 54 of the funds were in global 

equities, 17 in European equities, 16 

in global bonds and a further 16 were 

in global mixed assets. North 

American equities accounted for 15 

of the funds in the list, while 

Emerging Markets equities only 

managed three listings and only one 

European small-cap equity fund 

made it into the Top 100. 

The Citywire Top 10 European Fund Managers 

“I think the biggest surprise was the 

spread of fund groups”, says Richard 

Lander, director, Citywire Holding 

Ltd.“Despite the talk of consolidation, 

there were 80 groups represented 

here. No one really dominated and 

you have a big spread from the biggest 

pan-European groups, such as DWS 

Investments and Crédit Agricole, to 

really small outfits such as Riverfield or 

Salzburger Sparkasse.” 

Bendahan’s fund focuses on the 

stock markets of Portugal, Spain, Italy 

and Greece, “where companies have 

been growing rapidly over the last 

decade to catch up with the more 

developed economies of northern 

Europe,”says Lander. In second place 

behind Bendahan is Markus Kaiser, 

who runs several funds for Frankfurtbased 

investment house Veritas SG 

Investment Trust. 

Meanwhile, German firm, DWS 

Investments, has the most fund 

managers in the Top 100. It has five 

managers in the list, while Crédit 

Agricole has four and HSBC and 

Jupiter each have three. However, 

more of the top managers are based in 

the United Kingdom than in any other 

country. Some 25 are based in the UK, 

with 20 in Germany, 14 in France and 

8 in Switzerland. 

Lander explains that the Europe Top 

100 Fund Managers’ list contains the 

managers who have produced the 

best performance “taking account of 

the risks they have taken against their 

funds’ benchmarks.” Citywire 

distinguishes its tracking by following 

the performance records of fund 

managers, rather than tracking the 

funds themselves, “in the belief that 

the talent of the individual manager is 

a crucial factor in delivering extra 

performance for investors.” The 

company’s performance records “also 

take into account managers who run 

multiple funds or change jobs.” 

The research also found that 

German investors have the best access 

to the Top 100 fund managers. Of the 

157 funds they run, 74 are registered 

for sale in Germany, while another 50 

are available in Austria. They are 

followed by Luxembourg, which 

although it is primarily a fund 

administration centre, rather than a 

retail fund market, has 54 of the funds 

available for sale, the United Kingdom 

(with 46), France (43), Spain (36) and 

the Netherlands (23). 

Pos Name Group Fund(s) Currently Managed Licensed for sale in: 

1 Eric Bendahan AXA Investment Managers AXA Europe Du Sud Cap France 

2 Markus Kaiser Veritas SG Investment Trust A2A Basis, A2A CHANCE Germany 

3 Daniel Varela Banque Piguet & Cie Piguet Global Fund International Bond EUR C Luxembourg and Switzerland 

4 Christophe Gay RSI Asset Management Sirius Fund Japan Opportunities Germany, Luxembourg and Switzerland 

5 David Pastel Pastel & Associés Valeur Intrinseque France 

6 Laurent Bouin1 CPR Asset Management CPR Obli-Reactif, CPR Croissance Reactive France 

7 Stephan Albrech Albrech & Cie DAB Adv I Fds - Albrech & Cie. 

Optiselect Fd A Ord 

Austria, Germany and Luxembourg 

8 Karl Surma “schilling” Asset Management SAM Vermoegensverwaltung Global Austria 

9 Tobias Klein First Private Investment Management EUROPA Aktienfonds ULM FP Germany 

10 Luigi Ripamonti Anima Anima America Italy 

Source: www.citywire.co.uk 1. Laurent Bouin left CPR Asset Management in February 2005 


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EUROPE 

34 


CUKUROVA SELL-OFFS 

GENERATE INVESTOR HEAT 

Once again, the US Federal Reserve’s stress on mounting 

inflationary pressure sent jitters throughout the emerging 

markets in March. Led by the private sector, Turkey was one of 

the fastest growing emerging markets in 2004, with GDP and 

GNP growth figures of 6.3% and 6.6% respectively and is 

sufficiently armoured to weather the shock of the capital 

outflows that resulted. Growth this year will fall to around 4.5%, 

still healthy by any standards – but the real temperature of 

investor interest in the country this year will likely be affected by 

private sector developments, such as continued divestments by 

the Cukurova Group. 

FOUR SWING TRANSACTIONS, 

together worth approximately 

$10bn in new foreign investment 

money will put their mark on capital 

inflows into the Turkish economy this 

year.The announcement in late March 

that Finland’s Telia Sonera intends to 

buy a 27% stake in Turkcell for $3.1bn, 

not only means a much needed capital 

injection into the Cukurova group, but 

signals a growing willingness for non- 

Turkish companies to commit to long 

term direct investment in the country 

once more. 

The fate of Cukurova Holding 

appears to be centre stage in the selloff 

of Turkish assets, particularly in 

the buoyant telecommunications 

sector. In late February, Cukurova 

sold around 24bn shares, worth 

around $174m, in Turkcell to JP 

Morgan (equal to just under 2% of 

Turkcell shares) to sell on to non- 

Turkish investors, which left the 

Cukurova group holding a minority 

40% stake. Funds from the sale of 

the shares were used to amortise 

debts owed to Yapi Kredi Bank, 

including $100m in annual interest 

payments and monthly payments of 

$15m to SDIF. 

Yapi Kredi Bank, another 

Cukurova company, itself is under 

the hammer and it now looks as if 

the bank will be successfully sold off 

to a joint venture between Koç Bank 

and Italy’s Unicredito. 

In a separate move, Garanti Bank, 

majority owned by the Sahenc family, 

is also looking for a foreign buyer. A 

mandate was awarded to Morgan 

Stanley in mid-March to find a buyer 

for one of Turkey’s leading export 

financing houses and commercial 

bank. Garanti has been looking, so far 

unsuccessfully, for a buyer since a 

projected deal with Italy’s Bank Intesa 

fell through in early 2004. Turkey’s 

banking sector is ripe for increased 

foreign investment with a slew of 

middle ranking banks up for sale, with 

additional consolidation possibilities 

in the market. Vakifbank, Sekerbank 

are among the key names on the 

block, with the government reporting 

“significant” interest building up on 

the back of consistent economic 

growth. A block sale or public offering 

in Vakifbank, Turkey's seventh largest 

bank by assets, is still likely although 

there are still issues outstanding 

regarding the nature of its ownership. 

Currently foundations and charities 

hold 75% of Vakifbank, with 25% 

owned by the employee pension fund. 

Until the bank’s ultimate 

shareholding is restructured to 

facilitate its privatisation however, it is 

unlikely that a sale will be able to take 

place any time soon. 

On the public sector side, the 

government has announced its 

intention to re-inject some life into 

the country’s mordant privatisation 

programme with the sell-off of iron 

and steel major Erdermir and oil and 

refining company Tupras. The 

combined value of these public and 

private sector sales is well over $10bn. 

The moves have resonance as the 

outlook for indirect investment 

capital inflows appears to be more 

volatile over the short term. In spite 

of a flow of generally market friendly 

news, as hedge funds and global 

banks “used to capitalising on a 

popular carry-trade in emerging 

markets, started to unwind their 

leveraged positions,” according to ˙Is¸ 

Bank researchers. The reasons for the 

outflows were varied. Investors took 

Federal Reserve chairman 

Greenspan’s reported comments 

that current low long term bond 


yields represented a “conundrum” to 

heart by selling holdings in low yield 

long-term government bonds. In 

Turkey’s specific case, additional 

concerns rested on the delay in the 

country’s IMF standby agreement. It 

is a telling point. Until this year 

Prime Minister Erdogan continued 

the process of economic reform, 

working closely with the IMF and 

World Bank. The upshot was that any 

negative impact of the Iraq war was 

well contained, and reforms 

introduced during the 

last three years, together 

with the implementation 

of a floating exchange 

rate produced a more 

robust economy. “All the 

key economic signals for 

the economy are 

extremely positive,” says 

Meltem Agçi, general 

manager of Oyak 

Securities in Istanbul. 

“However we obviously 

cannot easily decouple 

ourselves from that 

Dec-00 

emerging markets tag, which 

invariably affects capital inflows from 

time to time. But the underlying 

fundamentals remain positive.” 

The Turkish economy performed 

credibly in 2003 and 2004. Interest rates 

came down significantly, the Turkish 

lira regained stability, the new Turkish 

lira was introduced, and economic 

growth and inflation targets were 

achieved. The economy is driven 

primarily by private consumer 

demand, which accounts for around 

70% of nominal GDP, compared with 

about 15% of GDP for public 

consumption. Fixed capital investment 

demand accounted for about 25% of 

GDP in the mid-1990s but has steadily 

fallen since to around 17% of GDP, 

with over 30% of this carried out by the 

public sector. As the Turkcell Holding 

deal shows, however, this may change. 


The degree of foreign investor 

interest in Turkcell is no surprise. With 

a total market capitalisation of 

$10.5bn and a good operating year 

behind it, the company is enjoying 

solid growth in subscriptions. Telia 

Sonera’s interest in Turkcell is also 

significant in a wider regional play. In 

early March Turkcell had announced 

that it had submitted a prequalification 

application for a 26% 

stake in the privatisation of Pakistan 

Telecommunication Company Ltd 

FTSE All World Emerging Banks 

300 

250 

200 

150 

100 

50 

0 

Jun-01 

Dec-01 

Jun-02 

Dec-02 

Jun-03 

Dec-03 

All World Emerging Banks Turkey Banks 

Jun-04 

(PTCL); though the deal is not a slam 

dunk, as at least 26 other companies, 

including the United Arab Emirates’ 

Telecommunications and Singapore 

Telecommunications Ltd (Sing-Tel). 

A firm decision is expected some 

time in the autumn. Through its 

Fintur subsidiary, Turkcell has also 

enjoyed strong market growth in 

southern Europe, having achieved 

3.5m subscribers in the region by the 

end of last year. Fintur has also 

begun offering telecoms services in 

the Ukraine. Meanwhile Turkcell 

Holding has also applied for the 

right to buy a significant stake in the 

privatisation of local telecoms 

provider Türk Telekomünikasyon 

A.S¸. (Türk Telekom). 

In 1995, as part of the division of the 

postal and telecommunications 

services, Türk Telekom was created as 

a joint-stock Company under the 

ownership of the Undersecretariat of 

Treasury of Republic of Turkey. 

Through its mobile subsidiary AVEA 

(the recently established company as a 

result of the merger of Aycell and ˙Is¸ – 

T˙IM), Türk Telekom provides 

integrated telecommunications 

services from PSTN to various other 

value added services. 

An extensive investment program 

undertaken during the late 1980s has 

led to a broad network, which is 

ranked today as the world’s 

13th largest network by 

capacity. As a result of the 

growth in mobile services, 

and the continued 

dynamics of the Turkish 

economy, revenue from 

telecom services is set for 

continued strong growth. 

Continuing strong cash 

Dec-04 

Mar-05 


flow, improving margins 

through operational 

effectiveness, strong 

dividend yields, and rapid 

expansion of mobile 

business especially after the recently 

completed mobile consolidation and 

margin improvement for value added 

services should, in theory, make the 

process relatively easy. 

However, the telecommunications 

provider has been up for grabs for 

some time. The government passed 

the legislation enabling the sale of 

more than 49% of Turk Telecom to 

foreign investors around three years 

ago and a final decision on the sell off 

is expected this year. Financial 

advisors on the sell off include BNP 

Paribas, PDF Corporate Finance and 

Denizbank, while legal advisers 

include Turkish legal firm Cerrahoglu 

& Baker Mackenzie. The formal 

tender announcement for the 

minimum 51% of Türk Telekom 

shares is expected to be launched 

before the end of 2005. 

35

COVER STORY: NAPSTER 

36 

As the century turned 

Napster rapidly became the 

world’s first so-called peer-topeer 

(P2P) file sharing service. 

This made it possible for users 

to exchange music as MP3 

files. Napster’s popularity was 

instantaneous and enormous 

and by mid-2000 some 20m 

users were visiting Napster’s 

website, making it the fastest 

growing home-software 

application in history. Only a 

year later however, cashstrapped 

and dogged by 

dozens of lawsuits, Napster 

stared bankruptcy in the 

face. These days, the 

company is riding high again 

and Napster finds itself 

nipping at almighty Apple’s 

heel once more. Dave Simons 

reports on how it was done. 


PICTURE THIS. YOU are scanning the 

radio on the drive home from work 

when, by chance, you catch the last 

few seconds of a favorite old hit from way 

back when. “Haven’t heard that one in 

years,” you think as the song fades. And 

what with the monotony of modern radio, 

chances are several more years will pass 

before you’ll hear it again. Let us say, 

however, that there was an online music 

library that allowed you to download in 

seconds any number of memorable 

melodies – including obscurities such as the 

one you stumbled upon this evening – any 

time, day or night. You could even transfer 

your songs to a portable digital-music 

player and bring them with you on the road, 

if you wanted. Sounds intriguing, doesn’t it? 

Meet Chris Gorog, chairman and chief 

executive officer of digital-music service 

Napster, who presides over such an 

Internet-based music bank, containing well 

over one million songs. Gorog believes that 

there are lots of folks just like you out there, who would 

gladly pony up $10 each month for the privilege of having 

unlimited access to their favorite music, or, for an 

additional $5, have the ability to drag-and-drop the tunes 

into a portable MP3 player. 

In fact, Gorog is so sure that his company’s newly 

launched Napster To Go ‘all-you-can-eat’ portable 

subscription service will revolutionise the musiclistening 

experience, that he is willing to take on the 

mighty Apple Computer and its insanely popular iPod 

digital-music player – quite possibly the most soughtafter 

listening device since the advent of the transistor 

radio. Why would Gorog think he even has a fighting 

chance against such a behemoth? 

Let us go back to that long-lost song on the radio. As a 

Napster subscriber, you could conceivably locate and 

download the song onto your personal computer (PC) or 

add it to your digital player’s song bank. Chances are, after 

a week or so you would have your fill of the forgotten 

classic and delete it from the track lineup, knowing full well 

that you could simply download it again in case you ever 

got the urge to hear it once more. In short, owning the song 

isn’t nearly as important as having access to it. 

Therein lays the fundamental difference between Apple 

and Napster. Those who use Apple’s own online music 

library, the iTunes Music Store, are charged a fee for each 

track they download and then get to keep the tracks for 

good whether they need to or not. And if you want to pack 

your iTunes for your next business trip, Apple insists that 

you use their proprietary iPod player. 

By contrast, Napster believes that you would rather pay a 

set fee each month and in return have access to as much 

music as your player can store. More important, Napster 

makes it possible for you to listen to the music on any one 


of a number of compatible players. It is called variety – and 

Chris Gorog thinks it is the key to Apple’s seemingly 

impenetrable lock on the digital-music business. 

The download motherlode 

The company that today finds itself nipping at Apple’s heel 

is an incarnation of the start-up enterprise that literally put 

downloadable music on the map. Founded in 1999 by 

Shawn Fanning, a freshman at Northeastern University in 

Boston, Napster became the world’s first so-called P2P file 

sharing service, which made it possible for users to 

exchange music as MP3 files (a process that reduces the 

size of larger audio files while still maintaining goodquality 

sound). Napster’s popularity was instantaneous 

and enormous. By mid-2000, 20m users were visiting 

Napster’s website, making it the fastest growing homesoftware 

application in history. 

Naturally, Napster’s free distribution system posed a 

potentially serious threat to the record industry. Before 

long, lawyers representing labels and artists sought to shut 

down the company on the grounds that it violated 

copyrights. Assuming a defensive posture, in 2001 Napster 

made plans to launch a fee-based service, but by the end of 

that year a Federal judge ordered the company offline until 

further notice. Cash-strapped and dogged by dozens of 

lawsuits, in 2002 the once-mighty Napster filed for Chapter 

11 bankruptcy protection. 

While Napster was quickly disintegrating, Apple was 

preparing to make media history. In 2001 came the iPod, a 

revolutionary audio device that utilised a sizeable hard-disc 

(initially 5GB, ultimately as high as 60GB) to store audio 

files. Then in the spring of 2003, Apple came up with a 

novel concept, one that owed in part to the success of 

Napster: to give the minions their music downloads, but 

37


38 

make them part of a legal,‘pay-for-play’service, dubbed the 

iTunes Music Store. Users could purchase songs at 99 cents 

apiece or $9.99 for an entire album. Business was brisk 

right off the bat. Within a week, Apple had moved over one 

million songs. It would reach the 300m mark by early 2005, 

helped along by succeeding generations of iPod, which 

would ultimately account for an incredible 82% of all 

digital player sales. So astounding was the iPod/iTunes 

phenomenon that when Apple unveiled its iMac G5 

computer in the fall of 2004, the accompanying marketing 

slogan read,“From the creators of iPod.” Not surprisingly, 

investors have piled in, driving Apple’s stock price from a 

pre-iPod low of $7 to a recent high of $45, with most of the 

gains coming within the last 12 months. 

Key to Apple’s tremendous success has been – big 

surprise – a highly strategic and incredibly effective 

marketing campaign, which right from the start 

emphasised the simplicity of the iTunes system, in the 

process allaying the fears of the world’s considerable 

technophobe population. Apple’s approach has been so 

spot-on – and its product so 

good, by and large – that 

millions of Internet-music 

neophytes have cheerfully 

plunked down $300 for the 

standard 20GB iPod, 

seemingly oblivious to the 

fact that their player was 

incompatible with any other 

online music source. Despite 

this apparent flaw, 

competitors have so far been 

unable to put so much as a 

dent in the Apple armor. 

But Gorog thinks all that is 

about to change. “With 

Apple, you are talking about 

expert marketing,” he says, 

“and you have to take your hat off to them. But it cannot 

continue that way for very long. You can control the 

software, hardware, the marketing message, all the while 

ensuring that consumers have a successful experience, and 

it all works very well in early adoption. But in mass 

adoption, consumers demand choice, price flexibility, and 

cross-platform inter-operability. I am very content with 

where we stand strategically on that point.” 

New Napster 

The seeds of Napster’s revival were sown back in late 2002, 

when Gorog, then CEO of digital media manufacturer 

Roxio, purchased the trademark and assets of the original 

Napster for $5m in cash. Despite the company’s 

spectacular fall from grace, Gorog believed that Napster’s 

brand name and proprietary technologies still had 

significant long-term value. But Gorog saw something 

more.“I’d always held that it really wasn’t about being free 

– that it was about this extraordinary experience where you 

Flush with $100m in available cash, in 

February of this year Gorog finally 

unveiled the real deal: Napster To Go, a 

portable subscription music service that 

allowed customers to download an 

infinite number of tracks from Napster's 

online song library to a compatible 

digital-audio player. Under the new plan, 

Napster To Go subscribers pay a flat 

rate of $14.95 each month for 

unlimited usage. 

could access virtually anything you could think of, 

download it to your PC, move it to your portable player, 

completely unfettered,” says Gorog. “People who 

experienced that just lit up with the glee of discovery. So 

right away, we made it our goal to replicate the original 

Napster model in a safe, legal environment.” 

In the autumn of 2003, a new, fee-based Napster 2.0 was 

offered to the public as a viable alternative to iPod/iTunes. 

Users could pay $10 per month for unlimited downloads, 

or, like Apple’s iTunes, could opt for the Napster Lite 

version at 99 cents per song. In late 2004, Roxio sold off its 

consumer-software division and began operating under 

the name of Napster. Its stock began trading on the 

NASDAQ a short time later. 

Flush with $100m in available cash, in February of this year 

Gorog finally unveiled the real deal: Napster To Go, a 

portable subscription music service that allowed customers to 

download an infinite number of tracks from Napster's online 

song library to a compatible digital-audio player. Under the 

new plan, Napster To Go subscribers pay a flat rate of $14.95 

each month for unlimited 

usage. If the subscription lags, 

further access is denied and 

all previously downloaded 

material removed.The process 

is made possible through the 

use of Janus, an extension to 

the digital rights management 

system (DRM) of Microsoft’s 

Windows Media, which 

allows users to transfer 

subscribed-to tracks from a 

desktop computer to a 

compatible portable player. 

Janus allows rights-protected 

songs to be distributed to 

customers through a 

subscription model such as 

Napster's, and subsequently copied to portable devices, 

whereupon they will expire at a specified date. 

Gorog points to the “fluidity”of the system, which makes 

it possible to easily move back and forth large portions of 

anyone’s personal music library. “If you had a 20GB 

portable device, you could easily have a replica of the music 

you have downloaded to your hard drive with you at all 

times,”says Gorog.“Want to take the top 20 jazz albums of 

all time along on your next business trip? Boom – drag and 

drop. And there it is. It really is a powerful tool.” 

How does Gorog react to his detractors who complain, 

‘Great – as soon as I stop paying that $14.95, they take 

away all my songs”? “I think what it comes down to is that 

people will change their view about what is important, and 

we are already seeing that happening,” says Gorog. “For 

those who want to collect and own the music, we still have 

our à la carte service. But another tremendous aspect of this 

system is that you have the potential for a much more 

informed and enlightened listening audience, just by virtue 


of the fact that you have ready access to such a tremendous 

volume of music.” 

Napster’s Numbers 

Napster’s optimism over its subscription-service launch is 

borne out in the recent numbers. In the final quarter of the 

2004 fiscal year, Napster took on 90,000 new subscribers, a 

50% increase from the previous quarter, while the 

company’s revenues jumped 30% to $12.1m from $9.3m 

just three months earlier. Though still running in the red 

(with an expected Q4 loss of $0.63 a share), in March 

Napster boosted its revenue guidance for the current 

quarter by $1m to $15m. Piper Jaffray has raised Napster’s 

By the end of the decade, 

analysts believe that the higher 

profit margins of Napster-styled 

subscription plans will eventually 

meet and then exceed iTunes-based 

pay-per-play plans to the tune of 

$890m vs. $800m in revenues. 

fiscal 2006 revenue estimate to $86.5m and its subscriber 

base to 655,000 (from a current 270,000), with an 

“outperform” price target of $14. The analyst expects that 

the success of Napster To Go will be closely tied to the 

movement of Janus-enabled portable audio devices, which 

at present includes manufacturers such as Samsung, iRiver, 

Dell and Creative. MSRP for Napster-compatible players 

currently ranges from around $225 to $450, though IDC 

analyst Susan Kevorkian sees prices eventually dropping to 

under $100 in some instances. 

While this may create some badly needed competition 

for the iPod, Kervorkian believes that subscription services 

such as Napster’s will first have to allow customers to 

become acclimated to the idea of “renting” music on their 

portable players. Additionally, says Kevorkian, some people 

may find the Napster system a bit more challenging than 

Apple’s, but she also added that the Napster To Go model 

is“novel, it is leveraging technology for music consumption 


in ways that have never really been done before.” 

If Napster’s current subscriber base seems miniscule 

compared to iTunes’ 300,000,000 downloads, observers say 

that it’s the trend that counts. By the end of the decade, 

analysts believe that the higher profit margins of Napsterstyled 

subscription plans will eventually meet and then 

exceed iTunes-based pay-per-play plans to the tune of 

$890m vs. $800m in revenues. 

“We are looking at a market that is expected to move 

from around 15-20m portable players today, to upwards of 

80m in just a few short years,”says Gorog.“That is a major 

portion of the market still ahead of us. So that is 

something that we are obviously really focused on.” 

Though Napster’s list of compatible players currently 

includes only a handful of models, by the fall, Gorog 

expects there to be upwards of 50 to 60 different varieties to 

choose from. “I think it will be difficult to find a WMAbased 

player that isn’t compatible with Napster To Go 

before very long,”says Gorog. 

Analyst Mark Mulligan of Jupiter Research in London 

admits that subscription plans such as those espoused by 

Napster may indeed have a bright future.“Napster To Go will 

significantly enhance value for existing customers and will 

be the tipping point for many ‘wavering voters,’” remarks 

Mulligan. Although the plan may not make Apple “twitch 

nervously” over the near-term, Mulligan called Napster To 

Go a “milestone,” one that significantly strengthens the 

subscription service proposition. “Sure it will take time for 

consumers to become familiar with the rental model, let 

alone the portable rental model,” says Mulligan,“but when 

music fans get their heads around the concept, subscription 

39


40 

services offer the ability to consume much more music for 

much less money then with à la carte.” 

Gorog expects steady state margins on the subscription 

side to range anywhere from 30% to 40% going forward, or 

roughly four times the profit margin on the download 

business.“Which is pretty healthy for us,”he says. 

How does Apple feel about the upstart Napster 

encroaching on its digital domain? Hard to say. Though 

Apple officials declined an 

interview request, in a 

recent e-mail to musicindustry 

executives, Apple 

CEO Steve Jobs noted 

how Napster’s Janusbased 

security system 

could be breached simply 

by manually recording the 

downloaded music stream 

– which, as Mulligan 

points out, can just as 

easily be accomplished on 

iTunes. “The difference of 

course is that you have to 

pay for each track rather 

than a flat fee for an 

Can Napster find the key to break Apple’s hold on the 

digital-music business? 

450 

400 

350 

300 

250 

200 

150 

100 

unlimited amount,”adds Mulligan. 

Gorog considers the Jobs’ jab an indication that Apple 

does indeed take Napster quite seriously.“When I think of 

our competition going forward, in the short term, obviously 

I’m thinking of Apple,” says Gorog.“But in the long term, 

I’m really not, mainly because I think they are going to 

marginalise themselves as they traditionally have by 

working with a closed proprietary system – a walled 

garden, if you will – for their consumers. And what ends up 

happening is that their customers can’t really relate with 

the rest of the technological world.” 

In iPod’s proprietary design, Gorog sees a vulnerability he 

is more than willing to exploit. For instance, because Apple 

hasn’t licensed its software to 

third parties, the iPod isn’t 

available to use with Napster 

To Go. “While I think that is 

unfortunate for Apple, in 

reality it becomes a great 

competitive advantage for 

us,” says Gorog, “because we 

have built all of our 

technologies on the Microsoft 

platform, which is very important in the MP3 player market, 

especially since Microsoft has market-share leadership in 

the hard-drive and flash-memory categories.” 

Of equal significance, says Gorog, is the number of 

leading digital-entertainment manufacturers who are 

going into the average living room with equipment built on 

the Microsoft platform. And the same holds true for car 

audio says Gorog, “under this scenario, compatibility is 

obviously not an issue going forward.” 

50 

Dec-03 

Feb-04 

Apr-04 

Jun-04 

Napster makes it possible for you to 

listen to the music on any one of a 

number of compatible players. It is called 

variety – and Chris Gorog thinks it is the 

key to Apple’s seemingly impenetrable 

lock on the digital-music business. 

Hear today, gone tomorrow 

If over the next several years Napster’s business plan turns 

out to be a successful one, observers may point to the fact 

that Napster was in some respects the first company to 

truly acknowledge that music is no longer the tactile 

commodity it once was. Of course, this is nothing new.The 

fragile plastic and puny cover space of the compact disc 

long ago de-emphasised the visual aspect of the 

Aug-04 

Oct-04 

Dec-04 

Apple Computer FTSE US Media & Entertainment Index 

Feb-05 

FTSE US Info Tech Hardware Index FTSE US Software & Computer Services Index 


traditional album, while 

the ability to copy music 

in digital form has 

allowed listeners to 

bypass song sequencing 

altogether and simply 

compile and shuffle tracks 

by any number of artists at 

will. And then there is the 

issue of portability. With 

laptops now 

outnumbering desktops 

and cell phones fast 

replacing land lines, 

having the ability to cart 

around your entire record 

collection in a device the 

size of your shirt pocket is enormously enticing, 

particularly where the all-important youth demographic is 

concerned. “Downloads to the PC only has not really 

resonated among 18-24 year olds,”notes Gorog.“But with 

portability, they go crazy. And that demographic is the one 

that has had the most passionate interest in this product. 

That’s very exciting for us.” 

As audio gradually transforms completely from a 

physical medium to a bunch of bits and bytes on the 

computer, Napster appears to be unusually well positioned 

to serve the new disposable music marketplace. 

“I’ve watched my kids buy a CD, and once they’d rip it, 

they could roller-skate over the original if they wanted 

to,” says Gorog. “It didn’t 

matter – because at that 

point they didn’t value it. 

What I believe is happening 

is an absolute paradigm 

shift in all media but in 

music in particular where 

people will clamor for 

instantaneous access to 

everything, anytime, 

anywhere. That is what they will pay for and that is what 

they will really value. Let us face it – if you were a record 

collector, you spent years dragging around all those 

albums and CDs from place to place, listening to only a 

small percentage of them while all the rest gathered dust. 

But in this new environment, the idea of owning a CD, or 

a set of music files, or whatever, will become less 

essential. And, in time, the whole concept of how we 

value our music will change for good.” 


Pierre Francotte, chief executive officer 

(CEO) of Euroclear SA/NV 


Armed with a new corporate structure 

and a perspicuous business plan, 

Euroclear has it all to play for. 

Formally announced at the end of last 

year, the two strands of Euroclear’s 

forward plan combine the 

harmonisation of market practices 

across the Euroclear group’s five 

domestic European markets and in the 

international securities markets, with 

the creation of a single transactionprocessing 

platform. Francesca 

Carnevale went to Brussels to discuss 

the substance behind the strategy and 

found Euroclear’s chief executives 

evoking a powerful polemic on the 

business drivers for change. 

IN 

PURSUIT 

OF THE 

STRATEGIC 

DOUBLE 

CORPORATE PROFILE: EUROCLEAR 

41


42 

EUROCLEAR’S NEW MEDIUM and long-term 

directional strategy hinges on two elemental tasks. 

The first is a project to migrate the processing of 

securities transactions to a single settlement engine (or 

technology platform) serving three of the central securities 

depositories (CSDs) that form part of the Euroclear group – 

namely Euroclear Bank, Euroclear France and CRESTCo – 

by the end of 2006. The second element builds on the single 

settlement engine project and involves the harmonisation 

of market practices within the Euronext-zone markets of 

Belgium, France and the Netherlands and the launch of a 

single processing platform to service this market. This 

second strand is described in a recent Euroclear market 

update paper as “an integrated settlement solution for stock 

exchange and over-the-counter (OTC) activities,” and it is 

expected to be underway by 2007. In four-to-five years 

then, the world’s largest provider of domestic and crossborder 

settlement services will operate a single transactionprocessing 

platform for all the markets in Euroclear, 

encompassing settlement, custody and collateral 

management, and using one common interface to send and 

receive instructions and reports. 

The articulation of the new strategy is significant, by any 

standards, and that for a number of reasons. First, it 

reflects the growing confidence of Euroclear to act 

decisively in a marketplace that is still seeking answers to 

questions regarding the long-term structure of pan- 

European cross-border settlement (and clearing) services. 

It clearly lays out Euroclear’s particular road map. Second, 

it cuts one of the Gordian knots in the European settlement 

weave, namely that the creation of a unified market is not 

possible in the near term partly because of a complex 

structure of legacy settlement systems already in place. 

Third, it makes sense from a purely business perspective. 

With today’s focus on servicing every phase of the 

investment lifecycle as a means of customer retention and 

client acquisition, the back-office transaction management 

aspects need to be as efficient as possible. 

Finally, the strategy is an inevitable response to an 

increasingly demanding client base that is simultaneously 

becoming more global in its outlook and now requires an 

appropriate infrastructure able to cope efficiently and cost 

effectively with cross-border settlement— particularly 

when this involves instruments denominated in multiple 

currencies and/or a diversified securities portfolio. That 

infrastructure perforce requires an up to date, robust and 

high-capacity settlement platform. 

Acknowledging the convergence of these factors in the 

drive towards a pan-European settlement solution, Pierre 

Francotte, chief executive officer (CEO) of Euroclear 

SA/NA, explains the “business sense” behind the strategy. 

His is a particularly Continental polemic, with inevitable 

geopolitical undertones.“It is the drive for Europe itself to 

become more competitive,” he states. “Euroclear, in this 

regard, is a catalyst for change, spearheading consolidation 

among CSDs and market practice harmonisation.” 

In kick-starting its new business model, a restructuring 

of the Euroclear business was itself a priority. At the 

beginning of this year, a new structure was announced. 

Euroclear SA/NV was established as the new holding 

company of the group's national and international central 

securities depositories (CSDs). The new company, 

incorporated in Belgium and with branch offices in 

Amsterdam, London and Paris, owns the group's shared 

securities-processing platforms and delivers a range of 

services to the group's depositories, including development 

of its technology platform. As part of the restructuring of 

the group, Euroclear Bank has relinquished its ownership 

of the group's three CSDs and instead becomes a sister 

company to them, under the ownership of Euroclear 

SA/NV. CIK, the Belgian CSD will likely also become a 

sister company of the other Euroclear depositories later this 

year, subject to final completion of the purchase agreement 

with Euronext. 

In part, the restructuring was a natural precursor to the 

implementation of the single platform initiative. It 

provides the institutions, which have a stake in the 

Euroclear business, with greater comfort. According to 

Francotte, "The new structure minimises systemic risk by 

segregating the group's CSDs and their clients in the 

highly unlikely event of Euroclear Bank's insolvency." At 

the time of the restructuring, Francotte moved from being 

CEO of Euroclear Bank to becoming the first CEO of the 

new Euroclear SA/NV. Ignace Combes, deputy CEO and 

vice chairman of the management committee of Euroclear 

SA/NV meanwhile explains that: "The impact of this 

restructuring on Euroclear's clients is minimal. As 

Euroclear SA/NV only provides services to the other 

Euroclear group entities, clients will continue to access 

Euroclear services through Euroclear Bank, CRESTCo, 

Euroclear France or Euroclear Nederland, as they have 

always done." 

Operationally, as an additional safeguard, in the light of 

events such as 9/11, Euroclear is in the process of 

establishing a state-of-the-art business-continuity 

programme, focusing on two live synchronous data 

centres. “The business will continually rebalance between 

them,” explains Combes. “If one falls out, the other takes 

over. Obviously, there needs to be a certain distance 

between the two centres. Today’s sophisticated technology 

is able to ensure that the two are perfectly synchronised, if 

located within a reasonable distance.” The plan is to 

establish the two live data centres and a third 

asynchronous data centre in another country some time in 

2006. The advantage of having a third data centre, explains 

Combes, is that if a force majeur event occurs, “Euroclear 

will be able to restart, in a different country, within a 

maximum period of three hours.” 

Internally then Euroclear’s strategy has cohesion and 

depth. Externally, Euroclear is hearing the beat of a 

different drum. In the broader business context, it quickly 

becomes apparent that for Francotte at least, a committed 

European, the heart of the matter of Euroclear’s broadbrush 

strategy rests with the Lisbon Agenda of March 2000 


Euroclear’s New 

Corporate Structure 

(As of January 1 2005) 

EUROCLEAR 

BANK 

Brussels 

Euroclear’s Former 

Structure 

EUROCLEAR 

FRANCE 

Paris 

EUROCLEAR 

FRANCE 

Paris 

when the EU heads of states and governments agreed to 

make the European Community (EC) “the most 

competitive and dynamic knowledge-driven economy by 

2010”. “We are all in this for the long term,” he stresses, 

“and we are now focused on the remaining obstacles to 

developing a truly European capital marketplace.”Europe's 

barriers in becoming a single market have come down to a 

significant degree, he maintains. In specific areas, such as 

clearing and settlement, initiatives such as SWIFT’s ISO 

15022 messaging, which allows CSDs and their clients to 

communicate in a standardised manner, has invariably 

helped the overall trend. There is also regulatory and 

industry support, with bodies such as IOSCO, ECSDA and 

ISSA keen to see greater co-operation between Europe’s 

CSDs and ICSDs. Francotte also cites other significant 

initiatives that have emerged alongside the Lisbon Accord, 

such as the MiFD’s European Passport, allowing banks 

already regulated in one EU country to provide services on 

a remote basis within the EU without additional regulation. 


EUROCLEAR PLC 

EUROCLEAR SA/NV 

Brussels 

CRESTCo 

London 

EUROCLEAR PLC 


Brussels 

CRESTCo 

London 

EUROCLEAR 

NEDERLAND 

Amsterdam 

EUROCLEAR 

NEDERLAND 

Amsterdam 


London 


London 


London 

CIK 

Brussels 

[2005*] 

Deregulation of large swathes of the financial services 

industry and the implementation of the single currency, 

were key reasons for shifting patterns of investment in the 

European theatre. “The first effect was that any investor, 

from anywhere in Europe, could more readily take a 

position in, say, French equities, for example. Second, it has 

allowed a discernable shift towards sectoral investment as 

foreign exchange risk has been largely eliminated,” he 

explains. Combine this change with the ability to do crossborder 

business at a lower cost,“and you see a mounting 

propensity or greater appetite for investment beyond 

national borders,”he adds. 

At the same time, expands Francotte, cross-border 

trading in European equities is expected to continue 

growing, spurred by individualisation of pension plans, 

improved trading technology and expertise, and the rise of 

a multiplicity of investment styles. “Short-term trends 

aside, this increase in trading volumes is a long-term trend, 

and is here to stay. It is all the more important then that a 

43


44 

cheap, efficient post-trade environment is created for this 

growing pool of cross-border investors,”says Francotte. 

Painfully aware of the constrictions still extant in the 

fragmented clearing and settlement landscape in Europe, 

he dramatically explains the scarifying magnitude of the 

costs of fragmentation borne by the market, “which are 

estimated to be in the order of €4bn to €5bn a year.” He 

further cites the supporting example of Merrill Lynch,“who 

kindly said we could quote their numbers, though the 

figures are a few years old,”he qualifies. “Its total trading, 

clearing and settlement costs were more or less the same in 

both the US and Europe, but it is the volume that these 

costs apply to that is astounding. Merrill Lynch was 

spending exactly the same amount of money to trade 2m 

shares on the NYSE each day as it did for 70,000 shares 

across Europe.” Clearly, he says, expanding on his theme: 

“Thinking as an investment banker, I have to ask,‘If I am to 

grow business, where can I do it?’” 

Francotte positions broader geopolitical considerations 

as a further shift in gear. Competition is intensifying 

between the financial markets of North America, the Far 

East and Europe. Inevitably then, he posits, “Investment 

bankers will tell you that the currently fragmented posttrade 

infrastructure in Europe is such that it is having an 

impact on their future business decisions.” 

Francotte’s views are particularly trenchant given that 

Euroclear has emerged from this patchwork to date as the 

world’s largest provider of domestic and cross-border 

settlement and related services for bond, equity and fund 

transactions. Governed by 24 market institutions and two 

independent directors, and owned entirely by its 

customers, the Euroclear group comprises Euroclear Bank, 

based in Brussels, as well as Euroclear France, Euroclear 

Nederland and CRESTCo, the central securities 

depositories of France, the Netherlands, and the UK and 

Ireland, respectively. 

How Euroclear got there is almost the stuff of airport 

thrillers. Driving competition, consolidation and 

acquisition have been the watchwords of the European 

settlement (and clearing) markets during the last decade, 

with relationships, alliances, mergers and intense 

acquisition activity acting as moving pieces on the 

European checker board. The hand controlling the moves 

was obvious. Historically, all markets had their own CSDs 

to handle the settlement of domestic and transactions. 

Each of these platforms had evolved according to the 

particularities of their own marketplace and local 

regulatory regimes. In consequence, the market is now rife 

with a lack of standardisation, which didn’t really matter 

that much when the majority of settlement activity 

stemmed from domestic trades. But with the rise of crossborder 

trading and a growing demand for cost efficient 

cross-border settlement services, a network of standalone 

CSDs was increasingly untenable. 

Two institutions emerged as drivers of change: 

Clearstream, an alliance of Cedel and Deutsche Börse 

Clearing (now owned entirely by Deutsche Börse), and the 

Brussels-based Euroclear. While both have tried and are 

still trying to unify cross-border clearing and settlement in 

their own image—in trying to achieve their goal, they 

chose entirely different approaches. Clearstream favours a 

‘vertical silo’ model, where the exchange only allows 

clearing and settlement to occur in the post-trade 

businesses that it owns. Euroclear however, prefers a 

more open, horizontal approach, a perspective also 

championed by the European Securities Forum (ESF). The 

horizontal approach means that the provision of 

settlement services is exchange neutral, meaning that 

exchange members are free to choose the settlement 

location that best meets their needs. 

Clearstream was acquired by Deutsche Börse back in 

February 2002. Euroclear then remained free to pursue its 

open-ended approach of gradually acquiring several of 

Europe's CSDs, with each acquisition providing a boost to 

Euroclear’s growth strategy. And soon, under Euroclear’s 

new business model, the CSDs in the Euroclear group will 

become a single settlement infrastructure provider, 

“offering significant cost savings and reducing operational 

risk,”says Francotte. 

Euroclear and Clearstream have long lived alongside 

each other in an atmosphere of uneasy truce. In 

November last year, Clearstream and Euroclear 

announced they had successfully implemented the second 

phase of a new Automated Daytime Bridge between both 

CSDs. The 'Bridge' is an electronic communications link 

that facilitates the efficient settlement of securities 

transactions between counterparties in Clearstream 

Banking Luxembourg and Euroclear Bank. This second 

phase provides improvements, such as the extension of 

instruction deadlines and same-day Bridge transactions 

between the CSDs and builds on an initial phase, which 

was completed five months earlier. The first phase, 

completed in June 2004, delivered improved settlement 

efficiency and enabled customers to reduce their costs by 

having more opportunities to settle Bridge transactions 

that failed during the overnight process. 

While on the surface, it appears a common-sense 

move, it was a long time in coming and neither party 

arrived there too gracefully. Clearstream Banking 

Frankfurt had for some time previously fallen foul of the 

European Commission, which had found it in breach of 

competition rules in refusing to supply Euroclear Bank 

with certain clearing and settlement services. Everyone 

appears to have made up and Euroclear plays down any 

residual hard feelings. Explains Combes, “We sit together 

on important industry institutions, such as ECSDA. We 

also have common interests, like the Bridge, on which we 

will both build.” 

Tellingly perhaps, although Euroclear’s annual results 

announcement mentioned the Bridge initiative, it pointedly 

mentioned “larger numbers of new and existing clients have 

elected to settle their securities transactions on a book-entry 

basis in Euroclear Bank, with Bridge transactions 

accounting for a dwindling proportion of overall business.” 


Francotte does not duck the issue of competition and the 

essential dynamic of the battle between the two entities to 

determine the future structure of clearing and settlement in 

Europe. “In the end, it will be the market to decide which 

model best suits their needs by placing their business with 

the best provider. If there is to be a monopoly, it should be 

decided by the market and not our regulators,” he 

maintains. But Francotte insists he would prefer an open 

and competitive marketplace which gives users choice. 

“There is no need to create a monopoly. It won’t 

necessarily help the situation,”he adds. 

Combes concedes that there is still much to be resolved 

in the market place before either Euroclear’s or 

Clearstream’s approach will win the day. For the time 

being, Euroclear appears to have the upper hand. But there 

is still much to play for, with the Italian and Spanish 

clearing and settlement systems, among others, remaining 

firmly independent of either Euroclear or Clearstream. 

Irrespective, it does not appear to worry Francotte overly 

much. His sanguine view stems from a firm belief that 

Euroclear is planted firmly in a business area in which there 

is need for competition, not less of it. Nor does Euroclear 

have pretensions beyond what it regards as its natural 

hinterland. “We have no overseas acquisitions in mind,” 

explains Combes. “Our main focus is on Europe. If a 

customer wants us to add a link to a market we do not 

already serve, we will add that link to the 32 local-market 

CSD relationships already in place. We take the view that 

there are many ways to work with CSDs. We do not need 

to buy them outright.” Combes is also keen to stress that 

part and parcel of Euroclear’s strategy is to work closely 

with the appropriate regulatory authorities. 

Understandably then, in Francotte’s road map, the 

agreement between Euroclear and Euronext on the 

acquisition of CIK, the central securities depository of 

Belgium, a wholly owned subsidiary of Euronext, is a 

natural outer marker. The acquisition process began in 

November 2004 and the deal is expected to be finalised by 

the summer, subject to appropriate legal and regulatory 

process. The deal with Euronext builds on a July 2001 deal 

between the parties that transferred CIK’s book-entry 

settlement and custody business to Euroclear. Under the 

terms of the new arrangement, both the book-entry 

business and the physical securities activity of CIK – 

including the newly launched ‘Printing on Demand’service, 

SICAV settlement and nominative register management, 

among others – will be consolidated in Euroclear.“Belgian 

clients will be able to benefit from a single entry-point for 

all of their settlement activity, physical as well as 

immobilised,” explains Combes. “The acquisition by 

Euroclear of CIK will help to facilitate the completion of 

Euronext’s business model,” he expands. “Eventually, this 

will lead to a unified settlement platform to complement 

Euronext’s single order book. It will also further ease crossborder 

trading and provide a natural environment for CIK 

and the other Euronext-market CSDs to continue 

developing other services for their clients.” 


Ignace Combes, deputy CEO and vice chairman of the management 

committee of Euroclear SA/NV. 

Combes is keen to stress that through acquisition, 

Euroclear has “grown in understanding.” There are a “lot of 

things we discovered,”he explains. “Local CSDs were very 

effective, for example, in the way in which they consulted 

with their market. Consequently, as a group, we have 

learned how to get input and consult more effectively. We 

have also learned to be more sensitive to local aspects.” 

Aside from the obvious market drivers that are 

propelling Euroclear on its current route, there are also 

more piquant reasons still for Euroclear’s growth plan. 

According to its annual report, Euroclear group recorded 

across the board gains in operating performance through 

2004, including a 20% increase in settlement turnover and 

a 10% rise in the value of client assets held in custody. The 

total value of securities transactions settled last year was 

?307.1trn and securities held for Euroclear clients reached 

?13.1trn. Growth, says Combes, “can be attributed to a 

combination of satisfying our clients’ day-to-day needs 

everyday and making progress on delivering a post-trade 

infrastructure that will meet their needs in the future.” 

It is apparent that Euroclear nowadays “enjoys a much 

greater sense of the role it needs to play in the markets,” 

says Combes.“Teamwork is a strong internal motor. We 

are a much more integrated organisation these days, with 

a real sense of shared objectives.” Francotte adds that, 

“Euroclear has taken on a big challenge, not always 

pleasing everybody. It is important to stress that we are 

striving to improve the local and international appeal of 

the capital markets in Europe.” It is an imperative, thinks 

Francotte. “If we don’t take this role, if we don’t succeed, 

we believe Europe’s capital markets will move 

somewhere else. So where we need to take the initiative, 

let’s take the initiative.” 

45

SUB-CUSTODY 

46 

In a hard hitting article, Tim Steel posits the 

view that the outlook for sub-custodian services 

in Europe will be much tougher than before. In 

an increasingly sophisticated and complex 

market, the resolve of many sub-custody 

providers will be tested as their infrastructure, 

reach and product set are stretched and tested 

again and again. 

SUB- 

CUSTODY 

RACING 

TO 

THE 

FINISH 

THERE IS PLENTY of anecdotal evidence to suggest 

that a significant number of sub-custodians in 

Continental Europe have yet to wake up to certain 

unpalatable realities. Market consensus has it that the 

majority of the region’s agent banks face a challenging 

future. Unable to offer the breadth of product set and 

geographic reach now demanded by an increasingly 

sophisticated and diversified client base – or indeed to fund 

the sort of infrastructure investment necessary to rectify 

those shortcomings – it is argued that the genus of monomarket 

sub-custodian that have traditionally serviced the 

local custody, clearing and settlement needs of institutional 

investors and intermediaries face imminent extinction. 

The past few years have seen the inexorable rise of pan- 

European providers, notably Citigroup and BNP Paribas, 

offering multiple product lines across multiple markets. 

While Europe remains a deeply fragmented proposition as 

far as post-trade processing is concerned – a tangle of 

diverse and at times flat out contradictory regulatory, 

legislative and tax environments give the lie to any notions 

of a single common market – it is still possible for these 

pan-regional players to build and leverage economies of 

scale. 

As Brian Todd, head of network management, EMEA for 

JPMorgan Investor Services – which is principally a buyer 

of sub-custody services in Continental Europe – notes: 

“Sub-custody is bought on the basis of service, but that 

service is pretty well defined in terms of what it takes to be 

a sub-custodian: custody, settlement, corporate actions, 

income collection, securities lending and borrowing. So 

ultimately it comes down to being a commercial 

conversation around price, settlement cut-offs, systems, the 

number of markets a provider can service – and if you buy 

in bulk, you can get a better price.” 

Consolidation in the sub-custody sphere in recent years 

has been driven by two engines: strategic reviews within 

individual banks – pace the merger of BNP and Paribas in 

France – and by banks deciding that they only to want to 

compete in those lines of business where they can build 

significant scale and/or market leadership. For many, this 

product set no longer includes sub-custody. “As a result 

we are now down to two or three quality providers in 

each market and at the same time we are seeing 

emergence of the pan-regional sub-custodians,” says 

Todd.“This trend is not one that is going to go away, and 

over time we will see the consolidation of individual subcustodians 

into those groups.” 

Stephen Brown, regional head of network management, 

Europe, Middle East, Africa and Americas at Northern Trust – 

another buyer of sub-custody services in Europe – stresses 


that the shift towards pan-regional providers does not mean 

there are no longer any good indigenous mono-market 

providers to be found. Brown concedes that Northern’s 

network today largely comprises regional providers. “Over 

the last few years we have changed our custodians in a 

number of markets and on all but one occasion we have 

consolidated with a regional provider,”he says. 

Lack of scale and geographic reach is a problem for monomarket 

providers, he adds, while strong pan-regional players 

can boast credit and service quality across more than one 

location. “The fact that they are regional providers 

demonstrates clear commitment to the business,” Brown 

says. “They also tend to evidence greater investment in 

technology based upon capability and contingency planning, 

and typically also have broader experience and client base. 

For us as a global custodian we can certainly derive 

relationship, servicing and pricing advantages from using a 

single provider across multiple markets.” 

While sub-custody clients might give the impression that 

service is less important than cost, in reality they want the 

best of both worlds: top quality service allied to a keen price. 

“That is not an easy balance to strike,”says Jon Lloyd, head 

of clearing, settlement and custody at BNP Paribas 

Securities Services. “European integration and 

harmonisation is taking longer to achieve than predicted 

and it is also proving very expensive – 25-30% of my IT 

budget for the coming year is being spent on implementing 

mandatory market changes. Now, I have a broad franchise 

across Europe to amortise that against, but for a monomarket 

provider that is a huge amount of cost to take 

onboard. Factor in Basel II and TARGET 2, and the monomarket 

provider is extremely exposed.” 

Factor in the commercial aspirations of the region’s 

depositories (of which more later), and it is easy to 

understand why many of those sub-custodians that have 

not quit the business – casualties include Dresdner in 

Germany, Bank Leu in Switzerland, CSFB in Russia and 

most recently ABN AMRO, which sold out to Citigroup – 

are looking to alliances and white labelling in order to 

survive. Both ING Bank and Allied Irish Bank, for example, 

have tied the knot with The Bank of New York. The global 

custodian has also just signed a custody deal with Natexis 

Banques Populaires which is expected to evolve into a fully 

fledged alliance in due course. 

Giulio di Cerbo, managing director, Citigroup Global 

Transaction Services, sees white labelling as an important 

growth area going forward. “Sub-custodians are asking 

themselves whether they have the necessary scale and how 

core the business is to them,” he says. “They could 

obviously choose to sell or to enter a joint venture but a 

number of banks, while recognising there is a need for a 

pan-European solution, are looking to retain their clients 

and their business. In that situation we can white label the 

offering on their behalf. 

“They continue to service their client base and distribution 

channels, but rather than investing in other European 

linkages, they can leverage our scale and single common 


Stephen Brown, regional head of network management, Europe, 

Middle East, Africa and Americas at Northern Trust 

technology across multiple jurisdictions. It makes little 

difference to Citigroup whether the volumes coming in 

originate from Germany, France or Italy, so we can provide 

one price across multiple jurisdictions, one set of standards, 

one set of reporting, one communication methodology – and 

those save costs both for the client and us,”says di Cerbo. 

New European directives mean major clients no longer 

buy or sell through a local country broker but rather are 

members of exchanges, he continues. “However, for many 

broker-dealers and banks that is an unwelcome cost burden. 

So we now provide on-exchange clearing and, in addition, 

peripheral services such as cross-border margining and 

access to multiple CCPs and depositories. Should securities 

not come in as expected, we will deliver them from our 

lendable portfolio to the exchange on behalf of our client, and 

we also provide inter-day liquidity and inventory financing 

where banks and brokers have residuals in their account at 

the end of the day.” 

Asian sub-custody 

In Asia, however, there are no such concerns.As Paul Hedges, 

global head of securities services at Standard Chartered Bank, 

notes a key difference between the post-trade environments 

in Asia and Europe is the harmony at the depository level.“I 

sit on the Asia Pacific Central Securities Depository Group 

(ACG) and while the depositories do communicate with each 

other, the level of harmonisation and linkages you see in 

Europe simply does not exist here,”says Hedges.“The ACG is 

talking about hammering out various Memorandums of 

Understanding between CSDs, but we are a long way away 

from that becoming a reality – and for the right reasons, as 

every market in Asia is clearly very different, with no common 

currency or regulatory framework.” 

For his part, Colin Brooks, deputy head of custody and 

47

SUB-CUSTODY 

48 

Giulio di Cerbo, 

managing director, 

Citigroup Global 

Transaction Services 

clearing at HSBC in Hong Kong, feels that Asia has come a 

long way in the last five or six years in terms of uniformity – 

“settlement cycles have come into line and all the markets 

are dematerialised, there is an overall view that markets 

need to be more transparent and there must be a level 

playing field between market participants” – but he agrees 

that the region remains some way away from seeing the sort 

of linkages between exchanges and depositories now so 

common in Europe. 

As for the sub-custody product in Asia, Brooks says it too 

has matured considerably in recent years. “In the past you 

were judged on your ability to settle a trade efficiently and 

process a corporate action,” he says. “These days, however, 

our clients want much more of us – they expect us to truly act 

as their eyes and ears on the ground, to act as their business 

partner and to really understand what their business entails 

and provide them with a customised suite of products.” 

Paul Hedges says that, whereas the region’s subcustodians 

have traditionally serviced ‘Western’ clients, there 

is now a fast growing Asian client base as a result of 

demographic changes, the rise of provident funds and 

personal retirement plans as well as new investment by Asian 

non-government and government institutions both within 

and without the region. He believes this shift will directly 

benefit pan-regional players like Standard Chartered and 

HSBC. “In Europe we have seen a move 

towards pan-regional sub-custody provision 

for a number of reasons: commonality of 

currency; harmonisation on the regulatory 

front but primarily due to acquisitions,” says 

Hedges. In Asia, however, the growth of the 

pan-regional providers has primarily been 

driven by consumer banking presence and 

latterly wholesale banking activities, he adds. 

“Certain markets – Malaysia, Korea, 

Indonesia, Japan – have traditionally been 

dominated by mono-market banks with 

immense local influence stemming from 

huge, predominantly corporate businesses,” 

says Hedges.“In addition, in some markets – 

Singapore for instance – the mono-market 

players have been protected by the regulatory 

environment and ownership rules, as we 

were restricted from offering certain services. 

“What has changed over the last couple of 

years, and indeed has gained significant 

momentum in the past 6-8 months, is that 

due to demographic and other changes the 

buyers of sub-custody services are starting to 

look at Asia as an investment destination in 

itself – but they only want to access the 

region through a single window. So the 

region will follow the same path as Europe – 

but for different reasons, and at a different 

level of intensity.” 

Colin Brooks believes that the traditional 

strengths of pan-regional providers – scale 

economies, deeper pockets, streamlined access to multiple 

markets – will prove compelling going forward.“The truth is 

that these days there are really only a few markets – such as 

Japan, Australia and Singapore – where you still have serious 

mono-market providers,” he says. “There was a huge 

shakeout during the Asian crisis at the end of the Nineties, at 

which time a lot of local banks saw their credit ratings 

lowered and they consequently lost a lot of business. As a 

result, many no longer offer sub-custody as a product, and we 

have since seen an approximate halving in the number of 

active sub-custody providers in the region.” 

As a pan-regional provider will often already be servicing a 

particular client in multiple markets, when that client comes 

to review their arrangements in another market, it is simpler 

to go with the provider they already know, adds Brooks.“We 

already know their priorities, and so are able to tailor our 

services to those requirements in a new market,”he says.“We 

are also very much aware of not just regional but also global 

best practice, which again puts us at an advantage.” 

Nonetheless, Brooks acknowledges that competition in 

the sub-custody arena remains fierce, with continued 

downward pressure on margins.“That said, I have been in 

this business 15 years and that has always been the case,” 

he adds. “One way to manage that is to bring on more 

clients and expand the breadth of product we offer to 


include higher margin offerings. If you are just offering 

vanilla custody, the attraction of investing in that product in 

isolation is far more limited than it was a few years ago, but 

if you view it as an essential foundation supporting other 

products it makes a lot more sense.” 

Flexible services and solutions 

Jon Lloyd believes there is now a greater appreciation of the 

role of the sub-custodian as a risk manager, a source of 

lobbying expertise and connectivity and a source of cost 

avoidance.“Clients also see us as a very important cushion 

against the volatility in the marketplace,” he adds. “As we 

push for consolidation and harmonisation in Europe, the 

sheer volume of change is so much greater than before and 

that leads to higher levels of risk. The fact that the client can 

avoid getting involved in that day-to-day, with us taking 

away that pain, is becoming an important part of the 

relationship.”Lloyd cites recent examples of market changes 

in two key markets: “In Italy there have been a number of 

issues with the Express II platform which we have sought to 

minimise; similarly there are currently changes going on in 

Spain which are causing major market disruption.” 

However, Lloyd feels it is important to strike a balance 

between consolidation and the competition issues it raises – 

not least on the depository front. As JPMorgan’s Brian Todd 

notes, the ability to access markets directly, in the process 

lowering costs and streamlining operations by eliminating 

multiple clearing and settlement interfaces, is a perennial 

threat to sub-custodians.“There are two types of clients,”he 

says.“Global custodians like ourselves who are buying subcustody 

for our traditional ‘buy and hold’ markets, and then 

there are the broker-dealers who are buying it in order to pass 

trades through the market in real time and support a trading 

operation – and they are opening up to the idea of becoming 

direct remote member participants.” 

This impingement by depositories into the sphere of 

commercial banking is seen as fundamentally uncompetitive 

by Lloyd. “There are ways and means of competing: either 

directly by attracting your competitors’ clients through the 

quality of your product offering; or you can compete via 

pricing,”he says.“While there has been a lot of fanfare in the 

UK market with CREST bringing down the cost of 

settlement, we are seeing the Dutch, French and Belgium 

central securities depositories (CSDs) all increasing prices. 

That is a great way to make the sub-custodian suffer, because 

they are being squeezed on one side by clients wanting lower 

prices and then on the other by rising prices at CSD level. 

That is not a healthy dynamic – depository consolidation was 

supposed to be about economies of scale, harmonisation and 

driving down costs for the market.” 

Over at Citigroup – which, like BNP Paribas, is a leading 

light within the Fair & Clear pressure group opposed to 

what its members see as the CSD’s unchecked 

expansionist tendencies – Giulio di Cerbo is equally blunt. 

“There are commercial entities like banks and then there 

are utilities, such as depositories, which should be user 

owned,”he says.“We want a strongly regulated post-trade 


environment just as there is the pre-trade world, and we 

do not want to see utilities running commercial or liquidity 

risks.” (The depositories, on the other hand, reject any 

suggestion that their move up the value chain is in any 

way uncompetitive or inappropriate). 

Stephen Brown says that Northern Trust already self-clears 

and self-custodies in the United States, United Kingdom and 

Canada. The bank will also have to consider this option in 

Europe “if the market can create a single quality asset 

servicing European CSD”.“Certainly Euroclear’s plans for its 

integrated custody and settlement engine for its markets – is 

on paper an attractive proposition, although it will no doubt 

also bring some new operational challenges,” he says. 

However, Brown concedes that, for now, sub-custodians still 

have an edge to servicing the more sophisticated and 

demanding global custodians. “Sub-custodians offer the 

experience, understanding, and broad local knowledge and 

expertise that depositories do not generally have,” he says. 

“However, some depositories, including Euroclear, are 

already in the sub-custody space, and they are working hard 

to offer the premier sub-custody service that global 

custodians demand.” 

“Providing core services is fundamental. But just as 

important is the ability to be flexible and create flexible 

solutions. That is not something depositories are not known 

for – they tend to provide a ‘one size fits all’ service, whereas 

as global custodians our clients are constantly challenging us 

to do different things, and so we need our sub-custodians to 

be flexible and innovative.That is not something depositories 

can yet offer,”Brown adds. 

Colin Brooks, deputy head of 

custody and clearing at 

HSBC in Hong Kong 

49

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