Section 1 - FTSE

BATTLING MARKET FRAGMENTATION: THE ASIAN ASSET SERVICING ROUNDTABLE
CLEARSTREAM:
THE GLOBAL
EQUATION
I S S U E 3 2 • M A R C H / A P R I L 2 0 0 9
How to conduct sovereign
over-borrowing
CVM sets the standard for
Brazilian corporate governance
Dutch pension funds lead on
fiduciary management
What now for
offshore exchanges?
THE IMPORTANCE OF COLLATERAL MANAGEMENT IN ASIAN SBL

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FTSE GLOBAL MARKETS • MARCH/APRIL 2009
Outlook
IF THERE IS a recurring topic in this edition, it is trust and fiduciary
care. Paul Whitfield introduces the theme in the Market Leader,
outlining a mounting trend in the Low Countries towards fiduciary
management.The trend is expected to be replicated elsewhere in Europe.
Investment management firm BlackRock, for one, thinks the trend will be
substantial. In December, it predicted that the value of assets run by
fiduciary managers in the UK alone would rise from the current figure of
about £2bn to over £300bn within the next few years.
Fiduciary management refers to the provision, by a single supplier, of
a range of services that taken together remove the operational
management of a pension fund from trustees, handing it to a third party
manager. What it cannot do however is lift the fiduciary responsibility
from the shoulders of the trustees, who are still ultimately responsible
for the performance and lawful management of their fund.
The movements towards fiduciary care and transparency are global,
rather than regional trends. Moreover, they encompass the spectrum of
investment activity. Neil O’Hara picks up the theme in his article on the
dynamics of the US asset servicing industry. While the global recession
has dampened investor and banking sentiment and activity in the
financial markets, asset service providers have directly benefited from
the resulting downturn in two ways.
Following the rescue of Bear Stearns, the Lehman Brothers
bankruptcy and Bernard Madoff's alleged Ponzi scheme, attention is
now focused squarely on counterparty risk. Moreover, the safety of
assets held in trust that are not exposed to the parent entity's credit
risk has sent hedge funds and institutional investors scuttling to
custodian banks. In addition, money managers who have seen their
asset-based top line revenues slashed are now homing in on the
bottom line. Asset service providers, who can take over middle and
back office functions, turning them from fixed into variable costs, have
benefited in consequence.
Emerging markets are jumping on a similar bandwagon. John
Rumsey in São Paulo reports on moves by Brazil’s market regulator, the
Comissão de Valores Mobiliários (CVM), to enforce procedures in cases
concerning possible derivatives scandals (it is unable to name the
companies). It looks to be a timely moment for the CVM to be
designing new rules that will help further develop the corporate
governance agenda in Brazil. The new focus is on achieving real gains
through the fostering of greater transparency, which will increase the
level of local disclosure requirements substantially.
In this and subsequent editions we will be looking at how regulators
will help or hinder the rebuilding of the sometimes scorched remains of
the financial markets. Our focus in this edition is on the UK’s Financial
Services Authority (FSA). With its reputation dented in the wake of the
financial crisis, the FSA finds itself under a spotlight, with market
participants anxious to see how it intends to regulate going forward.
Some market watchers worry that the FSA will impose a US Sarbanes
Oxley type regime, thereby eradicating the principles-based regulation
that traditionally has been a cornerstone of the UK framework. Others
believe that FSA will hold firm to its fundamental doctrines, albeit with
a somewhat heavier hand under new chairman Lord Adair Turner. Lynn
Strongin Dodds reviews the options.
Francesca Carnevale,
Editorial Director
March 2009
1

2
Contents
COVER STORY
DEPARTMENTS
MARKET LEADER
IN THE MARKETS
COUNTRY REPORT
INDEX REVIEW
DEBT REPORT
TRADING REPORT
DATA PAGES
COVER STORY: CLEARSTREAM: A GLOBAL VIEWPOINT ....................Page 65
Once upon a time pitted in a soulless debate on the efficacy of a horizontal versus a vertical
clearing and settlement model in Europe, Clearstream broke out of its chains and into a new
and seemingly limitless global future. Francesca Carnevale explains how Clearstream
reinvented both itself and the opportunities provided by globalisation.
THE MOVE TOWARDS FIDUCIARY MANAGEMENT ......................Page 6
Why Dutch institutional investors are leading the way in Europe
STICKING TO PRINCIPLES? WHAT NOW FOR THE FSA?....................Page 12
Lynn Strongin Dodds assesses the options facing the UK’s financial regulator
CORPORATE GOVERNANCE, CVM STYLE ..........................................................Page 18
CVM’s efforts to introduce transparency into the Brazilian capital markets
NEW RULES FOR DEPOSITARY RECEIPTS ..................................................Page 24
David Simons on the effects the easing of rules covering DR programmes
FRANCE: CREDIT CRISIS SARKOZY STYLE........................................Page 28
The idiosyncrasies of Nicolas Sarkozy’s approach to the banking crisis
SAUDI ARABIA: UNLOCKING POTENTIAL..............................................Page 32
Liberalising the Saudi capital and investment markets is now a priority
SAUDI ARABIAN BANKS BUCK THE TREND ..............................Page 38
Why the country’s banks look to be relatively inured from the global credit crunch
ROCK, SCISSORS, PAPER, STOCK MARKETS ..................................Page 42
Simon Denham, managing director, Capital Spreads on current index trends
WILL THE PFANDBRIEF MARKET RECOVER BEFORE TIME? ..Page 43
The beginnings of a new issue pipeline in 2009
CEDULAS RETUNED......................................................................................................Page 46
Spanish covered bonds look ready for a recovery
A PILE UP OF SOVEREIGN BONDS..................................................................Page 48
Can the market cope with the explosion of sovereign issuance? Andrew Cavenagh reports.
THE ATTRACTION OF DARK POOLS ............................................................Page 81
Ruth Liley reports on the trading strategies employed in centres of non displayed liquidity
THE NEED FOR SPEED ................................................................................................Page 84
By Michael Krogmann, executive director, Cash Market Development, Deutsche Börse
ETF Data, supplied by Barclays Global Investors ..................................................PAGE 86
Securities Lending Trends by Data Explorer ..........................................................PAGE 89
Fidessa Fragmentation Index ....................................................................................PAGE 90
Market Reports by FTSE Research ............................................................................PAGE 92
Index Calendar ............................................................................................................PAGE 96
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

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4
Contents
FEATURES
EXCHANGE REPORT
THE OFFSHORE EXCHANGE DILEMMA..........................................Page 50
Until recently, offshore exchanges have traded on their uniqueness. However, as the global
financial markets undergo seismic shifts in the wake of the global liquidity crisis and falling
exchange trading volume (albeit temporary). However, difficult questions are now
surfacing. Will offshore exchanges ultimately be forced into mergers with onshore partners?
Or will they be able to develop other survival techniques? Lynn Strongin Dodds reports.
OTC STANDS ITS GROUND ........................................................................Page 54
Derivatives exchanges have had to watch from the wings in recent years while the OTC
market ran away with the lion's share of new business. Protestations about counterparty
risk inherent in bilateral contracts fell on deaf ears as investors chose to ignore the
possibility that a major securities dealer could fail. The financial crisis—and the Lehman
bankruptcy in particular—jolted market participants' faith. However, the derivatives
exchanges have not yet been able to leverage that fact. Neil O’Hara explains why.
ECONOMIC REPORT
CALIFORNIA: ALL THAT GLISTERS ......................................................Page 57
Who dreams these days about living in California? As a standalone entity, the state
remains one of the world’s top eight economies, yet it is beset with problems. It
struggles with a dysfunctional legislature, and a $42bn budget deficit. California’s
unemployment rate is third-highest in America, while its credit rating is the lowest
among the 50 states. The state’s vast higher education system is outmoded and the crash
in housing prices has wiped out $1trn in personal wealth. Meanwhile, California’s
fabled venture capital (VC) industry—caught in the worldwide credit freeze—faces a
“nuclear winter.” What next? By Art Detman
ASSET SERVICES
ASIAN SECURITIES LENDING ..................................................................Page 60
There’s more promise than SBL business in Asia outside of key markets (namely Japan,
Australia, Hong Kong and Singapore). Even so, securities lending professionals remain
upbeat about the medium and long term promise of the market. For now, collateral
management is high on the agenda of market participants, which tend to be central
banks, state pension funds and prime brokers. How soon before the promise breaks into
a boom? Francesca Carnevale reports
US ASSET SERVICES ON THE UPTICK ..............................................Page 68
Bill Tyree, a partner and head of investor services and markets at Brown Brothers
Harriman (BBH), says the benefits of independent custody often did not resonate with
asset managers and hedge funds. They were too busy making money, and nothing had
happened in the market to alert them to [any] danger—until last year's meltdown set off
the alarm. Neil O’Hara reports on the business uptick in asset service provision in the
United States.
ROUNDTABLE: ASIAN SECURITIES SERVICES ............................Page 71
The financial crisis has provided a challenging time for Asian asset service providers.
Institutional investors are more concerned now about counterparty risk and certain asset
classes as well as the fund managers they are using. This latest roundtable discussion
highlights the challenges of building up asset services in the demanding and highly
fragmented Asian landscape
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

EUROPEAN PENSIONS: THE APPEALOF FIDUCIARY MANAGEMENT
6
Market Leader
While there is no hard-and-fast definition of fiduciary management, the term generally refers to the
provision, by a single supplier, of a range of services that taken together remove the operational
management of a pension fund from trustees, handing it to a third party manager. What it cannot
do is lift the fiduciary responsibility from the shoulders of the trustees, who are still ultimately
responsible for the performance and lawful management of their fund.
Photograph © Lajo_2/Dreamstime.com, supplied February 2009.
DUTCH TAKE A
LEAD IN PENSION
MANAGEMENT
Pension managers in the Netherlands have taken a lead in
adopting fiduciary management—handing operations to an
outside supplier. The lure of maximising returns and managing risk
may mean the UK is the next in line but there are issues to be
resolved first. Paul Whitfield reports.
WHEN IT COMES to pension
management, where the
Dutch lead others tend to
follow. Pension funds in the
Netherlands were among the first to
embrace alternative asset classes, led
the drive into private equity funds,
championed absolute return funds,
and have been at the forefront of the
adoption of socially responsible
investment criteria in their
management processes.
Could fiduciary management be the
next big thing to come from the low
countries? That is the prediction of
some experts who now constate that
the boom in fiduciary management in
the Netherlands will spread across
Europe. The first stop in that expansion
is expected to be the United Kingdom,
according to BlackRock, a listed
investment management firm. In
December, BlackRock predicted that
the value of assets run by fiduciary
managers in the UK will rise from the
current figure of about £2bn to £300bn
within four years. “I am struck by the
level of interest in fiduciary
management,” says Andrew Dyson,
managing director and head of
BlackRock’s institutional business for
the Europe, Middle East and Africa
(EMEA) region.“The financial crisis has
created a tipping point. It brought
home to many pension schemes how
they don’t necessarily have the
resources to maximise investment
opportunities or manage risks.”
While there is no hard-and-fast
definition of fiduciary management,
the term generally refers to the
provision, by a single supplier, of a
range of services that taken together
remove the operational management
of a pension fund from trustees,
handing it to a third party manager.
What it cannot do is lift the fiduciary
responsibility from the shoulders of
the trustees, who are still ultimately
responsible for the performance and
lawful management of their fund.
“Trustees can delegate authority but
they cannot delegate responsibility,”
says Clive Pugh, a partner at Burges
Salmon and a former lawyer for
Britain’s Pensions Regulator.“Fiduciary
management seems to suggest that
trustees are absolved of some of those
duties, but that is not the case.”
A good, if still not perfect,
comparison of the role of trustees and
a fiduciary manager is that of a listed
company in which a board, operating
in a role similar to the trustees,
oversees the functioning of a
management team, operating in the
fiduciary manager’s role.
The term fiduciary management was
coined by investment bank Goldman
Sachs & Co. It is also often referred to
as implemented consulting. The father
of fiduciary management is generally
recognised to be the Dutch academic
Dr Anton van Nunen, a director at
Dutch pension consultantsVan Nunen
& Partners. Van Nunen has
championed the idea for many years
and published his thoughts and
arguments in favour of a fiduciary
management approach in the book
Fiduciary Management: Blueprint for
Pension Fund Excellence.
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

Van Nunen outlines a compelling
case for fiduciary management in the
opening chapter of his book. “As the
twenty-first century began to unfold,
there was substantial discontent among
plan sponsors and other institutions
regarding the prevailing investment
management structure. Too many
people had a role while no one had
overall responsibility,” he wrote. “The
fund managers were not allowed to
share their expertise; their job was
simply to manage funds according to
the style that had led to their selection
… The consultants were paid a per diem
and gave their advice
accordingly … Meanwhile,
having outsourced much of
the work of running a
pension plan, the plan
sponsor was likely to be a
small organisation with
limited expertise. It was
deeply dependent on both
its consultants and
managers, just as it was
dependent on its actuaries
and other experts for
specialised counsel.
Fiduciary Management
came into being in response
to these problems.”
Fiduciary management
services typically include the provision
of strategic asset allocation advice and
the development and maintenance of
an investment policy; the screening
and selection of external asset
managers; the management of the
underlying portfolio mix and risk
management, investment performance
monitoring and reporting services.
For the time being the provision of such
services remains nascent or non existent
in most European markets.The exception
is the Netherlands where in the space of
about five years it has risen to become the
dominant pension management system
amongst the country’s defined benefit
pension schemes.
FTSE GLOBAL MARKETS • MARCH/APRIL 2009
A tipping point was reached in the
Dutch market at the start of 2008
when for the first time the number of
Dutch pension funds that had
outsourced management of their
schemes to fiduciary services
outweighed those that retained
control themselves. The 13th annual
review of the Dutch fund management
industry, published in October by
consultants Bureau Bosch, found that
Dutch funds under fiduciary
management had risen to €515bn,
accounting for about 72% of all
pension fund assets.
“The reason there is a market for
fiduciary management is that defined
benefit pension funds are all dealing
with increasingly complex issues and
problems around the world, namely
volatility ofcapital markets, changing
regulations and accounting changes,”
says Patrick Disney, managing director
Institutional Business for the EMEA
region ofinvestment manager services
provider SEI.
The figure is slightly inflated by the
inclusion of in-house fiduciary services
at some of the country’s biggest
pension funds, but the size and rapid
growth of fiduciary management in the
Netherlands is still compelling and is
demanding attention in other
European markets.“The reason there is
a market for fiduciary management is
that defined benefit pension funds are
all dealing with increasingly complex
issues and problems around the world,
namely volatility of capital markets,
changing regulations and accounting
changes,” says Patrick Disney,
managing director Institutional
Business for the EMEA region of
investment manager services provider
SEI. “It took hold in the Netherlands
where you had a combination of some
pretty powerful academic lobbyists that
have a lot of influence in the pension
field and sophisticated pension funds
confident enough to look at new ideas.”
It has also enjoyed considerable
support from Dutch industry groups.
The Dutch Fund and Asset
Management Association (DUFAS),
and the Dutch Association of
Company Pension Funds (OPF), in
November 2008 published a checklist
of good practice for fiduciary
management.The document,
which was supported by the
industry, is intended to serve
as a checklist for trustees as
they assess the benefits of
fiduciary management and
to help them select the
services they need.
The dominance of fiduciary
management in the Dutch
market will be key to its
possible expansion into new
markets. It has proven to
providers, many of which are
international consultants and
banks with the resources to
quickly replicate the model in
new market, that fiduciary
management can provide a lucrative
new income stream.
The immediate problem for wouldbe
providers is that the number of
markets in which fiduciary services can
be promoted is limited. The biggest
hindrance is that the provision of
fiduciary services is limited to
countries in which defined benefit
schemes are the dominant model. The
other problem is a question of
readiness. Pension funds need to have
embraced a level of complexity in
terms of their asset mix and be subject
to sufficient reporting demands before
the simplification offered by fiduciary
management becomes interesting.
7

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EUROPEAN PENSIONS: THE APPEALOF FIDUCIARY MANAGEMENT
10
Market Leader
These are the main reasons that the
UK, and to a lesser extent Germany,
have emerged as the principal targets
for expansion. It is also explains why
there is little scope for fiduciary
management services in other
European pension markets.“Fiduciary
management remains something that
the Italian market is simply not
prepared for,”says Giampaolo Serra, a
senior consultant at Bologna, Italy
based pension consultancy Prometeia.
For the short term, at least, the
limited number of markets suited to
fiduciary management services is not
likely to be a problem. As BlackRock’s
prediction makes clear, the UK market
alone offers hundreds of billions of
pounds of potential assets that could
be added to fiduciary managers’books.
“In Europe, the UK and the
Netherlands are going to be the key
markets for years to come and they are
the biggest defined benefit market,”
says SEI’s Disney. “You will begin to
see some interest in Germany, and
possibly Switzerland, but it will take
time for them to develop.”
The application of the FR17
accounting standards, which made
funding of pensions more transparent
and placed greater emphasis on
scheme liability risk, and in the UK the
findings of the Myners Report, which
placed increased emphasis on the need
to maximise and manage returns
through asset allocation, has placed
further stress on fund trustees.That has
increased pressure on pension fund
trustees, many of whom fulfil the role in
a part time capacity.
The size of the mandates up for grabs
in the UK was brought into focus last
year when Watson Wyatt was
appointed as a fiduciary manager for
the £3.2bn Merchant Navy Officers
Pension Fund. The appointment, made
in September 2008, was the largest of
its kind in the UK to date. Anecdotal
evidence suggests that the majority of
demand for fiduciary services in the UK
is coming from larger pension funds.
“Our research suggests that it is the
large schemes that are most open to the
sort of services offered by fiduciary
managers,” says Pugh of Burges
Salmon. “Smaller schemes often lack
the sophistication to be confident of
effectively managing the relationship
and are frankly under less pressure as
the complexity of their funds are often
less than those of larger funds.”
Larger funds also typically have
more experience with the use of
consultants and many, in both the UK
and Germany, already use services
known as implemented consulting or
delegated consulting, which are
reasonably close to the fiduciary
services model of management. That
tends to makes the transition to full
fiduciary management less of a leap
and thus more palatable.
Consultants tend to claim that the
emergence of fiduciary management
relationships is a result of the demand
of clients who are eager to push dayto-day
management responsibility
back onto external experts.
There is of course a price to pay for
these services and as with many
manager-of-manager type services
there is quite rightly some resistance to
adding a new layer of fees to pension
management. Fiduciary managers
insist that their services add value and
can improve the overall performance of
a fund. “There are efficiencies to be
targeted,” said Ruud Hendriks,
Goldman Sachs Asset Management’s
managing director EMEA, in a note on
his group’s fiduciary offering. “An
improved risk return profile…, time
savings on the part of the pension fund
since there is only one investment
manager to communicate with and one
consolidated set of reports… [and]
flexibility to change the structure of the
fund in step with changes to liabilities
or market conditions.”
For all the potentially evident logic
of such benefits there is however little
hard data that proves that funds that
adopt fiduciary management services
do in fact outperform other pensions
funds. That makes adopting the
services something of a leap of faith
and a potentially expensive one.
There are other potential barriers to
the adoption of the fiduciary services
across Europe. One of the biggest of
those remains the legal questions
raised by the outsourcing of almost all
management decisions by trustees.
“The services that some fiduciary
managers are offering in the
Netherlands seem to go further than
UK law allows,”says Pugh.“In the UK
the trustee is the fiduciary and they
certainly can not absolve themselves
of that duty.”
Fiduciary services managers argue
that there is no conflict with UK law as
the trustees maintain their fiduciary
responsibility in the management of
the relationship with the fiduciary
services supplier and through their
right to change managers if they are
not satisfied with the service.
Such a case is yet to be tested in
court and not everyone is convinced
that trustees will be fully protected.
“When something goes wrong there
is bound to be an argument over the
contractual terms and trustees may
find they had no right to delegate
the responsibilities that they
thought they could,” says Pugh.
“Dutch law is different to the UK
law and it may be that the reason
that this [fiduciary management]
turned up there first is that it better
fits their legal framework.”
Given the challenges facing pension
funds in the current investment
environment such concerns are likely
to take a back seat to the reassurance
that fiduciary management provides
trustees.That is good news for fiduciary
managers’expansion prospects.
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

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NEW LAMPS FOR OLD: REDEFINING MARKET REGULATION
12
In the Markets
There is no doubt firms will be required to strengthen their liquidity standards. Last
December, the FSA published a consultation paper which aims to significantly improve
firms’ ability to deal with liquidity risks and thereby increase the overall stability of the UK
financial markets. The ideas also build upon current international work on liquidity such as
Basel II. The consultation period ends March 2009 and the FSA hopes to introduce new
rules by October. Photograph © Luca Oleastri/Dreamstime.com, supplied February 2008.
Will the FSA ditch
its principles-based
approach?
ENGLISH LIGHT OPERA
composers Gilbert and Sullivan
held that, “A policeman’s lot is
not a happy one.” Pity then the FSA,
now firmly centre stage, caught by
populist desire to rein in and penalise
the recent excesses of the financial
markets and which, at the same time,
must ensure that financial institutions
are allowed sufficient laissez-faire to
ensure that London maintains its
financial markets pre eminence.
According to Mayiz Habbal,
managing director of the Securities
Scarred by the financial crisis,
the British government is
encouraging a much tougher
line on banking, trading and
capital markets activity. The
Financial Services Authority
(FSA) is centre stage in the new
financial order that will emerge
post credit crunch in the United
Kingdom. What is less certain is
what kind of regulation will
ensue in the coming months
and years. Some analysts fear
that a US Sarbanes Oxley type
regime will be imposed,
eradicating the principlesbased
regulation that
traditionally has been a
cornerstone of the UK
framework. Others believe that
FSA will hold firm to its
fundamental doctrines, albeit
with a somewhat heavier hand
under new chairman Lord
Adair Turner. Lynn Strongin
Dodds reviews the options.
and Investment Group at Celent, the
Boston-based financial research and
consulting company,“There could be a
move towards rules-based regulation
if there is a greater push towards
nationalisation of the banks. This is
because if the UK government is in
control of these banks, they may
create new rules and then the FSA
would have to implement [them].”
John Tattersall, a partner in the
financial services regulatory practice at
PricewaterhouseCoopers, on the
other hand does not think that will
happen.“I think the FSA has learned
the lessons from Northern Rock and
there is no doubt that its touch will be
tougher and management teams at
banks will have to become more
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NEW LAMPS FOR OLD: REDEFINING MARKET REGULATION
14
In the Markets
accountable. I hope we do not see
Sarbanes Oxley type of legislation
because it will stifle the banks. The
benefit of principle-based regulation
is that you can adapt easily to
changing circumstances.”
Alastair Graham, partner at law firm
White & Case, agrees, adding, “When
things go wrong, the knee jerk reaction
is usually to call for tighter regulation.
However, experience has
shown us that it does not
work. The story we have
been living for the past two
years is not new, it’s just that
the losses we are dealing
with this time have more
noughts after them and the
size of the financial crisis is
much larger. We may have a
case [such as] Bernie Madoff
today, but in the past there
was Robert Maxwell, Barings
and Enron to deal with. The
real issues are how can we
change the mindset in
financial services and
prevent the problems that
we are reacting to.”
Carlos Conceicao,
partner at law firm Clifford
Chance and former head of
the FSA's wholesale group
in enforcement, adds,
“There is no need of a
regulatory Big Bang to
change the world, but
whilst I do not think we will
see a Sarbanes Oxley
response and the complete
abandonment of principles-based
regulation, there will be much more
prescription. 'Regulation by principle'
is not a catchy slogan at the moment.
There will also be a change in the
FSA's approach. Sensitive to
accusations that it has been a lighttouch
regulator, as the FSA has said
itself, it will be far more involved and
aggressive in its day-to-day
regulation. The words 'intrusive
supervision' will be the new mantra."
The debate about rules versus
principle-based regulation is not
novel. Over the years, there has been
much discussion as to the merits of
each. A rules approach is when
regulators try to prescribe in a
detailed manner exactly what
companies should and should not do
“The Financial Services Authority
(FSA) was taken to task last year by the
Treasury Select Committee's report into
the Northern Rock debacle. It found
that the FSA “failed in its duty as
regulator” and did not allocate enough
resources or time in dealing with the
troubled bank. A catalogue ofmistakes
were made including high turnover of
FSA staff directly supervising the bank,
inadequate numbers of staff,
incomplete paperwork and only limited
understanding in the supervisory team
ofthe duties required.”
to meet their obligations. By contrast,
under the principles method,
regulators are less concerned about
the dotted Is and crossed Ts and
instead evaluate companies according
to broad doctrines.
Not surprisingly, the dialogue has
grown much louder over the past few
months. The FSA was taken to task last
year by the Treasury Select Committee's
report into the Northern Rock debacle.
It found that the FSA“failed in its duty
as regulator” and did not allocate
enough resources or time in dealing
with the troubled bank. A catalogue of
mistakes were made including high
turnover of FSA staff directly
supervising the bank, inadequate
numbers of staff, incomplete paperwork
and only limited understanding in the
supervisory team of the duties required.
The FSA has fallen on its
sword, saying that it was
guilty of supervising banks
“on the cheap”. However, the
regulator also stressed that it
should not be made to
shoulder the blame alone.
Market participants have
some sympathy with this
view, saying that the rules
based approach favoured in
the United States was no
better at anticipating or
dealing with its domestic
banking collapse.
David Rouch, a partner at
law firm Freshfields, says,
"People are looking for
someone to blame. The
politicians are not willing to
accept responsibility.The FSA
has been self-critical and has
accepted that there were
problems. However, the basic
framework of regulatory rules
is not broken."
Selwyn Blair-Ford, senior
domain expert at risk and
regulatory consultancy
FRSGlobal, notes, “There were some
warnings about the credit crunch but
bankers, central banks, academics,
finance ministers and regulators did not
foresee this financial crisis happening.
This is why it is unreasonable to expect
that the FSA alone would have
predicted it although they have
admitted that they fell below standards.
We expected them to have the
infrastructure and expertise to deal with
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NEW LAMPS FOR OLD: REDEFINING MARKET REGULATION
16
In the Markets
systemic risk. They did not and now
they are having to play catch up.”
A new age is certainly dawning
under Lord Turner, who took over the
helm last September. Speaking at The
Economist's recent inaugural City
Lecture, he noted that the scale of
proprietary trading over the past
decade had created risks, while
financial innovation had in many cases
delivered minimal economic value and
increased the dangers of financial
instability. However, Lord Turner
rebuffed calls to return to what he
called “narrow banking” whereby
institutions were restricted to either
investment banking or commercial
banking. He said the idea was a
“nostalgic elegy for a past age of
innocence and stability” where local
bank managers and the“wide boys”of
the City were far apart. The "originate
and distribute" model of financing
lending has a role to play in the future,
but it needs to be reformed, with less
complexity and opacity.
Ablueprint for the FSA’s future is
expected to be published in April. It
will not only set out the changes the
regulator has already made, but
include proposals in principle which
have been put forward and need
consultation. It will also highlight
areas where there is a need for global
cooperation. High on the FSA’s
agenda will be new approaches to
capital adequacy, requiring more
capital to be held by banks against
risky trading strategies and countercyclical
capital requirements to build
up adequate buffers during good
economic times, which can be drawn
on during downturns.
Remuneration is also expected to be
on the list. At the World Economic
Forum at Davos, Lord Turner warned
that banks’ remuneration committees
would have "the FSA on their back" if
they buckled under pressure and would
be punished by having capital
Selwyn Blair-Ford, senior domain expert at risk and regulatory consultancy FRSGlobal, says,
“There were some warnings about the credit crunch but bankers, central banks, academics,
finance ministers and regulators did not foresee this financial crisis happening. This is why it
is unreasonable to expect that the FSA alone would have predicted it although they have
admitted that they fell below standards. We expected them to have the infrastructure and
expertise to deal with systemic risk. They did not and now they are having to play catch up.”
requirements tightened. Many believe it
was the prospect of eye-watering
bonuses that partly led to the risktaking
culture that toppled the industry.
The FSA, though, is not currently
expected to impose tougher constraints,
because banks’ capital is being eroded
by the losses on bad loans.
There is no doubt, though, that firms
will be required to strengthen their
liquidity standards. Last December, the
FSA published a consultation paper
which aims to significantly improve
firms’ ability to deal with liquidity risks
and thereby increase the overall stability
of the UK financial markets. The ideas
also build upon current international
work on liquidity such as Basel II. The
consultation period ends in March 2009
and the FSA hopes to introduce new
rules by October.
Under the proposals, firms will have
to develop a new quantitative
framework for liquidity risk
management which places greater
focus on assessing the risks and
policies to tackle them. Firms will
need to complete an individual
liquidity adequacy form as well as
conducting regular stress andscenario
testing. This includes analysing the
firm’s cash flows, liquidity positions,
profitability and solvency from both a
short and long-term perspective.
According to Blair-Ford, “These
requirements will prompt a major
change in the way firms manage their
liquidity process. Not only will
companies need to develop new
metrics but their governance
structures will also have to be
tightened in order to meet these
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

higher standards regarding liquidity
than before.”
The FSA is also getting its own house
in order. To address its failings in the
Northern Rock collapse, the regulator
set up a supervisory enhancement
programme. The main planks comprise
the creation of a core supervisory team
to tend to the relationship with the core
firm as well as more direct contact with
senior managers within the supervisory
team. Other key features include the
expansion of the FSA’s specialist
prudential risk department following
the upgrade to divisional status, and
bolstering resources in the relevant
sector teams. In addition, current
supervisory training and the
competency framework for FSA staff
will be updated.
The FSA is also taking a tougher
stance on enforcement. In the past year,
it has launched four criminal
prosecutions in a renewed crackdown
on insider dealing, a criminal offence
Don’t work in the dark,
who knows what you might find
FTSE GLOBAL MARKETS • MARCH/APRIL 2009
that carries a maximum seven-year jail
term. Last June, Margaret Cole, the
FSA's head of enforcement, said, "One
of our goals is to get the City to take this
subject (market abuse) more seriously.
We feel that the threat of civil fines
hasn’t worked as well as we would have
liked. We’re convinced that the threat of
a custodial sentence is a much more
significant deterrent."
As one industry expert put it,“There
is a lot of pressure on the regulator to
come down hard on people who have
misbehaved, and regulatory action has
not delivered a sufficient deterrence."
In addition, the City watchdog is
hoping to upgrade the calibre of its
staff, which might not be that difficult
in these credit crunch times when
investment banks and other financial
institutions are slashing their ranks.
Bob McGee, international economist at
UK based economic consultancy
Independent Strategy, says, “The FSA
was a bit out of its depth in the current
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financial crisis but one of the main
criticisms over the years has been the
quality of its staff. They have not been
paid that well and as a result, it has
been difficult to attract and retain
good people.”
For example, four years ago, staff
were provided with extra training on
the back of surveys with industry
executives who complained that some
FSA frontline employees did not
understand the businesses they
regulated, were inconsistent decision
makers and came across as
adversarial. Rouch notes though, that
"It is not always a case of hiring high
quality people but getting the right
people into the right job. There was an
inadequate understanding of how
macro factors would affect individual
firms. When even management find
that a challenge, regulators need
people who can authoritatively
question institutions about what they
are doing."
17

BRAZIL: CORPORATE GOVERNANCE REFORMS
18
In the Markets
BRAZIL’S CVM
UPS THE ANTE ON
TRANSPARENCY
Brazil is gearing up for a second wave of corporate governance
reforms. These will focus on providing greater transparency for
investors in areas such as shareholder conflicts of interest and
clarity on remuneration as well as proposals to make voting at
meetings easier. Some measures are being resisted by companies
and the test of strength is just beginning, reports John Rumsey.
LAST YEAR WAS not the best
one for Brazilian corporate
governance thanks to a
scandal involving some of the
country’s biggest exporters. Two
companies reportedly lost hundreds
of millions of dollars each
speculating in derivatives. At the
same time, the loss of foreign
investors has removed a key
impetus for improving governance,
even though Brazilian funds are
The CVM is working to foster greater
transparency. The first big planned change is
the release for public consultation of new
rules on the information that companies
need to provide to the market and this covers
all companies listed as well as those that
issue bonds, albeit with different levels of
disclosure according to market segment. The
proposed rules will increase the level of
disclosure substantially, says Pinto.
Photograph provided by istockphoto.com,
February 2009.
increasingly stepping into the
breach. (Please refer to box: Brazilian
funds promote tough governance
agenda).
The derivatives scandals were
whopping. Meat processor Sadia was
forced to post a R545m write-down to
cover the third quarter on bets against
the dollar that soured as the real fell
sharply against the greenback in the
second half of last year. The company
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

BRAZIL: CORPORATE GOVERNANCE REFORMS
20
In the Markets
dismissed its chief financial officer and
in February dismissed a further four
directors, without indicating whether
their sackings were related to the
scandal. Meanwhile, paper and pulp
company Aracruz recorded $2.13bn in
losses stemming from similarly wrong
bets. Sadia was trading at R4.80 on
February 4th compared to a 52 week
high of R12.49 reached in June last
year, while Aracruz has fallen from a
high of R17.5 in May 2008 to R12.6, its
fall partly mitigated by a take-over bid
from rival Votorantim.
These losses have encouraged
typically passive institutional
investors to become more involved in
corporate governance. In a widelywatched
action, Previ, the influential
pension fund of the country’s largest
bank, called for an extraordinary
general meeting of Sadia, which was
held in November. The pension fund
wanted explanations of how the
manager had allegedly flouted
internal rules on hedging and called
for greater transparency and control.
Some investors are now litigating to
recoup some of the losses, notes
Sandra Guerra, founder of Better
Governance in São Paulo, which
monitors and pushes for better
standards. They may well have a case,
she thinks. Company boards blamed
the financial director of the company,
but it would be surprising if the
boards themselves did not know their
level of exposure, she remarks.“This is
part of a chief executive officer’s
responsibility. You really cannot
manage a company without knowing
this,”Guerra says.
The market regulator, the Comissão
de Valores Mobiliários (CVM), has
enforcement procedures in two cases
concerning derivatives (it is unable to
name the two companies). “Brazilian
law requires board and officers of
companies to exercise utmost care. We
will judge them by these standards,”
says Marcos Pinto at CVM. The good
news is that the scandal has made
investors much more aware of the
importance of the nuts and bolts of
reporting lines and authority, thinks
Better Governance’s Guerra. Investors
are asking who does what and who has
authority to sign for what. They are
seeking to identify who has overall
responsibility, she says.
Initiatives at the CVM
It looks to be a timely moment for the
CVM to be designing new rules that
will help further develop the corporate
governance agenda in Brazil. The new
focus is on achieving real gains, not
superficial, perception-based initiatives,
Guerra believes.
The CVM is working to foster greater
transparency. The first big planned
change is the release for public
consultation of new rules on the
information that companies need to
provide to the market and this covers all
companies listed as well as those that
issue bonds, albeit with different levels
of disclosure according to market
segment. The proposed rules will
increase the level of disclosure
substantially, says Pinto.
These new rules will compel listed
companies to give basic information
regarding remuneration of managers,
conflict of interest between controlling
shareholders and more detailed general
information on the business of the
company, Pinto says. The section
covering remuneration has been
particularly controversial as it proposes
revealing total packages paid to all
executives rather than one universal
number for the company’s directors,
says Pinto.
The reaction has been mixed, Pinto
confesses. Many investors say they
want this information and see it as
critical for judging management.
Companies are protesting that it is
not necessary to provide such a
detailed breakdown and that
releasing general information should
be sufficient. The consultation period
is slated to end in March 2009.
Measures to mitigate conflicts of
interest focus on disclosure, in line
with the CVM’s mandate. “We are
being very strict about disclosure of
information on related-party
transactions,”says Pinto. The new law
will require companies to disclose
each related-party transaction
(between managers and related
companies) and provide comparison
with market transactions. Brazilian
corporate law states that companies
have to be fair to all shareholders,
Pinto notes.The Bovespa stock market
has attracted many companies with
controlling shareholders that have
stakes in other companies and
relationships between themselves. It’s
very important for minority
shareholders to know which
transactions are happening so they
can spot and avoid conflicts of
interest, he says.
CVM’s reforms come at the same
time as the Institute of Brazilian
Corporate Governance (IBCG) is
planning on making comprehensive
changes to its code of governance, adds
Guerra. The new code will be much
more detailed in relation to risk and
tighten control over the board’s
responsibility in this area. This is likely
to promote the role of audit committees
and comes as many listed firms are
trying to understand better and
mitigate their exposure to risk as the
economy deteriorates, says Guerra. The
measures should dovetail with the
CVM’s moves. The two organisations
talk extensively and generally
participate in each other’s public
releases and consultations. The two
operate in slightly different planes, with
the CVM focusing on disclosure and
the IBCGon best practice.
Another significant change is soon to
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

The 9th Institutional Equity
Trading & Technology Summit
2009
21st – 24th April 2009 The CNIT Centre, Paris
www.tradetechequity.eu
-48.00 +77.00 -22.00 +212.00 E 98885.00 S 2565 - 4500 +87.61 - 23.69 E 2356 S 67889 _44.00 + 55.00
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Pacific Trading, RCM
Lead Sponsor Principal Sponsors Organised by:
Call +44 (0)20 7368 9465 Email tradetech@wbr.co.uk Visit www.tradetechequity.eu

BRAZIL: CORPORATE GOVERNANCE REFORMS
22
In the Markets
be released for consideration and
affects the key area of attendance and
voting at general meetings, long a
contested area in Brazil thanks to
restrictive requirements that
shareholders appear in person at
meetings. Given the size of Brazil and
the number of foreign participants, that
has effectively deterred participation
and quora are often not met.
Last year, CVM decided that
shareholders should be able to
participate in annual general meetings
(AGMs) via the internet, notes Pinto.
CVM is now floating an idea for a new
rule that will oblige companies to
provide for shareholders to vote by
proxy. “Once we have given
shareholders more information on the
companies they are willing to vote in,
they will be more willing to participate
in meetings and better able to monitor
the activities of controlling
shareholders,” reckons Pinto.
The moves will help stimulate
investors to think more carefully about
the role of corporate governance and
promote more vigilant policies, thinks
Guerra. In 2005-07, the years of
sustained market rises, many investors’
interest in corporate governance was
limited to asking if a company intended
to list on the Novo Mercado, the
segment with the most stringent listing
rules, she points out. If the answer was
yes, they thought they had completed
BRAZILIAN FUNDS PROMOTE TOUGH
GOVERNANCE AGENDA
In January, a group of key Brazilian fund managers
came together to force an extraordinary general
meeting (EGM) on Telemig, a mobile phone
company 100% owned by Spain’s Telefonica and
Portugal Telecom, marking a milestone. They were
calling publicly on the company to distribute some of
its large cash pile and were finally defeated in their
motion. The show of corporate governance muscle is
very rare for Brazil, where the few actions have been
mostly initiated by foreign investors.
Telemig’s EGM was watched closely both by
other cash-rich Brazilian companies, trying to figure
out what is prudent to keep on hand for a rockier
year ahead, and Brazilian fund managers, who are
starting to scrutinise practices of companies more
closely to wring out more value at a time of poor
market performance. Prior to the meeting, Telemig
twice declined written requests to distribute some of
its R714m in net cash, citing the current poor
economic outlook and investment needs. The four
Brazilian activists, Polo Capital, Claritas, GAP and
Vinson, which own some 8% of Telemig, argued that
it is precisely in testing times that companies needs
to focus on efficiency and purging excesses and add
that investments needs are small compared to
earnings before interest, tax, depreciation and
due diligence. They will now be looking
to get under the surface, she believes.
Investors will also be more closely
monitoring the decisions by individual
board members and electing members
with more knowledge of their
background and voting patterns, she
predicts. That could help promote more
conversations between the board and
investors. Moreover, she sees more tieups
similar to that between UK pension
fund Hermes and Brazilian fund Previ.
Previ has launched a guide for
companies on how to conduct AGMs
and a list of dos and don’ts. Hermes has
supported the measure. “When you get
big funds like this working together, it’s
pretty powerful,” Guerra says.
amortisation (EBITDA.) Capital expenditure needs
are some R200m against cash flow of R450m next
year, according to their calculations.
The activists also point out that Telemig’s policies
seem out of line with those pursued by parent
companies Telefonica and Portugal Telecom, which
both have net debt to EBITDA ratios of more than
two times while Telemig’s net cash position gives it
a negative ratio of 1.70. Telefonica’s own policies
state the company should be “prioritising
shareholders’ returns for the use of free cash flow”,
they say.
Telemig is certainly not alone in Brazil in pursuing a
share buyback programme, says Marcelo Mollica,
senior analyst at GAP, who points out that from
September to November, 14 Brazilian firms started
buyback programmes against just four in the
preceding eight months. “Companies are returning
cash to investors where it’s not needed,” he says.
The move by the four managers is unusual for
Brazil in its level of coordination. With many foreign
investors having pulled out of the Brazilian stock
markets over the last 12 months, it’s going to be
more important than ever to get Brazilian
shareholders involved in monitoring their own
companies, says Mollica.
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

BRAZIL: CORPORATE GOVERNANCE REFORMS
22
In the Markets
be released for consideration and
affects the key area of attendance and
voting at general meetings, long a
contested area in Brazil thanks to
restrictive requirements that
shareholders appear in person at
meetings. Given the size of Brazil and
the number of foreign participants, that
has effectively deterred participation
and quora are often not met.
Last year, CVM decided that
shareholders should be able to
participate in annual general meetings
(AGMs) via the internet, notes Pinto.
CVM is now floating an idea for a new
rule that will oblige companies to
provide for shareholders to vote by
proxy. “Once we have given
shareholders more information on the
companies they are willing to vote in,
they will be more willing to participate
in meetings and better able to monitor
the activities of controlling
shareholders,” reckons Pinto.
The moves will help stimulate
investors to think more carefully about
the role of corporate governance and
promote more vigilant policies, thinks
Guerra. In 2005-07, the years of
sustained market rises, many investors’
interest in corporate governance was
limited to asking if a company intended
to list on the Novo Mercado, the
segment with the most stringent listing
rules, she points out. If the answer was
yes, they thought they had completed
BRAZILIAN FUNDS PROMOTE TOUGH
GOVERNANCE AGENDA
In January, a group of key Brazilian fund managers
came together to force an extraordinary general
meeting (EGM) on Telemig, a mobile phone
company 100% owned by Spain’s Telefonica and
Portugal Telecom, marking a milestone. They were
calling publicly on the company to distribute some of
its large cash pile and were finally defeated in their
motion. The show of corporate governance muscle is
very rare for Brazil, where the few actions have been
mostly initiated by foreign investors.
Telemig’s EGM was watched closely both by
other cash-rich Brazilian companies, trying to figure
out what is prudent to keep on hand for a rockier
year ahead, and Brazilian fund managers, who are
starting to scrutinise practices of companies more
closely to wring out more value at a time of poor
market performance. Prior to the meeting, Telemig
twice declined written requests to distribute some of
its R714m in net cash, citing the current poor
economic outlook and investment needs. The four
Brazilian activists, Polo Capital, Claritas, GAP and
Vinson, which own some 8% of Telemig, argued that
it is precisely in testing times that companies needs
to focus on efficiency and purging excesses and add
that investments needs are small compared to
earnings before interest, tax, depreciation and
due diligence. They will now be looking
to get under the surface, she believes.
Investors will also be more closely
monitoring the decisions by individual
board members and electing members
with more knowledge of their
background and voting patterns, she
predicts. That could help promote more
conversations between the board and
investors. Moreover, she sees more tieups
similar to that between UK pension
fund Hermes and Brazilian fund Previ.
Previ has launched a guide for
companies on how to conduct AGMs
and a list of dos and don’ts. Hermes has
supported the measure. “When you get
big funds like this working together, it’s
pretty powerful,” Guerra says.
amortisation (EBITDA.) Capital expenditure needs
are some R200m against cash flow of R450m next
year, according to their calculations.
The activists also point out that Telemig’s policies
seem out of line with those pursued by parent
companies Telefonica and Portugal Telecom, which
both have net debt to EBITDA ratios of more than
two times while Telemig’s net cash position gives it
a negative ratio of 1.70. Telefonica’s own policies
state the company should be “prioritising
shareholders’ returns for the use of free cash flow”,
they say.
Telemig is certainly not alone in Brazil in pursuing a
share buyback programme, says Marcelo Mollica,
senior analyst at GAP, who points out that from
September to November, 14 Brazilian firms started
buyback programmes against just four in the
preceding eight months. “Companies are returning
cash to investors where it’s not needed,” he says.
The move by the four managers is unusual for
Brazil in its level of coordination. With many foreign
investors having pulled out of the Brazilian stock
markets over the last 12 months, it’s going to be
more important than ever to get Brazilian
shareholders involved in monitoring their own
companies, says Mollica.
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

TAKING ADVANTAGE OF DEPOSITARY RECEIPT REVAMP
24
In the Markets
Edwin Reyes, managing director, Deutsche
Bank Trust Company Americas. Like
JPMorgan, Deutsche Bank also maintains
strict guidelines for consulting issuers prior to
the establishment a new programme. Says
Reyes, “That way we are absolutely certain
that there is no objection on the issuers’ part.”
Photograph kindly supplied by Deutsche Bank
Trust Company Americas, February 2009.
FOR THE BETTER part of a year,
the depositary receipt industry
has been a tale of two trends—
liquidity, way up and new sponsored
programmes, way down. An estimated
$4.4trn in DRs was traded globally last
year, up 34% from 2007. However, in
2008, there were just 20 new listings
on European and Asian exchanges;
only a dozen set up shop in the US.
With world economies still drifting
downward and new capital issuance
in short supply, that situation is
unlikely to change any time soon.
On the bright side, market volatility
has done wonders for DR transactional
revenue. Furthermore, efforts by the US
Securities and Exchange Commission
(SEC) aimed at making DRs more
accessible and cost-effective, including
guidance related to compliance and deregistration,
are likely to help mollify
long-frustrated foreign issuers in
NEW RULES FOR
DEPOSITARY
RECEIPTS
A rule revision that took effect last October simplified the
process for establishing unsponsored over-the-counter (OTC)
programmes for non-registered United States companies, while
making it easier for non-US companies to establish Level I
programmes stateside. With many more shares now available to
US investors in the form of depositary receipts (DR), banks are
already gearing up to reap the benefits. From Boston, Dave
Simons reports.
particular. Meanwhile, a rule revision
that took effect last October simplified
the process for establishing unsponsored
over-the-counter
programmes for non-registered US
companies, while making it easier for
non-US companies to establish Level I
programmes stateside. A recent report
by JPMorgan suggests a possible
increase in US based merger-andacquisitions
activity among foreign
companies, which anticipate using
American depositary receipts (ADRs) as
their acquisition currency.
Unsponsored explosion
In keeping with recent trends, ADRs
have, in general, mirrored the reduced
growth in volume of US domestic
stocks. This, says Anthony Moro, vice
president and head of ADR business
development for the Bank of New York
Mellon, indicates the secular changes
affecting the global markets. “Despite
the recent setbacks, the trend towards
globalisation remains intact—the
majority of the top oil, automobile and
airline companies are all non-US. If
you want to be involved in those
sectors, you need to go international.”
Last year’s SEC ruling opened the
floodgates for Level 1 unsponsored
ADRs, and in the few short months
since the changes took effect business
has been brisk, to say the least. Some
605 un-sponsored DR programmes
were established in 2008, up 288
percent from 2007 (combined
sponsored and un-sponsored
programmes totalled 2,900 last year).
Says Moro, “It took 75 years for 2,000
programmes to come to the market,
and in all likelihood the next 2,000 will
be here by the end of next year.”
In reality, investors have had a similar
tool at their disposal for years. So-called
F-share securities—broker-created
shares that resemble ADRs—have
provided US dollar-denominated
access to any foreign or private issuer,
without notification. However, such
securities are generally opaque and
exceedingly volatile.
Through its latest effort, the SEC
seeks to bring some of this cross-border
activity out into the light. “It really isn’t
a rule change per se and the SEC
understands that,” says Moro. “The
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

TAKING ADVANTAGE OF DEPOSITARY RECEIPT REVAMP
24
In the Markets
Edwin Reyes, managing director, Deutsche
Bank Trust Company Americas. Like
JPMorgan, Deutsche Bank also maintains
strict guidelines for consulting issuers prior to
the establishment a new programme. Says
Reyes, “That way we are absolutely certain
that there is no objection on the issuers’ part.”
Photograph kindly supplied by Deutsche Bank
Trust Company Americas, February 2009.
FOR THE BETTER part of a year,
the depositary receipt industry
has been a tale of two trends—
liquidity, way up and new sponsored
programmes, way down. An estimated
$4.4trn in DRs was traded globally last
year, up 34% from 2007. However, in
2008, there were just 20 new listings
on European and Asian exchanges;
only a dozen set up shop in the US.
With world economies still drifting
downward and new capital issuance
in short supply, that situation is
unlikely to change any time soon.
On the bright side, market volatility
has done wonders for DR transactional
revenue. Furthermore, efforts by the US
Securities and Exchange Commission
(SEC) aimed at making DRs more
accessible and cost-effective, including
guidance related to compliance and deregistration,
are likely to help mollify
long-frustrated foreign issuers in
NEW RULES FOR
DEPOSITARY
RECEIPTS
A rule revision that took effect last October simplified the
process for establishing unsponsored over-the-counter (OTC)
programmes for non-registered United States companies, while
making it easier for non-US companies to establish Level I
programmes stateside. With many more shares now available to
US investors in the form of depositary receipts (DR), banks are
already gearing up to reap the benefits. From Boston, Dave
Simons reports.
particular. Meanwhile, a rule revision
that took effect last October simplified
the process for establishing unsponsored
over-the-counter
programmes for non-registered US
companies, while making it easier for
non-US companies to establish Level I
programmes stateside. A recent report
by JPMorgan suggests a possible
increase in US based merger-andacquisitions
activity among foreign
companies, which anticipate using
American depositary receipts (ADRs) as
their acquisition currency.
Unsponsored explosion
In keeping with recent trends, ADRs
have, in general, mirrored the reduced
growth in volume of US domestic
stocks. This, says Anthony Moro, vice
president and head of ADR business
development for the Bank of New York
Mellon, indicates the secular changes
affecting the global markets. “Despite
the recent setbacks, the trend towards
globalisation remains intact—the
majority of the top oil, automobile and
airline companies are all non-US. If
you want to be involved in those
sectors, you need to go international.”
Last year’s SEC ruling opened the
floodgates for Level 1 unsponsored
ADRs, and in the few short months
since the changes took effect business
has been brisk, to say the least. Some
605 un-sponsored DR programmes
were established in 2008, up 288
percent from 2007 (combined
sponsored and un-sponsored
programmes totalled 2,900 last year).
Says Moro, “It took 75 years for 2,000
programmes to come to the market,
and in all likelihood the next 2,000 will
be here by the end of next year.”
In reality, investors have had a similar
tool at their disposal for years. So-called
F-share securities—broker-created
shares that resemble ADRs—have
provided US dollar-denominated
access to any foreign or private issuer,
without notification. However, such
securities are generally opaque and
exceedingly volatile.
Through its latest effort, the SEC
seeks to bring some of this cross-border
activity out into the light. “It really isn’t
a rule change per se and the SEC
understands that,” says Moro. “The
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

TAKING ADVANTAGE OF DEPOSITARY RECEIPT REVAMP
26
In the Markets
demand has always been there, and the
securities have been available as well—
the only thing lacking was the
transparency. This restores some sanity
to that portion of the market.”
Still, some companies have raised
concerns over the manner in which
unsponsored DR programmes have been
set up. According to Claudine Gallagher,
global head of depositary receipts at
JPMorgan, the unsponsored provision is
advantageous so long as the issuing
company is properly notified of the
establishment of an un-sponsored
programme. Unlike sponsored ADRs that
benefit investor and issuer equally,
investors stand to gain the most from an
unsponsored programme. The equity
from an unsponsored DR can be accessed
simultaneously by a number of different
depositary banks, which can lead to
confusion even among investors, since
banks may have different procedures and
proprietary fee schedules.
“There is demand here in the US for
securities to be held locally where no
DR currently exists, and so the
depositary bank will create an
unsponsored programme to satisfy that
need,” says Gallagher. “Which is great
for the investor—however, the issuer
still needs to be apprised of what is
happening to their equity, which
investors are holding it, as well as
understand how the unsponsored
programme functions and how it is
performing over time.”
It is JPMorgan’s policy to launch all
un-sponsored ADRs in conjunction
with the issuing party. “We feel that it
is very important that the issuer
understands when a programme is
going to be created and how it is
going to operate before it gets
established,” says Gallagher.
Like JPMorgan, Deutsche Bank also
maintains strict guidelines for
consulting issuers prior to the
establishment a new programme, says
Edwin Reyes, managing director,
Deutsche Bank Trust Company
Americas. “That way we are absolutely
certain that there is no objection on the
issuers’ part.”
Reyes is hopeful that the explosion
of un-sponsored programmes will help
buoy the market, particularly as any
skittishness among affiliated
companies begins to abate.
“Companies are beginning to see the
benefits of these unsponsored ADR
programmes,” he says. “Once the
education process continues, at some
point they may even consider
converting to a sponsored programme.
That, in turn, becomes another avenue
for the depositary banks to explore and
naturally, as the markets begin to
recover, we expect to see an overall
improvement in DRs in general.”
There are already a number of
positive signs. Compliance costs have
come down, and most companies now
seem to understand that it’s no longer
impossible to get out of a listing if push
comes to shove. This “means that
companies may be more willing to
register early on,” says Reyes, “rather
than stay on the sidelines because they
feared they wouldn’t be able to get out
of the programme if it wasn’t working
out for them.”
Liberalising the rules governing
listing and de-registering provides
much more incentive for would-be
participants, agrees Gallagher. “Just
two or three years ago, if an issuer
had an ADR established it meant that
the issuer was in it for good … Now if
an issuer launches an ADR, luckily
there is a way to exit. So this change
has had a positive effect on the DR
market.” Additionally, the
streamlining of certain reporting
requirements is good news for
prospective foreign private issuers,
says Gallagher.
While capital raisings in general are
expected to remain weak, there are a
few potential bright spots. Smaller
Brazil, Russia, India, China (BRIC)based
companies in cutting-edge
sectors such as biotech and alternate
energies have indicated a desire to get
into the market during the latter part of
the year. “ADRs have real appeal for
those types of sectors, mainly because
they believe that US tech analysts are
better at valuing their businesses,
which in turn will lead to better market
valuations,” says Gallagher.
Despite the continued weakness, now
is not the time to rethink one’s business
model, says Gallagher. “The markets are
going to eventually come back, and
therefore you want to be in a position to
respond very rapidly once the moment is
at hand.” In the absence of new deals,
Gallagher is confident that the returns
on JPMorgan’s existing book of business
will be more than sufficient. “ADRs tend
to be a nice business model—when
business is down, it’s because the
markets are down, however under such
circumstances, the increased volatility
generally leads to higher-than-normal
issuance and cancellation volume. This is
not to say that we have no concerns
whatsoever but there are certainly ways
to get through difficult market
conditions.”
As companies batten down the
hatches, Bank of New York Mellon’s
Moro sees a continuation of corporateactions
work from existing clients,
augmented by the occasional capital
raising. “For now it’s all about staying in
touch with our clients and helping
them navigate around the rocky coast
of this market,” says Moro. When the
market does begin to recover, Moro
believes that issuers will be at the front
of the pack, led by equity offerings from
the BRIC companies. “The debt markets
will remain moderately closed, and, in
turn, equity will become the new debt,”
he says. In turn, says Moro, US listings
will likely come back stronger than
ever, as increased corporate governance
entices buyers like never before.
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

TAKING ADVANTAGE OF DEPOSITARY RECEIPT REVAMP
26
In the Markets
demand has always been there, and the
securities have been available as well—
the only thing lacking was the
transparency. This restores some sanity
to that portion of the market.”
Still, some companies have raised
concerns over the manner in which
unsponsored DR programmes have been
set up. According to Claudine Gallagher,
global head of depositary receipts at
JPMorgan, the unsponsored provision is
advantageous so long as the issuing
company is properly notified of the
establishment of an un-sponsored
programme. Unlike sponsored ADRs that
benefit investor and issuer equally,
investors stand to gain the most from an
unsponsored programme. The equity
from an unsponsored DR can be accessed
simultaneously by a number of different
depositary banks, which can lead to
confusion even among investors, since
banks may have different procedures and
proprietary fee schedules.
“There is demand here in the US for
securities to be held locally where no
DR currently exists, and so the
depositary bank will create an
unsponsored programme to satisfy that
need,” says Gallagher. “Which is great
for the investor—however, the issuer
still needs to be apprised of what is
happening to their equity, which
investors are holding it, as well as
understand how the unsponsored
programme functions and how it is
performing over time.”
It is JPMorgan’s policy to launch all
un-sponsored ADRs in conjunction
with the issuing party. “We feel that it
is very important that the issuer
understands when a programme is
going to be created and how it is
going to operate before it gets
established,” says Gallagher.
Like JPMorgan, Deutsche Bank also
maintains strict guidelines for
consulting issuers prior to the
establishment a new programme, says
Edwin Reyes, managing director,
Deutsche Bank Trust Company
Americas. “That way we are absolutely
certain that there is no objection on the
issuers’ part.”
Reyes is hopeful that the explosion
of un-sponsored programmes will help
buoy the market, particularly as any
skittishness among affiliated
companies begins to abate.
“Companies are beginning to see the
benefits of these unsponsored ADR
programmes,” he says. “Once the
education process continues, at some
point they may even consider
converting to a sponsored programme.
That, in turn, becomes another avenue
for the depositary banks to explore and
naturally, as the markets begin to
recover, we expect to see an overall
improvement in DRs in general.”
There are already a number of
positive signs. Compliance costs have
come down, and most companies now
seem to understand that it’s no longer
impossible to get out of a listing if push
comes to shove. This “means that
companies may be more willing to
register early on,” says Reyes, “rather
than stay on the sidelines because they
feared they wouldn’t be able to get out
of the programme if it wasn’t working
out for them.”
Liberalising the rules governing
listing and de-registering provides
much more incentive for would-be
participants, agrees Gallagher. “Just
two or three years ago, if an issuer
had an ADR established it meant that
the issuer was in it for good … Now if
an issuer launches an ADR, luckily
there is a way to exit. So this change
has had a positive effect on the DR
market.” Additionally, the
streamlining of certain reporting
requirements is good news for
prospective foreign private issuers,
says Gallagher.
While capital raisings in general are
expected to remain weak, there are a
few potential bright spots. Smaller
Brazil, Russia, India, China (BRIC)based
companies in cutting-edge
sectors such as biotech and alternate
energies have indicated a desire to get
into the market during the latter part of
the year. “ADRs have real appeal for
those types of sectors, mainly because
they believe that US tech analysts are
better at valuing their businesses,
which in turn will lead to better market
valuations,” says Gallagher.
Despite the continued weakness, now
is not the time to rethink one’s business
model, says Gallagher. “The markets are
going to eventually come back, and
therefore you want to be in a position to
respond very rapidly once the moment is
at hand.” In the absence of new deals,
Gallagher is confident that the returns
on JPMorgan’s existing book of business
will be more than sufficient. “ADRs tend
to be a nice business model—when
business is down, it’s because the
markets are down, however under such
circumstances, the increased volatility
generally leads to higher-than-normal
issuance and cancellation volume. This is
not to say that we have no concerns
whatsoever but there are certainly ways
to get through difficult market
conditions.”
As companies batten down the
hatches, Bank of New York Mellon’s
Moro sees a continuation of corporateactions
work from existing clients,
augmented by the occasional capital
raising. “For now it’s all about staying in
touch with our clients and helping
them navigate around the rocky coast
of this market,” says Moro. When the
market does begin to recover, Moro
believes that issuers will be at the front
of the pack, led by equity offerings from
the BRIC companies. “The debt markets
will remain moderately closed, and, in
turn, equity will become the new debt,”
he says. In turn, says Moro, US listings
will likely come back stronger than
ever, as increased corporate governance
entices buyers like never before.
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

RESPONDING TO THE CREDIT CRISIS SARKOZY-STYLE
28
Country Report
German Chancellor Angela Merkel,
left, and French President Nicolas
Sarkozy listen during a conference on
security policy, (Sicherheitskonferenz)
at the hotel Bayerischer Hof in
Munich, southern Germany, on
Saturday, February 7th 2009.
Photograph taken by Frank Augstein
for Associated Press. Photograph
supplied by PA Photos, February 2009.
LIBERTY, FRATERNITY
& BANK BAILOUTS
It is not often that Nicolas Sarkozy chooses to shun the spotlight.
However, at the end of January the normally irrepressible French
president was nowhere to be found. The reason for the low profile
was not so difficult to track down as the president. On January 29th
some 2m French workers marched in cities and towns across France
to protest the government’s failure to adequately address their
concerns arising from the financial crisis and France’s looming
recession. Paul Whitfield reports from Paris on the impact of the
Sarkozy government’s response to the global financial crisis.
SARKOZY IS NOT the first
French politician to have been
laid low by protests, a point he
recognised himself when he
resurfaced for a television interview
on February 5th this year.
“Demonstrations are a constant for our
country,” he said. “It is normal that the
French people are upset.” However,
even as Sarkozy swallowed his pride to
empathise with his antagonists he
could be forgiven for a metaphorical
glance at his comparatively peaceful
near neighbours in the United
Kingdom and Germany and quietly
pondering, “why me?”
The answer seems to have far more
to do with the willingness of French
voters to take to the streets than any
particular failure on Sarkozy’s behalf.
Much like his peers, such as Germany’s
chancellor Angela Merkel and the
United Kingdom’s premier Gordon
Brown, Sarkozy has unveiled a raft of
measures designed initially to underpin
the banking sector, and more latterly to
invest in the economy at large and the
labour market in particular. In
December last year the government
announced a €26bn (£22.7bn) stimulus
including €10.5bn for loans to France’s
biggest lenders that will be used to
shore up capital reserves and should
help them keep lending. A similar
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

amount was made available to other
French banks later in the month.
Moreover, at the same time, the state
agreed to underwrite up to €110bn of
new bank lending through 2009.
Sarkozy’s support for French banks
differs from the UK bank bailouts in so
much as they are meant to encourage
lending by ostensibly healthy banks
rather than saving failing banks. The
French scheme has, however, tweaked
the nose of the European Commission
(EC), which initially considered the
measures as unfair state aid. Sarkozy
got his way, not least because other
countries, including Merkel’s Germany,
said they would follow the French path.
In consequence, the EC adopted new
guidelines on state intervention in
FTSE GLOBAL MARKETS • MARCH/APRIL 2009
banks to allow Sarkozy’s model to play
out. One key difference between
Sarkozy’s package and those of Brown
and Merkel is its size: it is far smaller
than those of both its neighbours.
Sarkozy can thank good fortune
rather than any particular skill for that
difference. French banks have always
been conservative lenders and through
a mixture of good management and
luck were less exposed to the fallout
from the sub prime collapse in the
United States than its counterparts in
both the United Kingdom and
Germany. Equally, the French
government is in a stronger position to
profit from its support than either of its
neighbours—at least in the short term.
France’s €20bn of loans to its banks will
generate about €1.4bn of interest in
2009, which Sarkozy says he will use to
fund “social schemes”. A further €3bn
of state funds is being used to purchase
equity in failed Franco-Belgian lender
Dexia, though €2bn of that is being
provided by France’s state-controlled
investment fund CDC.
These numbers pale against the
£100bn that the UK Treasury said in
January it expects to spend on
measures aimed at unfreezing credit.
That sum comes on top of a £37bn
bank bailout plan announced in
October 2008 and a £20bn stimulus in
November. The British government is
also backing some £1trn of bank
liabilities. Germany’s main retail
lenders have also received significant
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RESPONDING TO THE CREDIT CRISIS SARKOZY-STYLE
30
Country Report
support. Merkel’s government has
extended €92bn in publicly funded
debt guarantees and liquidity lines to
prop up Munich-based property lender
Hypo Real and is pondering its
nationalisation.
In addition, the German state has
spent €10bn buying Commerzbank
equity and has earmarked €8.2bn more
that will be made available in loans. A
further €10bn has been made available to
BayernLB. The total size of a German
bailout package, hurried through the
German parliament in five days, is
estimated to be €480bn, of which €400bn
is in a fund guaranteeing bank debt to
jump-start lending and €80bn is
earmarked for equity injections.
For all its relative modesty, the
French bank bailout has attracted much
ire from French unions and the general
public, which claim the government
has concentrated on propping up banks
at the expense of supporting consumer
spending and job creation.
Sarkozy is unrepentant about not
doing more to support consumer
spending. Speaking in his February
television interview, he said that the
US and British efforts to engineer a
recovery by stimulating consumer
spending had been a mistake that he
would not repeat. “If the British do
that [stimulate consumption] it is
because they do not have any
industry,” he said. “Gordon Brown can
not do what I do…he cut VAT because
he has little choice.”
It is not the first time that Sarkozy has
sought to score points on the domestic
front by criticising his foreign
counterparts. In November last year he
pointedly rebuked Angela Merkel at a
joint press conference when he declared
that “France is working on it [the crisis];
Germany is thinking about it.” In fact,
Germany’s plan for dealing with the
crisis sits somewhere between the
French and the British plans, being a
mixture of support for industrial
investment and consumers. A package
of measures agreed by Merkel’s
coalition in mid-January included
investment in public services, steps to
lower health- insurance payments, cuts
to the lowest income-tax rate and a
family-targeted cash give away of €100
for each child.
Sarkozy, meanwhile, remains
resolute in his belief that the best way
to protect jobs is to stimulate business
investment. In his February 5th
interview he shunned calls for
personal tax cuts or assistance and
instead outlined plans to cut business
tax by €8bn a year from 2010. He also
reiterated plans to provide up to €6bn
of aid to carmakers, noting that the
industry accounted for about 10% of
all French private sector employment.
Unemployment is fast emerging as
Sarkozy’s Achilles heel. France is
expected to enter its first recession in 16
years in 2009 and the jobless rate is
rising at its fastest level in 10 years. The
European Commission predicts the
French economy will shrink 1.8% this
year, its worst performance since World
War II. Unemployment in France,
which already stands at an
uncomfortable 8%, is expected to reach
9.8% by the end of 2009 and top 10.6%
by 2010, according to the Commission.
The rise in unemployment has
brought with it specific political
challenges for the French leader who
must be acutely aware that the crisis,
and rising unemployment, is playing
into the hands of France’s rejuvenated
radical left. Of particular concern to
politicians of both the right and left
central parties is the rise of Solidaire
Unitaire Démocratique, a union with
ties to far-left Trotskyist and other
communist groups that has risen to
become the second biggest union
amongst France’s rail workers. There is
no parallel to that in the political
spectrum in either the UK or Germany.
Sarkozy’s personal approval rating
tumbled 6 percentage points
following the strikes, to 41%, his
lowest level since taking power last
year, according to a Ifop/Paris Match
poll published at the end of January.
Brown and Merkel also have their
own problems. Brown has seen his
popularity dip in recent months after
it received an initial boost in the
early days of the crisis. A recent poll,
conducted by YouGov for Channel 4
News, found that just 36% of British
voters thought Brown was the best
leader to deal with the crisis, down
from 41% in October.
Merkel, who faces elections in
September, has also seen her party’s
popularity slip, even as her personal
ratings have held firm. Merkel’s
coalition government, consisting of her
own party the Christian Democratic
Union, the Christian Social Union and
Free Democratic Party, has fallen to just
50% in recent polls.
The pressures that the leaders are
under coupled with their differing
convictions on how to deal with the
crisis makes the possibility of a
coordinated response to the crisis from
Europe’s biggest economies unlikely. In
the early days of the crisis Sarkozy tried
to harangue the European Union to
come out with a unified response to the
emerging crisis, though the best he
could manage was to elicit a unified
statement. He also notably attempted
to push European governments into
adopting his idea of launching
sovereign wealth funds to invest in
domestic business, only to be rebuffed
by both Britain and Germany.
Sarkozy evidently remains an
optimist. He wants European
countries to adopt a common position
on reforming the financial system and
has said that he plans to lead talks on
the matter. Sarkozy may have toned
down his profile in France, European
leaders clearly should not expect the
same reticence.
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

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SAUDI ARABIA: CONTINUED MARKET LIBERALISATION
32
Country Report
UNLOCKING
POTENTIAL
The Saudi Arabian capital markets are complex beasts. Because
retail, rather than institutional investors form the bulk of the
activity on the Tadawul, the Saudi stock exchange, the market
suffers from a higher volatility than would be expected of the
largest exchange in the region. Moreover, the Saudi debt market
remains flat, but with a massive internal infrastructure spending
programme requiring significant investment inflows from both
the public and private sector, could all that change in 2009?
AT THE END of January 2009
the TASI, the main index of the
Tadawul, the Saudi stock
exchange, stood at 4,808, up 0.1%
over December but 77% down on its
all time high of 20,634 achieved
almost three years ago on the 25th
February 2006. At its peak the Tadawul
was the tenth largest stock exchange
in the world, based on the combined
capitalisation of its listed stocks. While
the Tadawul has often won plaudits
for its trading and settlement set-up
and competed in terms of market cap
with the biggest exchanges in the
world, in some ways the Saudi stock
market is immature. Even as the
market peaked in 2006 it had only 78
listed stocks, many with a limited free
float. While institutional investors
dominate most of the capital markets
in Saudi Arabia, retail investors still
account for 90% of trading volume on
the Tadawul, with trading based as
much on hearsay and market rumour
as statistical research. Even so, the
market is slowly evolving into a more
broad-based investment market with
a growing institutional investor base.
Among a raft of changes that are
modernising and liberalising the
Saudi trading market, perhaps the one
most likely to have the biggest longterm
impact is the introduction by the
Among a raft of changes that are modernising and liberalising the
Saudi trading market, perhaps the most significant of late is the
introduction by the Capital Markets Authority (CMA) of a
new law, last August, which allows non-resident foreign
investors access to individually listed stocks for the
first time. Until then foreign investors were
restricted to investing in mutual funds.
Photograph © Krishnacreations/
Dreamstime.com, supplied
February 2009.
Capital Markets Authority (CMA) of a
new law, last August, which allows
non-resident foreign investors access
to individually listed stocks for the
first time. Until then foreign investors
were restricted to access only through
mutual funds. Foreign asset managers
are still not allowed to trade shares
directly but must enter into an
innovative swap arrangement in
which their brokerage conducts the
trade on their behalf and then retains
the shares, passing on any profits or
dividends until such a time as the
broker is instructed to sell the shares
and remit the proceeds.
“Overseas buying interest is a
welcome introduction to the Saudi
market,” says John Coverdale,
managing director at SABB. “In normal
market conditions, the nature of
international investment flows means
that when the market is undervalued
money will come in and help underpin
prices. Similarly when the market is too
frothy or overvalued then overseas
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

SAUDI ARABIA: CONTINUED MARKET LIBERALISATION
34
Country Report
money tends to drain away so helping
to reduce volatility.”
There are a number of drawbacks to
this arrangement however. Most
significantly perhaps is that as the
shares themselves are not technically
owned by the international investors,
they are technically exposed to
potentially a great degree of
counterparty risk should their
brokerage for any reason enter into
administration. In the post-Lehman
Brothers era then, there may be some
reluctance by some international
investors to rely on the CMA to
protect their interests in the event of a
default. The lack of direct ownership
also prevents international investors
who build significant stakes in
companies from pushing for
representation on the board or from
voting in the event of a takeover.
Despite these limitations, Adeeb Al-
Sowailim, chief executive officer
(CEO) at Falcom, one of the new
breed of Saudi investment banks,
thinks that the changes introduced
into the market along with the
introduction of new initiatives to
boost disclosure, such as the
publication of the identity of
shareholders that hold at least a 5%
stake in a company, “are welcome
steps towards creating an
environment that foreign investors
feel comfortable with. Eventually the
regime will allow full foreign
ownership of shares.”
While foreign investors wait for an
opportunity to tap the still resilient
Saudi economy, the country is moving
apace with modernisation of its
capital markets. The opening up of the
investment market for international
investors has coincided with a
significant increase in the amount of
equity research available. Even though
Saudi banks have long had in-house
research teams they have traditionally
focused on macro-level economic and
sector reports rather than on
individual stocks. A combination of
competition from the newly licensed
brokerage firms and a desire from the
Saudi banks to improve their client
offering has led to an explosion in
both the quality, range and amount of
research on offer. For the first time
regular analysis of individual shares of
major companies is now available,
providing valuations based on
internationally recognised models
such as discounted equity cash flow,
dividend discount and peer based
valuations as well as buy, hold or sell
recommendations. “The provision of
this type of service is the first step if
international investors are to commit
significant funds into the Tadawul,”
maintains Al-Sowailim. “The research
Adeeb Al-Sowailim, chief executive officer
(CEO) at Falcom, one of the new breed of
Saudi investment banks, thinks that the
latest changes along with the introduction of
new initiatives to boost disclosure, such as
the publication of the identity of
shareholders that hold at least a 5% stake in
a company “ are welcome steps towards
creating an environment that foreign
investors feel comfortable with and that will
eventually allow full foreign ownership of
shares.” Photograph kindly supplied by
Falcom, February 2009.
also provides a guide to the local retail
investors as to likely long-term
company valuations thereby lowering
the influence of the rumour mill that
can occasionally take hold of the
market,” he adds.
For the brokerage firms, research is
also seen as key differentiator in the
highly competitive market and a strong
show of commitment to their clients.
Many have invested heavily in
expanding the depth of their research
coverage, often focusing not just on
companies in Saudi Arabia but across
the six-member Gulf Cooperation
Council (GCC). As research improves
and Saudi firms become more
comfortable with the levels of
disclosure expected by international
investors, the Saudi market should
eventually attract significant
investment flows, thinks Tim Gray, chief
executive at HSBC Saudi Arabia which
has now issued over $1bn of swaps on
Saudi shares since the end of August
2008. “We already have excellent
execution and clearing, settlement and
custody capabilities so the introduction
of better and more research completes
the picture.” Although another key
component, the ability to short and
therefore hedge risk, remains off the
agenda for the foreseeable future, in
the view of most market participants
the Tadawul is likely to become more
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

SAUDI ARABIA: CONTINUED MARKET LIBERALISATION
36
Country Report
firmly established on the radar of
international investors.
Although the lucrative foreign
investment market is the immediate
focus of many brokerages, the longterm
potential of the local retail
market has not been forgotten and a
slew of investment products are now
being developed for both this and the
institutional market.
The heavy fall of the TASI and the
volatility sometimes exhibited by the
Tadawul have opened the eyes of some
of Saudi Arabia’s 15m retail investors,
many of whom have been introduced
to the stock exchange through their
participation in the government’s
initial public offering (IPO)
programme, to the risks inherent in
stock picking as an investment
strategy. A number of the banks are
investing heavily in their investment
management arms and expanding the
number of products available. One
product, exchange traded funds (ETFs),
is well suited to the day-trading
environment of the Saudi retail market
because they can be bought and sold
like shares, have lower costs than
mutual funds and give exposure to a
wider constituent than individual
shares. Falcom has already taken the
first steps to launching an ETF with the
creation of its Sharia Index which is
licensed by the Tadawul. The index
represents 112 companies, nearly 78%
of the TASI index, that are approved by
Sharia scholars. “The index is calculated
in real-time, published in Saudi riyals
and over time we expect it to be used
as the basis of index-linked funds, ETFs
and over-the-counter (OTC) products.
The Falcom Shariah index also has
clear and transparent rules and
governance procedures that ensure
that it is investable and straightforward
to track,” said Al-Sowailim.
With the TASI falling 52.5% in 2008
and remaining subdued in the opening
weeks of 2009 investors are being
encouraged to look at Saudi Arabia’s
nascent sukuk market. Saudi Hollandi
Bank’s successful closing of a SR775m
mudaraba sukuk, as part of a planned
SR1.5bn Islamic note issuance
programme, has given hope for a revival
of the Saudi sukuk market which had
been in the doldrums, along with sukuk
issuance in other GCC countries and
the global debt markets. Even so,
issuance has been relatively constant
albeit at a low level since SABIC’s
ground-breaking SR3bn issuance in
2006. SABIC’s three issues still remain
the de facto benchmarks for Saudi
sukuk in the absence of government
issued paper. This may change as
companies previously reliant solely on
bank funding or on shareholder capital
seek alternative sources of funding as
traditional sources continue to tighten
during the course of 2009. Ultimately,
the spur to further issuance may,
ironically, be provided outside the
country. The Malaysian sukuk market
continues to be healthy, with a
substantial issuance pipeline in the first
half of 2009. Moreover, a fillip may also
be provided by Turkey and South Korea,
both of which are said to be planning
substantial sovereign sukuk issues in
the first quarter of this year. In their
efforts to promote Riyadh as a centre for
Islamic finance, the Saudi authorities
are likely to be keen to promote wider
use of sukuks by Saudi corporates.
The structure of the mudaraba
sukuk is similar to that of a traditional
securitisation in that a special purpose
vehicle (SPV) is created and income
relating to a specific project or income
scheme is paid into this. The sukuk
then represents ownership of units of
equal value in the SPV equity and is
registered in the names of holders and
produces returns according to the
percentage of ownership of share. This
makes it an ideal structure for banks
to raise capital to make loans as well
as for companies involved in large
Tim Gray, chief executive at HSBC Saudi
Arabia, which has structured a number of
sukuks, thinks that the instruments will
play a key role in the funding mix of projects
alongside local and international bank
funding, equity issuance, private equity and
government pools. “The sheer scale of the
projects planned in the Kingdom and the
amount of funding required means that
realistically every pool of liquidity will need
to be tapped.” Photograph kindly supplied by
HSBC, February 2009.
scale infrastructure projects which
have clearly identifiable revenue
streams. Gray at HSBC, which has
structured a number of the sukuks
issued to date, thinks that while the
unique nature of each sukuk issued
means it is difficult to boost issuance
levels quickly they will undoubtedly
play a key role in the funding mix of
projects alongside local and
international bank funding, equity
issuance, private equity and
government pools. “The sheer scale of
the projects planned in the Kingdom
and the amount of funding required
means that realistically every pool of
liquidity will need to be tapped.”
An increase in sukuk issuance will
be welcomed by investors in what is
still a “buy and hold” market with
limited trading on the secondary
market. An increase in issuance will
eventually feed through though and
should increase liquidity and tighten
spreads. This will give confidence to
international investors who have been
largely untapped in what remains
primarily a domestic market.
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

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SAUDI ARABIA: FISCAL SURPLUS BUOYS BANKS
38
Country Report
A stricter approach to credit risk is something that has been actively encouraged by the Saudi
Arabian Monetary Agency (SAMA), the central bank. “There is considerable evidence from the
international markets that many financial institutions fail because of high vulnerability to
credit risk. Also, credit risk management in the banking industry is an area of primary concern
and focus of SAMA’s off-site and on-site supervisory work and it continues to encourage banks
towards more sophistication in this area,” explains Abdulrahman Al-Hamidy, deputy governor
of SAMA. Photograph © Pavel Hamr/Dreamstime.com, supplied February 2009.
Saudi banks
buck the trend
The Saudi Arabian banking sector appears relatively immune to the vagaries of the global credit
crisis. In part, this insulation is a result of the large fiscal packages announced by the Saudi
government over the last 24 months, supporting a vast array of local infrastructure projects, either
through direct investment or capital goods financing. While some of the infrastructure projects
may be deferred, the majority of them look likely to go ahead, amounting to a stimulus worth a
tad above $400bn into the Saudi economy over the next five years. Even if the oil price hovers at
around $40 a barrel (and the Saudi government requires a price of around $50 to balance its
budget) the large fiscal surpluses built up over the last few years more than cover any potential
shortfall. Moreover, the banks appear to have solid support from the central bank, which has amply
demonstrated its willingness to intervene to ease liquidity issues. How best can local banks leverage
this project bonanza and central bank support?
“ WE ARE IN a fortunate
position in Saudi Arabia in
that national spending
plans and the strong fiscal position of
the government means that while the
Kingdom is not cocooned from the
issues facing the global economy, it is
probably cushioned, certainly at the
moment, from the worst of its effects,”
says John Coverdale, managing
director (MD) at SABB.
The positive banking results
reported by Saudi banks for the
2008 financial year certainly support
this view. While many banks
reported some slowing in income
growth and write downs in the
fourth quarter of 2008, their
aggregated performance and
relatively upbeat projections for the
2009 financial year are in marked
contrast to the dour predictions
elsewhere in the region and further
afield. Such is the divide in outlook
that some of the Kingdom’s
financial institutions appear to have
gone to some lengths to distance
themselves from their former
international partners.
Samba MD and chief executive
officer (CEO) Eisa al-Eisa, for
example, when announcing net
income for the bank of SR4.5bn in
2008, was keen to disassociate the
bank from its previous partner
Citigroup, explaining that Samba had
separated from Citigroup back in
2003. Although Samba’s overall net
income was down 7.7% year-on-year
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

after a challenging fourth quarter, the
bank says its outlook remains positive.
Samba’s total assets last year rose by
16% to SR179bn, compared to
SR154bn in 2007. Over the same
period investments rose to SR54bn, a
modest 1% increase, while total loans
and advances stood at SR98bn, up
22% versus the previous year. Total
deposits were up 16% versus 2007 at
SR134bn and Samba’s loan-todeposit
ratio was 73%, well below the
regulatory requirement of 85%.
Commenting on a balance sheet with
total equity standing at SR20.2bn
supporting total assets of SR 179bn,
al-Eisa believes that, “Samba’s
performance was achieved despite the
financial and economic crises gripping
the world’s economies. Our financial
position is based on a sound footing,
with adequate capitalisation and
healthy regulatory ratios.”
Another Saudi bank that appears to
buck the global trend is Arab National
Bank (ANB), which posted net profits
in 2008 of $663m. The key to the
bank’s success “against the backdrop
of a challenging global environment”
believes MD and CEO Dr. Robert Eid,
“is a high level of diversification in
terms of income and the robust nature
of our asset mix.” This allowed assets
to reach $32bn in 2008 against $25bn,
an increase of 28%. Investments
reached $7.5bn compared to $5.6bn
for the same period last year
representing an increase of 34%,
while the loans portfolio rose by 22%
to $19.9bn and customers’ deposits
increased by 26% to $24.7bn
Even so, brokerage and listings
advisory business was one area where
virtually all of the Saudi banks’ income
declined. Saudi banks account for over
90% of the trading activity on the
Tadawul, the Saudi stock exchange,
which recorded a 27% fall in the
volume of transactions (from 65.67m
trades in 2007 to 52.14m last year).
FTSE GLOBAL MARKETS • MARCH/APRIL 2009
Samba, for instance, saw income
from brokerage reduce by SR304m.
The turmoil on the Tadawul, where
the TASI, the main index, dropped by
a massive 52.5% last year, limited the
number of initial public offerings
(IPOs) to just 13 in 2008 compared to
26 in 2007. Saudi Arabia’s stock
exchange has always been vulnerable
to massive swings as it remains
essentially a retail market, with
institutional funds accounting for less
than 3% of the total.
Saudi banks face significant and
growing competition in the retail
segment from both the rise of local
brokerages, such as Falcom and
international companies such as
EFG-Hermes which have recently
established operations in the country,
mostly working out of Riyadh. The
government is encouraging
competition. The Capital Markets
Authority (CMA) as of the end of
January 2009 had issued 110 licences
to institutions wishing to set up
operations in the Kingdom. While
many of these are relatively small,
with little or no business, others have
set up much larger operations. The
consequence of this influx is that the
already tight margins on brokerage
operations in the country are now
under renewed pressure as the new
entrants look to gain market share.
Changing conditions in the local
market have encouraged many Saudi
banks to actively diversify their
business streams. SABB’s Coverdale,
for instance, attributes much of the
bank’s stable performance through
2008 (a more than satisfactory 12%
uptick in net profits to $779m) to the
growth in non-funds income. A
substantive upturn in revenue was
recorded largely across the board in
SABB’s card, account relationship
management and trade-related
businesses. “This sustained
performance has been achieved by
Samba managing director and chief executive
officer (CEO) Eisa al-Eisa announced net
income for the bank of SR4.5bn in 2008 and
was keen to disassociate the bank from its
previous partner Citigroup. (Samba
separated from Citigroup in 2003). Although
Samba’s overall net income was down 7.7%
year-on-year after a challenging fourth
quarter, the bank says its outlook remains
positive. Photograph kindly supplied by
Samba, February 2009
SABB’s continued focus on core
banking activities, supported by the
underlying fundamental strength of
the Saudi economy. The quality of our
asset book remains strong, with loan
growth being fully funded by
increased customer deposits. Surplus
deposits raised have been invested in
accordance with our conservative
investment policy,” explains Coverdale.
According to Coverdale, SABB uses
sophisticated modelling, credit
scoring and risk analysis in its various
businesses lines and also sets the bar
high in terms of loan qualification.
Saudi banks are also supported by
local loan repayment practices. When
loans or mortgage products are sold in
Saudi Arabia to individuals, for
instance, repayments are normally
deducted at source from their salary
39

SAUDI ARABIA: FISCAL SURPLUS BUOYS BANKS
40
Country Report
via the employer in much the same
way that income tax is deducted
elsewhere in the world. This process
significantly reduces the levels of nonperforming
loans in the Kingdom. Al-
Eisa says that Samba’s “nonperforming
loans (NPLs)-to-loan
ratio now stands at 1.8%, compared to
2.3% back in 2007. We continue to set
aside much higher provisions than the
regulatory requirement, thereby
improving our loan leverage ratio
(LLR) coverage to 167% compared to
160% in 2007.”
Another bank taking a conservative
approach is Riyad Bank. At the end of
2008 its loan book rose stood at
SR96.4bn, up 43% on the year and 7%
on the quarter. Much of this growth
has been in loans to small and
medium sized enterprises (SMEs), a
sector the bank has been heavily
targeting. More importantly Riyad
Bank has met with significant success
in attracting new deposits, which
surged 20% in the fourth quarter in a
highly competitive market. This
helped drive down the loans-todeposit
ratio to 92% (from 103% in
September) and leaves the bank well
positioned going into 2009.
This stricter approach to credit risk
has been actively encouraged by the
Saudi Arabian Monetary Agency
(SAMA), the central bank. “There is
considerable evidence from the
international markets that many
financial institutions fail because of
high vulnerability to credit risk. Also,
credit risk management in the banking
industry is an area of primary concern
and focus of SAMA’s off-site and onsite
supervisory work and it continues
to encourage banks towards more
sophistication in this area,” explains
Abdulrahman Al-Hamidy, deputy
governor of SAMA. The
implementation of Basel II at the
beginning of 2008 has given further
impetus to management of all risk in
the banks, he adds. “The credit risk
management systems in banks are
going through a thorough review and
enhancement as most banks are
working on the implementation of
their internal credit risk rating
systems,” notes Al-Hamidy. “These
systems are expected to collect
qualitative and quantitative financial
data on their customers and also data
on their facilities, collaterals, and other
related information. Furthermore,
these systems will help collecting data
on customer default history and credit
losses. The objective of these systems
is to provide information on the
probability of default and loss given
default.” This process should be further
aided by the creation of a national data
pool for corporate customers which is
currently being developed.
SAMA is also active elsewhere.
Although the lack of liquidity in the
banking system and wider economy is
less of an issue in Saudi Arabia than
elsewhere, some of the banks are
exposed to overseas borrowing.
However, this accounts for only a small
proportion of their funding.
Nonetheless, there is undoubtedly
competition between institutions for
deposits and this trend is only expected
to intensify as more foreign banks
enter the country. In the meantime, in
their search for liquidity, local banks
have been helped by SAMA’s
intervention in the markets. At the end
of November, the central bank lowered
the repurchase (repo) rate from 4% to
3% and the cash reserve requirement
on demand deposits from 10% to 7%.
Since then SAMA has made two
further cuts to the repo rate. The latest
intervention came on 19th January this
year when the central bank took the
repo rate down to 2% and the reverse
repo rate to 0.75% in order to “ensure
that credit is available for genuine
corporate demand at lower rates,”
according to an official statement.
John Coverdale, managing director (MD) at
SABB. According to Coverdale, SABB uses
sophisticated modelling, credit scoring and risk
analysis in its various business lines and also
sets the bar high in terms of loan qualification.
Moreover, Saudi banks are also supported by
local loan repayment practices. Photograph
kindly supplied by SABB, February 2008.
Repo and reverse repo transactions
are the primary tools that SAMA has
used to offset temporary swings in
bank reserves, as well as to boost
liquidity. A repo temporarily adds
reserve balances to the banking
system while reverse repos have the
opposite effect. In repos, SAMA
makes overnight loans to banks in
collateral of the government securities
portfolio held by banks with a
maximum of 75% of this portfolio at
the announced repo rate. In reverse
repo, SAMA borrows from banks at
the reverse repo rate. The latest action
by SAMA of reducing repo and
reverse repo rates adds more stability
to the inter-banking market, boosts
liquidity and makes more reserves
available for banks, at a lower cost, if
the need emerges. In October SAMA
announced that to date no bank had
used this facility but as conditions
worsened for the banks in the fourth
quarter there was no indication
whether this was still the case.
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS

Spotlight on Colombia:
A Q&A Session with Global X Funds founder and CEO Bruno del Ama
Why did you choose the FTSE Colombia 20 Index as the basis for Global X’s newest Exchange Traded Fund?
It is difficult and expensive to access the Colombian market and this is the first Colombian ETF globally. FTSE developed a custom made index for
the Colombian market that balances the liquidity needs of an ETF with the diversification requirements from U.S. regulators. The index represents
the performance of the top 20 stocks, ranked by liquidity, then size, in one of the world’s fastest growing emerging markets.
What is the performance story?
Amidst global market turmoil over the course of the trailing year, ending 30 January 2009, Colombia was one of the top performing emerging
markets. The FTSE Colombia 20 Index was down only 5.38% in USD total return terms over that period, as compared with the FTSE Emerging All
Cap Index, which fell by 50.92%.
FTSE Colombia 20 1-Year Performance
Index Rebased (31 Jan 2008 =100)
140
120
100
80
60
40
20
Jan-2008
Feb-2008
Mar-2008
FTSE Colombia 20 Index FTSE Latin Americas All Cap Index FTSE Emerging All Cap Index
What kinds of companies are found in the Colombia 20 Index?
The constituents of the Colombia 20 index span multiple industries, although there is some concentration in Oil & Gas, Banks, and Financial Services
as classified by ICB supersector. The top two companies in the index are Ecopetrol SA, the largest Latin America IPO in 2007, and Bancolombia SA,
the largest commercial bank in the country.
FTSE Colombia 20 Top 5 Constituents
Apr-2008
Rank Constituent Name ICB Supersector Index Market Cap (USDm) Index Weight (%)
1 Empresa Colombiana de Petroleos Oil & Gas 1,012 19.87
2 Bancolombia Banks 423 8.30
2 Bancolombia PN Banks 570 11.19
3 Colombiana de Inversiones Financial Services 258 5.07
4 Banco De Bogota Banks 253 4.98
5 Inversiones Argos Construction & Materials 250 4.92
Totals 2,766 54.32
Source: FTSE Group, as at 30 January 2009. FTSE does not accept any liability for any errors or omissions in the FTSE indices or underlying data. No further distribution of FTSE Data is permitted without FTSE's express written consent
For further information about GlobalX Funds, please contact Bruno del Ama at bdelama@globalxfunds.com or visit www.globalxfunds.com
THE FTSE I WANT THE WORLD INDEX
FTSE. It’s how the world says index.
May-2008
Global markets grow more complex and interconnected every day.To stay abreast, you need a comprehensive
index that can slice and dice markets the way you do. The FTSE Global Equity Index Series was the first
benchmark to cover the world seamlessly with a single consistent and transparent methodology. Wherever
you invest, FTSE gives you the clearest view of how you are doing. www.ftse.com/invest_world
© FTSE International Limited (‘FTSE’) 2009. All rights reserved. FTSE ® is a trade mark owned by the London Stock Exchange Plc and The Financial Times Limited and are used by FTSE under licence.
Jun-2008
Jul-2008
Aug-2008
Sep-2008
Oct-2008
Nov-2008
Dec-2008
Jan-2009

INDEX REVIEW: THE DARKEST HOUR BEFORE THE DAWN?
42
Index Review
ROCK, PAPER,
SCISSORS, STERLING
At times like this, where the dark before the dawn seems ever
deeper, it is quite simple to advise investors to keep their hands
in their pockets rather than risk a punt or two on a reversal of
fortune. Even so, traders should always be aware that bear
markets do end at some point and the resulting bounce can be
dramatic. Simon Denham, managing director of spread betting
firm Capital Spreads, looks for hope amid the wreckage.
MY LAST MISSIVE concerned
the need for that iconic
moment when a major name
disappears and defines the moment
when we can say “that was the
bottom”. Might it be near? Both RBS
and Lloyds/HBOS look suspiciously
terminal; indeed, at 11p per share the
entire share capital of RBS is now
valued at little more than a three
month call option. In the
Scandinavian banking crisis of the
1990s equity holders were wiped out
and many banks merged or sold off to
create Nordea Group. The potential
for huge job losses if the UK takes this
same route will cause alarm in the
Exchequer as tax revenues and
spending are already under pressure.
Truth is, capital economies rely on
strong banks for growth. A major
handicap for both the communist and
the Islamic economic models over the
last century has been their lack of
ability to borrow to expand. Everything
had to be centrally planned/funded or
paid for cash down. The upshot is
much slower growth and the
depressing fact that the poor generally
remain poor and the wealthy reap all
the rewards. If too many banks go to
the wall and/or their appetite for
lending is seriously curtailed it will
have a serious affect on growth
potential for many years to come.
The UK’s public fiscal position is
precarious as ever more funds have
been committed to social wellbeing
programmes with little consideration
given to the long term costs of such
projects. Over the last three months
untold billions have been added to
this total in the form of props to the
financial services sector. The result,
predictably, is an economy resembling
one of those test crash dummies
driving into a brick wall. Business
surveys are reporting unheard of
weakness in confidence, order books
and rate of decline.
It is tempting to say that equity
markets and investors tend to look
past current problems and focus on
future opportunity. However,
companies which have not reported
losses for decades are now swimming
in red ink and the situation for weaker
businesses remains grim and is likely
worsen. The destruction of capital has
been monumental and there will be a
massive issuance of Gilts, Bunds,
Treasuries etc over the next three to six
years. This glut of state debt is likely to
soak up a big chunk of available
investment funds and may create a
heavy squeeze on investment
elsewhere. From where are the excess
funds, needed to drive a serious bull
market, going to come?
While equity market returns look
Simon Denham, managing director of spread
betting firm, Capital Spreads, October 2008.
tempting the same can be said for
corporate bonds. Much of the five to
eight year UK corporate debt is giving
yields in the low teens when the
equivalent equity return is generally at
4% to 6%. This yield gap is giving
company treasurers little scope to issue
debt to finance growth (with no real
appetite for equity issuance either).
Markets are current oscillating
around the same general area day
after day, with the FTSE struggling to
break away from the 4000 to 4450
range. It had broken above and below
these levels several times since
October but only for a few days until
the pressure to return becomes too
great. This weakness might be
considered surprising as the index is
comprised of so many foreign and
international firms (given the
thrashing being given to sterling). It is
said over 70% of the turnover of FTSE
100 stocks is made abroad. If this is
indeed the case, the attraction for UK
stocks in their sterling depreciated
state must be compelling. The
problem is that any foreign portfolio
manager looking at UK equities
investments is looking at serious value
destruction over and above the mere
weakness of the actual stock. Sterling
has more than halved versus the yen
since the summer of 2007 and has
given up 35% against the dollar and
euro. It is a brave fund manager who
is willing to buck a trend like that.
As ever Ladies and Gentlemen,
Place your bets.
MARCH/APRIL 2009 • FTSE GLOBAL MARKETS