FTSE Global Equity Index Series

Kjerstin Hatch, portfolio 

manager at distressed-debt 

investor Madison Capital 

Management in New York. 

Junk 

bonds take 

centre stage 

The US corporate bond market experienced its 

most dramatic day since the Enron and Worldcom 

scandals on May 5 when Standard & Poor’s (S&P’s) 

cut its credit ratings on General Motors (GM) and 

the Ford Motor Company to junk status. The 

removal of these two American household names 

from the investment-grade ranks turned 

US$290bn of senior unsecured debt into junk 

bonds – the largest such transformation ever seen 

in a single day – and will influence the direction 

of the US bond markets for months to come. 

Andrew Cavenagh reports. 

FTSE GLOBAL MARKETS • JULY/AUGUST 2005 

THE IMPACT OF S&P's ratings action, which lowered 

the long-term ratings GM and Ford from BBB- to BB 

and BB+ respectively, on the quoted debt of both 

companies, was immediate and savage. The following day, 

GM’s 2033 long-dated bond dropped more than four points 

to 74.5 cents on the dollar (bumping its yield up from the 

8.375% coupon to 11.42%). In the meantime the shorterterm 

2013 instrument issued by Ford Motor Credit, the auto 

maker’s finance arm, lost more than three points to close the 

week at 87 cents on the dollar.The extent of the reaction led 

one banker to comment: “If you look at the spreads on the 

short-dated bonds now, they look quite attractive.” 

It did not take long for the knock-on effect to catch up 

with the US automotive supply industry. On May 18, S&P 

lowered its rating on Delphi from BB to B, having previously 

downgraded it on April 21 and also cut Collins & Aikman’s 

(C&A’s) further from CCC+ to CCC-. Within hours, C&A 

DEBT REPORT: US BOND ISSUES 

51

DEBT REPORT: US BOND ISSUES 

52 

applied for court protection 

from its creditors under the 

US Chapter 11 bankruptcy 

code of practice. 

Dramatic as the investor 

reaction was, there is little 

risk that GM or Ford will 

have to contemplate this 

course – at least in the near 

to medium term. While 

most analysts believe that 

further downgrades are 

eminently possible (S&P 

has put both companies' 

ratings on negative watch) 

they still have large cash positions and substantial undrawn 

bank facilities.“The companies have a lot of liquidity and that 

is a source of hope,” maintains Scott Sprinzen, the S&P 

analyst in New York who covers the industry. “In the auto 

sector there have been examples of dramatic turnarounds.” 

Sprinzen adds that the big cash holdings combined with 

relatively light profiles of maturing debt make it unlikely that 

either company could seek Chapter 11 protection in the next 

two years.“You have to be able to demonstrate that you’re 

insolvent, and that’s hard to do when you are sitting on a lot 

of cash,”he points out. 

While the senior unsecured bond markets are probably 

closed to both companies for the foreseeable future, they 

can still raise further liquidity if required by selling more 

asset-backed securities. Almost all their main asset types 

(retail loans, wholesale loans, retail leases) are securitisable. 

Alternately, they can unload loan portfolios to third parties 

in the whole-loan markets. Nevertheless, the loss of 

investment grade status for two motor titans will have 

widespread ramifications for the corporate – and other – 

bond markets. It has already led to the downgrading of 

several collateralised debt obligations (CDOs) in which 

Ford and/or GM bonds formed part of the collateral. 

Following a review of 561 European synthetic CDOs, S&P 

said 19 of the 745 classes required downgrading and a 

further 25 needed to be placed on negative watch. 

While much of the reaction to date has focused on the 

CDO market – much of it down to hedge funds that 

misread arbitrage opportunities in the derivatives of the 

equity and mezzanine tranches covering positions – 

investment grade portfolio managers may well have to 

offload tens of billions of dollars' worth of the auto makers' 

bonds in the coming weeks. 

The picture is clouded, however, by the impending 

change in Lehman Brothers' US Aggregate Bond Index, the 

most widely used US measure for tracking investment 

grade credits. From July 1, the index will use the middle 

rating from the top three agencies (S&P, Moody’s and 

Fitch) rather than the lower of S&P's or Moody's as it does 

at present. Provided Moody’s and Fitch do not downgrade 

the companies to sub-investment grade in the meantime, 

their bonds could become eligible holdings again in a few 

US Auto Sector measures impact of new junk bond status 

120 

110 

100 

90 

80 

70 

31-Dec-03 

31-Jan-04 

29-Feb-04 

31-Mar-04 

30-Apr-04 

31-May-04 

30-Jun-04 

31-Jul-04 

31-Aug-04 

30-Sep-04 

31-Oct-04 

30-Nov-04 

Ford Mtr Cr Co Cont Offer Bd Mtnf 7.100 09/20/13 

31-Dec-04 

31-Jan-05 

29-Feb-05 

31-Mar-05 

30-Apr-05 

31-May-05 

General Mtrs Corp Deb 8.375 07/15/33 

Data as at June 05. Source: FTSE Group. 

weeks. A lot of investors 

holding GM and Ford 

bonds are consequently 

expected to sit tight.“That 

means the process of 

shifting Ford and GM 

[stock] is not going to 

happen in one go,”says the 

deputy head of credit 

strategy at one of the 

leading Continental 

European banks in 

London. “Personally, I 

think it is going to be 

relatively protracted.” 

He adds that the sell-off could have a bigger impact on the 

high-yield bond markets in Europe than in the US, given 

that the downgraded debt of GM and Ford would account 

for a much higher percentage – about a third – of the market 

on this side of the Atlantic.“I think over time the effect you 

see will be more pronounced in Europe,”says the banker. 

There is also a risk that the Ford/GM situation will blight 

wider corporate issuance in the US. The latest figures from 

the data provider Dealogic revealed a dramatic drop in new 

issues from speculative-grade companies in the second 

quarter so far – 69% down on the comparable period of 

2004 – and a 7% decline in the volume from investmentgrade 

companies.This followed the pattern seen in the first 

three months of 2005, where junk bond issuance dropped 

64% and investment-grade 18% on last year, but in part 

reflects stronger cash positions after seven quarters of 

continuous profits growth. 

There was also evidence that investor confidence in the 

senior unsecured sector was starting to ebb before S&P 

announced the Ford and GM downgrades. Spreads had 

certainly started to widen in March, after GM had warned 

that its profits for 2005 were likely to be 80% lower than 

previous forecasts. The month also saw the inflow of foreign 

capital into US corporate bonds dive from about US$80bn in 

February to US$48bn, a development that aroused the 

interest of foreign-exchange analysts and dealers who 

believe the subsequent Ford and GM downgrades can only 

accelerate this move. “I would have thought that that [the 

downgrades] is ultimately going to put pressure on those 

credit markets going forward,” says Richard Franulovich, 

senior currency strategist at Westpac Banking Corp in New 

York, “the next big adjustment is a further widening of 

spreads.” Franulovich adds that Ford and GM’s loss of 

investment grade status was also affecting the market for US 

Treasuries, with the yields on short term bills dropping as 

low as 3%.“It is generating a flight to quality,”he explains. 

The rating agencies are not forecasting a general decline 

in corporate access to unsecured capital market debt at this 

stage.“We have not really seen it show up yet,”says David 

Hamilton, head of default research at Moody’s Investor 

Services in New York.“The damage seems to be fairly well 

contained to pockets of distress at this point.” In its latest 

JULY/AUGUST 2005 • FTSE GLOBAL MARKETS

monthly default report, Moody’s 

for risk over the coming months. 

also points out that while it expects 

“The resilience of the market has 

(12-month ahead) default rates to 

not really been tested so far [in 

rise from the current 2% to 3.3% by 

this crisis].” He adds that buyers 

April 2006, this figure will still be 

are likely to become more 

below the 20-year average annual 

selective. “I guess they are going 

rate of 4.9%. 

to become very much more 

Standard & Poor’s (S&P) also 

discriminating towards credit, and 

published a positive credit outlook 

there will be a lot more 

for US corporate bonds in mid- 

differentiation between sectors.” 

April. The agency’s analysis 

Hatch at Madison believes that 

revealed that in the first quarter of 

the distressed debt market for 

2005 the ratio of downgrades to 

corporate debt is consequently set 

total rating actions fell to 53% - 

for spectacular growth over the 

dropping well below the 18-year 

next three years in the aftermath of 

average of 62%. It attributed the 

the high-profile cases such as 

improvement to the expanding 

Enron, Worldcom and K-Mart, as 

economy (US GDP rose 4.4% in 

external factors and a change in 

2004) which had seen the profits of 

corporate approach will produce a 

speculative-grade companies rise Diane Vazza, director of Global Fixed Income further wave of bankruptcy filings 

more rapidly than those of 

Research at Standard and Poor’s. 

from middle-tier companies. On 

investment grade ones. The S&P 

top of the pressures of rising 

outlook did caution, however, while most industries interest rates, commodity prices and increased competition 

seemed to be “extremely solid”a few still had problems and from foreign competitors, Hatch maintains that Chapter 11 

highlighted airlines, petrochemical companies, retail and no longer carries the stigma it did a decade ago and that 

restaurant businesses as those most at risk. It said more some companies increasingly view it as a strategic tool to 

than 30% of the companies in these sectors had negative get rid of unwanted financial burdens, such as pension 

outlooks. Diane Vazza, managing director in global fixed- obligations, healthcare costs and expensive leases. 

income research at S&P in New York, adds that defaults The most recent example was United Airlines’successful 

among high-yield issuers will start to “tick up”as the credit court petition on May 10 to transfer US$10bn of pension 

quality of issuers deteriorates in what is an ageing bull liabilities from its four schemes to the Federal pension 

market. She points out that 50% of speculative-grade protection plan. Hatch believes the senior unsecured bonds 

issues this year have been rated B- or lower, with triple-C of companies that use the bankruptcy regime for these 

bonds carrying a 29% chance of default in their first year. purposes should offer better recovery rates. She points to 

“Gains from here are going to be limited,”she concludes. the experience of the “slew” of companies that entered 

In the high-yield market, Moody’s estimates there are Chapter 11 over the past four years to seek protection from 

US$56bn of high-yield corporate bonds due to mature, and asbestos claims. “The recovery rates for those bonds are 

which need refinancing, over the next three years. The higher than for those [companies] with an honest to 

figure includes US$20bn of maturing debt in the goodness reason for going into Chapter 11.” 

telecommunications, technology and media sector, which At the same time she cautions that overall recovery rates 

was the primary source of corporate defaults in 2004. in the distressed debt market are likely to plummet as 

Investors in US corporates also expect to see some sectors higher interest rates, fuel costs and commodity prices make 

to suffer more than others. Kjerstin Hatch, portfolio manager the economic environment – and refinancing – more 

at distressed-debt investor Madison Capital Management in difficult. “It is not going to be as easy to rely on the next 

New York, says those that will come under the most stress churn.” In many cases, she says companies that enter 

over the next three years are automotive suppliers, airlines, bankruptcy proceedings will no longer have any 

textile manufacturers, and some of the traditional worthwhile assets to restructure and holders – or buyers – 

supermarket groups. They will struggle to compete on cost of their paper will need to revise their expectations 

with the low-wage Wall-mart model suggests Hatch.“Your accordingly. She expects recovery rates – as a percentage of 

old-time supermarket stores are still operating under a bonds’par values - to drop from the current 50-70% range 

unionised system,”Hatch explains.“And I think we are going into the “teens and low 20s”. She believes the trend will 

to see more pain in the airline sector – probably Delta.” work in the favour of the more established distressed-debt 

Meanwhile, Matein Khalid, the capital markets specialists, as these lower returns will drive many of the 

strategist and chief dealer at Union National Bank in Abu relative newcomers out of the market and reduce the 

Dhabi who previously managed global bond portfolios at demand for such debt.“I think as money flows out, you will 

Chase Manhattan and First Chicago in New York, says get the over-reaction and that will give opportunities to the 

the difficulties in these sectors will test investor appetite experienced investors.” 


53

DEBT REPORT: JUMBO PFANDBRIEFE 

54 

Jumbo 

How the 

took flight 

It is ten years since the birth of Jumbo Pfandbriefe propelled the antiquated covered-bond market 

from the relative calm of the backwaters of German finance onto the world stage. In that time the 

Jumbo covered bond market has grown from a gleam in a banker’s eye to more than €400bn today. 

Meanwhile new issuance of covered bonds for 2005 alone is forecast to top €130bn. The number 

of issuing countries has grown from one (Germany) to seven and at the same time the share of non- 

German investors in the Jumbo Pfandbriefe market has risen from as little as 5% to almost 30%. 

Where can the market go next? By Paul Whitfield 

THE SUCCESS OF today’s covered bond business 

seems a long way from the withering market into 

which a handful of German banking pioneers sought 

to pump life with the launch of the first Jumbo Pfandbriefe 

back in 1995. Then, a combination of small issuance size 

(typically less than DM60m; the equivalent of €30.6m) and 

an insignificant secondary market had squeezed liquidity 

out of the Pfandbriefe market driving spreads to 

insupportable levels. “Investors had to pay about 100bp 

over Libor,” says Claudia Vortmueller a covered-bond 

analyst at Commerzbank Corporates & Markets. 

The extent of the market’s liquidity problem became 

painfully evident in the two years prior to the birth of the 

Jumbo market. In 1993, a Pfandbriefe bull market had attracted 

large amounts of both investors and issuers into covered 

bonds. However, when the market turned in 1994 investors 

found themselves trapped by the paucity of willing buyers. 

The experience spooked investors. Foreign investment 

banks in particular were rattled and all but abandoned the 

market. By 1995 it was estimated that non-Germans held a 

meagre 5% share of the of Pfandbriefe market. Even in its 

homeland Pfandbriefe began to lose its appeal. From 

accounting for about half of the German bond market in 

1990, Pfandbriefe had shrunk to nearly a third by 1995. 

There is disagreement over what constituted the first Jumbo 

Pfandbriefe. Most agree that the first major step toward the 

new market, if not the birth of the Jumbo itself, came in May 

1995, with the DM500 million Frankfurter Hypothekenbank 

deal, a 5.875% June 1999 public sector Pfandbriefe. 

The deal was the first truly large Pfandbriefe but it lacked 

many of the essential features that have been enshrined in 

today’s Jumbo market. Crucially the market maker was also 

the issuer – Frankfurter Hypothekenbank (now Eurohypo 

AG) – an arrangement which while necessary, given the 

lack of other options, meant the market lacked the 

transparency of today’s Jumbos. 

The first Jumbo to incorporate most of the key features 

that sit at the core of today’s vehicles was an August 2005 

issue by Depfa. The bond was far larger than the 

Frankfurter issue, at DM2bn, and, crucially, it had three 

lead managers who also pledge to create a secondary 

market and maintain tight spreads. 

Since 1995 the Jumbo market has grown quickly. By mid 

1996 the amount of outstanding paper topped €50bn. Within 

another two years it had tripled in size to €150m and by 2000 

was approaching the €350m mark. Today’s outstanding 

volume of about €400 million makes the Jumbo Pfandbriefe 

market Europe’s fourth-largest bond market, behind the 

government bonds of Italy, Germany and France. 

Yet, however spectacular the growth of Jumbo 

Pfandbriefe has been in Germany, the most interesting 

aspect of its success has been the spread of Jumbo’s beyond 

German borders.“It is wrong to think of this as a German 

product anymore, covered-bonds are now a European 

market and we will see the percentage share of the 

German market continue to decrease over time as 

European issuance grows,”says Vortmueller. 

In 2000 about 90% of all new Jumbo issues originated in 

Germany, that percentage had fallen to 50% by 2003 and by 

the end of 2004 it had fallen to almost 30%. Investing in 


Jumbos is also no longer an exclusively German practice – a 

10-year €1bn Jumbo covered bond issued in February by 

Austria’s Kommunalkredit was bought by investors in France, 

Spain, the Benelux countries, Scandinavia, China and South 

Korea, as well as Austria and Germany. 

The attraction of Jumbo covered-bonds to foreign banks is 

easy to understand. On the supply side the bonds are popular 

with banks because they allow issuers with AA or A credit 

ratings to create instruments that typically enjoy ratings of 

AAA – making raising funds cheaper. On the buy side, the 

bonds have both the liquidity and size that are necessary to 

attract large investors. They also have the key advantage for 

banks of requiring only half the capital coverage of a bond 

issued directly by banks that issue mortgages. The reason for 

this, say regulators, is because the bonds are secured against 

stable long-term loans, making them particularly safe – 

though critics suggest that the narrow asset base means the 

bonds are not as safe as many think. 

The financial advantages of Pfandbriefe, coupled with 

the new found success of the Jumbo format, led, in 1999, to 

the first non-German issuance of covered-bonds when 

Spain launched its cédulas hipotecarias and France issued 

obligations foncières. More recently they have been joined 

by Austria, the UK (which in 2003 became the first country 

The Pfandbrief 

In 2005 the Jumbo Pfandbrief marks its 10th anniversary. 

For a decade, the Jumbo Pfandbrief has been setting the standard in the international fixed income market. From a 

standing start, the Jumbo Pfandbrief has grown to a market of 400 billion euros and an average issue size in excess 

of 1.7 billion euros. The groundbreaking Jumbo segment has spurred the development of the pan-European Jumbo 

covered bond market worth nearly 600 billion euros. 

The Jumbo Pfandbrief: quality, liquidity and a yield pick-up. 

Find out what investors should know about the Pfandbrief � � � www.pfandbrief.org 


to issue a covered-bond without specific legislative 

backing), Ireland, and in March 2005, Italy’s first Jumbo 

covered-bond – albeit one sponsored by the state rather 

than a private bank. 

The ranks of Jumbo covered-bonds are expected to be 

further swelled by issues from Sweden, Norway and perhaps 

Portugal, all which could make their debut later this year, and, 

at a later date, Finland, Poland and Hungary.“The coveredbond 

markets have expanded into almost all the European 

countries, but although legislation has been implemented, 

covered-bonds have not actually been issued in all areas,” 

says Christof Juetten, executive director, responsible for 

covered-bond Origination at Goldman Sachs International. 

For the time being the big three markets of Germany, 

Spain and France, collectively account for about 90% of all 

Jumbo covered-bond issuance. That high-rollers club may 

have to expand in the coming years, says Juetten.“We expect 

to see most growth from Italy. It is the last, large European 

economy which has yet to introduce covered-bonds on a 

significant scale.” Doomsayers had predicted that 

European-wide issuance of Jumbos would lead to thinner 

demand. In fact the opposite has occurred. Investors in new 

issuing countries have more than met their own domestic 

demand and begun to search in other markets. 

MEMBER INSTITUTIONS 

OF THE ASSOCIATION OF 

GERMAN MORTGAGE BANKS 

AHBR 

Berlin Hyp 

Deutsche Hypo 

Deutsche Schiffsbank 

Dexia Hypothekenbank 

DG HYP 

Düsseldorfer Hypothekenbank 

Essen Hyp 

Eurohypo 

HSH Nordbank Hypo 

Hypo Real Estate Bank 

Hypo Real Estate Holding 

HypoVereinsbank 

Karstadt Hypothekenbank 

MünchenerHyp 

SEB Hyp 

Warburg Hyp 

WL-BANK 

Württemberger Hypo 

Wüstenrot Hypothekenbank 

55

DEBT REPORT: JUMBO PFANDBRIEFE 

56 

It seems increasingly 

likely that issuance of 160 

covered Jumbos will soon 150 

spill out of Europe. A 140 

number of other countries, 130 

notably from central and 

120 

South America, have been 

110 

investigating the possibility 

100 

of issuing covered-bonds, 

90 

while delegates from US 

have also started to take an 

interest in the mechanics 

of constructing coveredbonds. 

“It will get very 

interesting if non- 

European countries come into the market, such as Mexico or 

a South American country. And of course if the US enters the 

mix then everything will change,”says Vortmueller. 

The growth of a larger market in covered-bonds has 

added length and depth to the covered-bond yield curve – 

in particular the Spanish cédulas have added mass and 

liquidity to the long end of the yield curve. Yet the market 

has also remained largely homogenous as a result of the 

adoption of similar legislation across the issuing countries. 

That is not expected to change. 

Juetten says: “The economic principles that drive the 

development of the product are the same and therefore a 

convergence of covered-bond legislation has taken place.” 

The exception to this has been Britain and Italy, both of 

which have issued covered bonds without the backing of 

legal infrastructure – though in the case of Italy that looks 

like a one off with new laws expected to be enacted soon. 

The success of the British bond has paved the way for more 

like it and importantly it has shown a way forward for banks 

in other countries, without specific covered bond legislation. 

“In (Britain and Italy) issuers have had to substitute the 

legislative framework with private law. Because they are 

effectively using structuring techniques and every issuer 

has a slightly different documentation more caution is 

needed when comparing one covered-bond with another,” 

says Karlo Fuchs, associate director Financial Institutions 

Ratings at Standard & Poor’s Frankfurt. The growth of 

covered-bonds outside Germany has given rise to another 

notable trend, namely the growth of the mortgage sector in 

the market. This too is expected to continue. 

Throughout the 1990s, the covered-bond market was 

dominated by German public-sector lending collateralised 

bonds. While the laws in the new issuing countries allow for 

the issuance of both mortgage and public sector based 

covered-bonds it is already evident that it is the former that 

will dominate. This development could have a negative 

impact on the market as it is attracting the interest of financial 

regulators, who are concerned that savings banks are issuing 

debt that ranks higher than the deposits of customers. 

The UK regulator has already issued guidelines that no 

more than 4% of total assets can be repackaged as debt. 

This has put the brakes on UK issuance of covered bonds 

“The high-rollers club” – Germany, Spain and France 

Dec-99 

Jun-00 

Dec-00 

Jun-01 

Dec-01 

Jun-02 

as a number of building 

societies are already 

pressing up against this 

limit. If an upcoming 

liberalisation of the laws 

governing issuers of 

Pfandbriefe in Germany 

leads to an increase in 

German savings bank 

issuance then the German 

regulator is expected to 

review its regulations. 

The actions of 

Data as at June 05. Source: FTSE Group. regulators and legislators 

will become increasingly 

important as the covered-bond market becomes ever more 

international and thus competitive. In such a market the 

impositions and protection afforded by regulators will go a 

long way to determine the availability and popularity of the 

different nation’s bonds. Thankfully, the biggest regulatory 

change facing the industry is likely to have a positive 

impact on the covered bonds market. The introduction of 

the Basel II accord, tipped for 2008, will more closely align 

banks’ capital requirements with the economic risk of 

holding different financial products. 

That will deliver a boost to fixed-income products in general. 

More specifically it is good news for covered bonds because it 

will allow a lower risk rating for mortgages – make the issuing 

of covered bonds more attractive and further securing the 

Jumbo market’s success for the next ten years and beyond. 

Dec-02 

FTSE France Pfandbrief Index FTSE German Pfandbrief Index FTSE Spain Pfandbrief Index 

Jun-03 

Dec-03 

Jun-04 

Dec-04 

JUMBO PFANDBRIEFE BASICS 

FIRST ISSUED IN Germany over 230 years ago 

Pfandbriefe (more or less pronounced fund brief) are 

covered-bonds collateralised by long-term debt – either 

mortgages or loans to the public sector. Despite an 

increasing geographical diversity of issuers the principles 

created in 1995 – with the launch of the Jumbo 

Pfandbriefe market - have been widely adopted as the 

governing tenet of all of Europe’s Jumbo markets. 

The minimum standards for Jumbo Pfandbriefe were 

officially adopted by German mortgage banks in 1997 

and updated again in 2004. They include: A minimum 

issue size of €1 billion, with a minimum initial issue size 

of at least €750 million. The average size tops the 

€1.5 billion mark. 

The use of only straight bond formats to create 

Jumbo paper – i.e. fixed coupon payable annually in 

arrears with bullet redemption. A minimum of three 

market-makers who are pledged to quote bid/ask (twoway) 

prices simultaneously for lots of up to €15 million. 

Market makers should also have agreed to maintain a 

standard and pre-determined bid offer spread based on 

the residual life of an issue – for example the maximum 

bid/offer spread for an 8 to 15 year maturity is 10bp. 


Agence France Trésor (AFT), the French public debt 

and treasury management agency, has never been 

one to take a back seat. In 2001 it issued the firstever 

government deal linked to Eurozone inflation 

and just four months ago – with the launch of its 

50 year note – it brought the longest ever G7 

government bond to the market. And it seems the 

issuer, which had to scale back €19.5bn of investor 

demand to price its €6bn 2055 deal, has started 

something of a trend. Chris Newlands reports. 

SINCE AFT LAUNCHED its 50 year note back in late 

February of this year, just 16 days after appointing 

Barclays Capital, BNP Paribas, CDC Ixis, Credit Suisse 

First Boston (CSFB), Deutsche, HSBC, CCF and JP Morgan 

to gauge the potential market demand for such a bond, both 

Telecom Italia and the UK’s Debt Management Office 

(DMO) have brought ultra long notes to the market – and 

the investment community believes there will be many more 

deals to follow.“We expect to see a lot more issuance of very 

long-term debt,”says Mary John Miller, director and head of 

fixed income at T. Rowe Price.“Historically low interest rates 

make this beneficial for issuers and the increasing demand 

for long duration investments among certain investors 

makes 50 year notes appealing. Rising long-term rates 

might dampen investor demand but the focus on pension 

plan reform and asset and liability matching should keep 

certain parts of the market very interested.” 

Wayne Bowers, head of global fixed income at Northern 

Trust Global Investments (NTGI), agrees: “We will see more 

governments following France's lead with Italy, Spain and 

others all likely to issue long maturity government debt, 

although perhaps not at the 50 year level. Expected and actual 

changes in pension legislation are driving investors’ demand 

for ultra long deals and, while these changes can take many 

months to filter through to trustee investment meetings, it 

should ensure that demand is maintained. Consequently, 

government borrowers will be encouraged to pursue an 

issuance programme that includes longer-dated notes.” 

Indeed, in addition to the UK’s 26 May nominal deal, the 

DMO is also making plans to bring the world’s first inflationlinked 

50 year bond to the market in either July or September. 

Meanwhile the German government is to decide when and if 

it will issue 50 year deals before the end of this year. At the 

same time, AFT expects to increase its existing €6bn issue to 

somewhere between €10bn and €15bn and (after a four year 

absence from the benchmark) the US treasury is looking at 

the prospect of launching a 30 year note. 

“We will examine if we have the flexibility to issue 30 year 

bonds while maintaining deep and liquid markets in our 

other securities,” said Timothy Bitsberger, the United States’ 

assistant treasury secretary for financial markets, in a 

statement.“We need to determine if nominal bond issuance is 

cost effective.”After taking public comments, the department 

will decide whether to issue the bond on 3 August. If the 

answer is yes (and the overwhelming expectation is that it will 

be) then the first auction will take place in February 2006. 


Wayne Bowers, head of global 

fixed income at Northern Trust 

Global Investments 

LONG 

BONDS 

GAIN 

FAVOUR 

DEBT REPORT: EUROPEAN LONG BONDS 

57

DEBT REPORT: EUROPEAN LONG BONDS 

58 

But continued demand from the European pension fund 

community and its appointed managers is crucial to the 

success of any future ultra long issuance. Analysis of AFT’s 50 

year February deal shows that pension and asset managers 

made up more than 50% of the €19.5bn order book, while 

hedge fund investors, insurance buyers and banks made up 

just 18%, 14% and 13% of total demand respectively. 

Philip Read, director of the €2.05bn pension scheme for 

Metal Box, the UK manufacturer, says: “It is very positive 

that any government wants to issue very long dated indexlinked 

bonds but there needs to be a lot more of it. There is 

no magic in a 50 year note, however. We have liabilities that 

go out 80 years and so having a 50 year note helps with that 

but it is not the be all and end all. What we need is a range 

of index-linked deals that stretch out as far as is necessary.” 

The pension fund community in the Netherlands 

endorses this. Forthcoming changes to Dutch pension 

solvency requirements, entitled FTK, that are scheduled to 

come into effect at the beginning of next year, will force 

pension fund investors to mark their liabilities to market 

ahead of fixed rate usage. This shift to fair value accounting 

will sharply increase the volatility of their liabilities and it is 

widely expected that investors will beef up their exposure to 

very long-dated paper and become forced sellers of equities 

and shorter-dated deals in order to reduce volatility. 

“The 30 year state-swap spread, which is already at 

historically tights, could narrow even further as a result of 

the new supervisory framework for pension funds and 

insurers that will be introduced in 2006,” says Bert 

Heemskerk, chairman of the executive board at Rabobank 

Nederland.“The rationale being that we expect the FTK to 

lead to a massive interest in receiving fixed ultra long swap 

Arnaud Mares, Head of Portfolio Strategy, at the UK’s Debt 

Management Office 

rates, which will push in spreads versus ultra long bonds.” 

Indeed, Harvinder Sian, an analyst at ABN Amro, believes 

that more than €120bn worth of Dutch pension and 

insurance assets will flow into long-bonds as a result of the 

new requirements and investors’ need to match liabilities. 

“Dutch pension funds should be big buyers of duration this 

year on regulatory factors,”he says.“Pension funds will want 

to hedge the risk in their long-term liabilities to avoid the 

most onerous regulation elements and we expect around 

€bn120-€150bn in [long-dated] buying.” 

But even though investors in the Netherlands are 

expected to be large consumers of very long-dated debt – 

and interestingly, demand from the Benelux region made 

up seven per cent of AFT’s €19.5bn order book – the 

Dutch government is unlikely to issue a 50 year bond any 

time soon. The borrower did, however, issue its first 30 

year bond in seven years at the end of April after 

instructing ABN Amro, Fortis and CSFB to investigate the 

potential market demand for the note. The Dutch State 

Treasury Agency had intended to issue a 10 year deal but 

found enough interest to price a €5.2bn 2037 deal that 

paid four basis points over German bunds and was 40% 

sold to pension and asset managers. 

Erik Wilders, head of the Dutch State Treasury Agency, 

says: “There is obviously demand in the market for very 

long-dated bonds and the research from ABN Amro, Fortis 

and CSFB found that there was indeed room for us to come 

to the market with a 30 year deal. But issuing a 50 year 

bond is simply not an option for us right now,” he adds. 

“You need a huge amount of outstanding debt to 

successfully launch such a deal and, at the moment, we do 

not have that. Our goal is to issue debt as cheaply as 

possible at a given level of risk.” 

But it is precisely this attitude that makes many buyers 

worry that 50 year bonds are a much better bet for issuers 

than investors.“While moves to increase the availability of 

very long-dated assets are to be welcomed, we expect these 

deals to be a sideshow for most investors,”says Jeremy Toner, 

fixed income portfolio manager at Investec Asset 

Management. “Although governments are showing an 

astute understanding of timing by issuing very long-dated 

instruments when inflation and interest rates are particularly 

low, investors face the risk of capital losses unless the bonds 

are priced with the potential for higher future inflation. 

Previous experience with very long dated bonds has been 

unhappy for investors. For example, the undated UK war 

bonds issued prior to WW1 and reissued at 3.5% in 1932 

(another period of very low inflation and interest rates) have 

experienced significant capital losses to date.” 

Denis Gould, head of UK fixed income at AXA 

Investment Managers, agrees: “There is clearly demand for 

ultra long maturities, especially from liability driven 

investors but we think the current craze for 50 years may 

wane. In government bonds, 50 year issues have the benefit 

of higher convexity, which is worth something, but 

investors receive next to no extra yield for moving out to a 

rather isolated point on the curve where liquidity could be 


poor. Worse, if many other countries follow France’s lead, 

demand could quite quickly become exhausted.” 

Jon Little, chief executive officer at Mellon Global 

Investments is equally as critical. “There was definitely a 

herd mentality going on with the French deal and I would 

not be surprised if after few years some of those investors 

that bought into the bond begin to wonder what they got 

themselves into. The pricing left a lot to be desired.” 

But this does not worry Benoit Coeuré, deputy chief 

executive officer at AFT. The borrower’s February deal 

attracted demand from at least 10 different countries 

including Italy, Germany, the UK, Japan, the US, Sweden 

and France, while its eventual size beat expectations by 

around 100 per cent. Indeed, the issuer plans to increase 

the size of that deal to somewhere between €10bn and 

€15bn and then has ambitions to launch an inflationlinked 

50 year note once this has been achieved. 

“We were definitely surprised by the amount of investor 

demand there was for our deal,”says Coeuré.“We expected 

and were committed to issuing a deal of somewhere 

between €3bn and €4bn but eventually brought a deal to 

market that was twice as big as we thought. What we learnt 

is that demand is very deep and that there is more than 

enough room for other issuers to come to the market. In fact 

the more that come the better and that does not just mean 

sovereigns. We would also like to see more non-sovereign 

issuers, such as utilities, bringing 50 year deals as this will 

add more depth and liquidity to the sector.” 

Arnaud Mares, head of portfolio strategy at the UK’s DMO, 

also rubbishes Gould’s suggestion that the appearance of too 

many government 50 year bonds will dilute and ultimately 

extinguish investor demand. He believes that there is more 

than enough space for other ultra long issues and is 

unconcerned by the fact that there has been a spate of 50 year 

deals in a relatively short space of time. 

“It was never an issue for us what the other governments 

were doing and whether or not we were the first into the 

market,”says Mares.“It is not a race. We know that there is 

significant demand out there from the pension fund 

community but demand is not restricted just to pension 

funds. ultra long bonds have a high convexity and this 

makes them appealing to other sections of the market, 

such as hedge funds and the trading desks of banks.” 

But whether or not the demand for 50 year deals dries 

up over the next couple of years, right now investor 

interest in such bonds remains strong. Continued moves 

from the various European regulators to increase 

protection for pensioners and reduce their exposure to 

market risk is increasing the need for fixed income 

products – particularly long-dated instruments as 

countries move to fair-value liability accounting. 

At the same time, national treasury agencies throughout 

Europe have been eyeing the opportunity to issue very 

long-term debt at a time when both interest rates and 

inflation are at relative lows. This demand and supply 

match-up looks set to mark the arrival of many more ultra 

long bonds over the next 12 months, despite investors’fear 


Benoit Coeuré, deputy chief executive officer at AFT 

of rising interest and inflation rates. 

“Nominal 50 year deals are not as attractive as 

inflation-linked bonds but you can be sure that investors 

will jump into any deal if other investors are doing so,” 

says Read at Metal Box.“People do not like to be left on 

the sidelines and European sovereigns will not have a 

problem finding demand.” 

“Interest in these deals will not wane,”adds Emeric Challier, 

global CIO for European fixed income at Fortis Investments 

“If governments become too active in issuing 50 year bonds 

we may see a fall in demand but this will only happen over the 

longer-term. Right now we are just at the beginning.” 

Emeric Challier, global CIO for European fixed income at Fortis 

Investments 

59

DEBT REPORT: UK GILTS 

60 

The Debt Management Office 

(DMO), the UK Government’s bond 

issuance office, an executive 

agency of the UK Treasury, is 

determined to build liquidity in 50year 

gilts following the first of its 

ultra long bonds being auctioned 

to investors in late May. Francesca 

Carnevale talked to Robert 

Stheeman, the DMO’s chief 

executive, about the market 

response to the auction and the 

agency’s issuance calendar for the 

remainder of the 2005-6 fiscal year. 

SMOOTHING THE WAY FOR 

ULTRA 

AS MAY SLOWLY ground to a close the DMO sold 

via auction an inaugural 50-year plain vanilla bond 

which marked the longest dated bond the UK 

Treasury has brought to the market in more than four 

decades. At present, the longest issues out in the market 

LONG 

with a finite maturity are for around 30 years (please refer to 

Table 1) – there are however some outstanding bonds (£3bn 

of ‘undated’ bonds, in fact) some stretching as far back as 

the nineteenth century. 

The new ultra long offering comprised £2.5bn of 2055- 

BONDS 

dated paper, carrying a coupon of 4.25% and issued at a 

yield of 4.21% (at the time of issuance, by comparison, the 

30-year benchmark bond offered a yield of 4.33%). The 

bond was in large part deemed attractive by market 

commentators, given a healthy backdrop of investor 


demand and the expectation that UK interest rates will 

begin to fall in the autumn. The bond also marks only the 

first stage in the UK’s issuance of ultra long-dated bonds, 

according to Robert Stheeman, the chief executive of the 

DMO, who expects its success to be followed by at least 

one further issue later this year and another early next. It 

could, he acknowledged be extended from the second 

quarter of the 2005/2006 financial year to include an indexlinked 

offering. 

The UK’s return to the long term gilt market has 

highlighted efforts by leading European sovereign issuers 

to lock-in low interest rates at a time when pension funds 

and insurers are clamouring for long-term assets. When 

France’s Agence France Trésor (AFT), for instance, issued a 

similar a €6bn 50-year bond through a syndicated offering 

it was more than three times oversubscribed, raising 

€19bn-worth of investor interest following a formal bookbuilding 

process. 

While Stheeman smilingly acknowledges that demand 

for the UK ultra long bond might have been stronger (the 

auction was covered 1.6 times), he is sanguine enough to 

state that the issue was “very normal for a long dated 

auction. We are always pleased with our issues and this is 

no exception. We spent a long time building up to it. The 

French government has issued something of comparable 

length, but not by auction. I have to say that it [the auction] 

very much met our expectations.”A second intention was 

to ensure a well-run auction process. “I would stress that 

for us it was very important to run an open, transparent 

process”, adds Stheeman. 

The DMO has long preferred the auction process over 

syndications. “It is a transparent and predictable way of 

issuing debt,” says Steve Whiting, the DMO’s policy 

advisor, continuing “while maintaining a level playing field 

for primary dealers and at the same time delivering value 

for money for the government.” 

“An auction suited our purpose well in that case” 

explains Arnaud Mares, who is head of portfolio strategy at 

the DMO. “There are very good arguments for using 

syndication [sic], but it also raises issues” he adds. 

FTSE All-Share Index vs. FTSE UK Gilts 

150 

140 

130 

120 

110 

100 

90 

80 

70 

60 

50 

May-00 

Nov-00 

May-01 

Nov-01 

May-02 

Nov-02 

May-03 

Nov-03 


May-04 

Nov-04 

May-05 

FTSE All-Share Index FTSE British Government Stocks over 15 years Index 

FTSE British Government Index-linked over 15 years Index 

Data as at June 05. Source: FTSE Group. 

United Kingdom: Structure of the assets of pension 

funds and insurance companies (as % of total assets) 

90 

80 

70 

60 

50 

40 

30 

20 

10 

Securities other than equities: short-term 

Medium-term bonds 

Long-term bonds 

Listed equities 

Non-listed equities 

Foreign equities 

0 

96 97 98 99 00 01 02 03 04 05 

Source: Ixis CIB 

Stheeman picks up the theme.“We would have to choose 

only a few lead managers for instance, so it could suggest 

we were favouring or giving status to a small group of 

banks. We try to treat all the gilt edged market makers 

(GEMMs) in an equal and transparent fashion. It is very 

important to us,”he says. 

But while the DMO is happy with the take up of the 

issue, Stheeman admits he was after rather bigger fish. The 

DMO was keen not just to sell down one or more ultra long 

bonds in the year, it was also keen to develop a long term 

viable market for ultra long dated gilts. "Liquidity is 

important, and it is something we have focused on very 

carefully. We had to be sure that whatever we introduced 

was sustainable," he says. That requirement comes into 

focus strongly as Stheeman outlines the UK’s medium 

term borrowing requirements.“For the next four years we 

will average over £50bn – more than last year,” says 

Stheeman, while Arnaud Mares stresses that the DMO 

“has no particular concerns on the ability of the capital 

markets to absorb this requirement. The market itself has 

expanded, turnover has increased and liquidity has 

improved. We do not sense the market has a problem with 

the increased level of issuance.” 

Stheeman’s ambitions for the ultra long dated bonds 

find a receptive audience among pension fund advisers 

who have warned that issuance of ultra long dated bonds 

must be substantial to avoid the problem of retirement 

funds locking away a limited supply of long dated paper 

and creating an illiquid market. In the late 1990s, for 

instance, when public finances were in surplus, trading in 

30-year gilts became illiquid for a time, producing in turn 

wide price swings. The US, for another, even suspended 

issuance of 30-year bonds back in 2001 when its budget 

was in surplus. The US Government has, however, 

recently launched a consultation on the resuming issuance 

of 30-year bonds. 

Ultra long dated bonds have a particular appeal to the 

investment community, for various reasons. Pension 

funds, for one, have largely been in favour of them. 

61

DEBT REPORT: UK GILTS 

62 

Interest in them by defined-benefit pension schemes, in 

particular, is being driven by ageing maturity profiles and 

legislation which encourages them to match their assets 

against their liabilities. Consequently as of the beginning of 

this year demand for long-dated bonds strongly 

outweighed supply, thereby creating a good climate for the 

UK via the DMO to return to the ultra long dated market. 

“It is fair to say that the vast majority of this issue has gone 

THE APPEAL OF THE ULTRA LONG BOND 

to the domestic market,”explains Stheeman, although this 

assessment is based on anecdotal evidence. It will be some 

time before the DMO gets a clear picture of the 

composition of buyers of the paper. “In a syndicated 

offering you get a better breakdown,”he acknowledges. 

Historically, UK pension funds and insurance companies 

have been by far the largest buyers of gilts – in particular 

index-linked gilts. This trend is likely to continue especially 

THE IDEA OF a very long-term bond is not brand new, but it has become very popular in recent months. In some 

part this is because pension funds are undergoing rising regulatory pressure to match long-term liabilities and 

assets. As well, governments have also acknowledged that current financial conditions make long-term bonds a 

cheap way to grow funds. 

The launch of the longest dated British Government securities ever issued – aside from undated gilts, which have 

no fixed redemption date – came in the aftermath of World War I. In June 1919 the Government launched two 

inaugural ultra long gilts on the same day: 4% Victory Bonds, which raised £287m and a further 4% Funding Loan 

dated 1960-1990 £288m. In today’s terms, the issues constituted a considerable operation for the time – 

equivalent to around £14bn in current money, according to Steve Whiting, a DMO policy advisor. 

Issuing authority for the bonds was obtained from the House of Commons by the then Chancellor of the Exchequer 

Austen Chamberlain on 2 June. “There then followed several days of speculation in the press over the terms and 

conditions of the bonds prior to their official launch in the Guildhall by the Chancellor and the Lord Mayor, on the 

evening of 12 June 1919,” he explains. Although the Prime Minister, Lloyd George could not be in attendance, he 

telephoned a message of support, stating that in buying the bonds you “get the premier security of the world”. His 

comments were received with cheers by the audience when they were read out by the Chancellor. As part of the 

launch of the new bonds, a floral fête was also held in Trafalgar Square in celebration. “In addition, at the Prime 

Minister's request, over 120 MPs agreed to speak as advocates of the new bonds in their constituencies,” says Mark 

Deacon, senior quantitative analyst at the DMO. 

Investors could purchase the bonds for cash or by exchanging Treasury bills or other short-dated gilts, “the latter 

being part of a government drive to reduce the proportion of the government's debt that was in either floating rate or 

short-dated form,” says Whiting. When it was issued, 4% Funding Loan 1960-1990 had a 71-year maturity. 

However, in practice it was redeemed early in November 1972, making it a 53-year bond. 4% Victory Bonds were 

redeemed in 1976, giving them a near 57-year maturity. 

Other ultra long double-dated gilts were issued after 1919. For instance, in 1954 the government issued 3.5% 

Funding Stock 1999-2004. This was created as a result of a conversion out of another gilt issue. The yield at issue 

was 3.62% and so this was consistent with the 3.5% coupon. The highest price for this bond in 1954 was £99 3/16 

and the lowest – at the end of the same year – was £95 1/16. Although this gilt was technically a 50-year gilt as its 

final maturity date was in 2004, it was actually redeemed early in 2003, making it a 49-year bond. Of the gilts 

currently in existence, the longest dated at issue is 5 

1/2% Treasury Stock 2008-2012 which was issued in 

October 1960, making it a 48-52 year depending on 

its precise redemption date. “At the time, there was 

Mark Deacon, senior 

rather a lot of speculation in the press when this 

quantitative analyst 

particular bond was launched that one of the 

objectives of the sale was to absorb demand, which 

was reported as being large and showing signs of 

increasing,” explains Whiting. “The last double-dated 

gilt was launched in 1980 and nowadays the policy of 

the UK government is to concentrate issuance on 

large benchmark bonds with a vanilla bullet structure, 

in line with the products available in other leading 

international bond markets,” adds Deacon. The 

demand for bonds is set to continue, thinks Deacon, 

and to increase as European institutional investors 

still have a large mismatch between their need for 

bonds and what they actually have in their books. 


as more schemes try to address their matching 

shortfalls. However, many schemes have 

liabilities with maturities longer than that of 

the longest-dated gilts. Index-linked gilts, for 

example, extend to 2035, with only nine issues 

available (and, reportedly, most of the UK’s 

pension schemes have liabilities that extend 

well beyond that date). Further, the 

implementation of international accounting 

standards (IAS) as well as more constraining 

regulations is forcing life insurance companies 

and pension funds to better match their 

liabilities. By marking-to-market larger parts 

of their balance sheets, these institutions are 

motivated to reduce their duration 

mismatches if they want to reduce the risk of 

high volatility in their financial results.The UK 

market is a powerful indicator of the potential 

impact this trend towards longer dated 

investments can have on the bond market. In 

the UK, the changes in regulation forcing 

pension funds to better match the duration of 

their liabilities has resulted in a strong 

increase of the bond portfolio weight in the 

asset allocation to the detriment of equities. 

The share of equities has fallen from 68% in 

1998 to 52% in 2004 and the share of bonds 

has risen from 25% to 39%. 

Since 2001, the UK institutional investors 

have been net sellers of equities and net 

buyers of bonds. The impact of the regulation change has 

been strong performance of long dated gilts and 

ultimately an inversion of the yield curve. As of the end of 

January 30-year gilts traded at a yield of 4.5% compared 

to 4.6% in the 10-year sector. At the peak of the inversion 

in January 2000, 30-year gilts yielded more than 1% less 

than the 10 year maturities. 

In the period before the DMO kick-started the ultra long 

dated bond issuance process, a shortage of long-dated 

sterling bonds had, in the meantime, encouraged banks 

and other financial institutions to offer products such as 

inflation swaps to help retirement funds hedge exposure to 

future liabilities. But it is/was nowhere near enough to help. 

No surprise then that the DMO ultra long inaugural bond 

was snapped up by the local market. 

Finally, it was becoming obvious that UK sovereign 

issuance was on the rise as the shortfall between 

government spending and tax revenue has widened 

considerably in recent years. Chancellor Gordon Brown 

signalled his intent to issue 50-year gilts in his March 2005 

Budget speech to the British Parliament, in a move that 

would “lock in low borrowing costs and simultaneously 

benefit taxpayers and investors”. 

Even though it was well aware of this confluence of 

trends, the DMO had undertaken a lengthy market 

consultation process well in advance of the March budget 

to test the appetite of the larger investment community 


Steve Whiting, Policy Advisor & Press Officer. 

towards longer dated issues. “It is becoming a typical 

process for us and others are now taking our lead,”explains 

Stheeman. The consultation was spearheaded by Arnaud 

Marés, and Steve Whiting.“Arnaud and Steve kicked it off 

in an informal way last summer,” explains Stheeman.“We 

needed to understand the structural needs of the market 

and our own investor base. The formal consultation began 

in earnest in December of last year.” 

Most of the dealers involved in the wide-ranging 

consultation process (taking in investment advisors, 

actuaries, pension trustees and market traders) gave 

preference to a 50-year issue, but some asked for a 40-year 

bond. Dealers also called for the DMO to re-open 

conventional bonds maturing in 2032 and 2038, and 

evinced an interest in launching a 2040 gilt, according to 

national press reports at the time. 

The DMO is likely to come to market with a further ultra 

long dated bond later this year. Take up on the next gilt 

issue will be a bellwether of the success of the DMO’s effort 

to stoke up liquidity. A further milestone will also be 

achieved, if the DMO manages to meet demand for an 

ultra long dated index-linked bond.“It is fundamentally a 

different animal,” concedes Stheeman, “and so that may 

take longer to achieve. We will have to take the measure of 

the market and demand and the technical issues in 

structuring an index-linked facility over such a long tenor.” 

Knowing the DMO, it will leave nothing to chance. 

63

SECTOR REPORT: DISTILLERS 

64 

Blithe Spirits IN A 

The spirit of capitalism is up and roaring – at least 

among the world’s distillers. The few remaining 

liquor giants today squint avariciously at each 

other’s brands, with a view to takeovers and 

amalgamations. Allied Domecq, the British-based 

company that is the world’s second largest liquor 

seller, having scarcely digested its spoils from the 

Seagram’s carve up of four years ago, is now itself 

on the slab awaiting the brand-hoarders’ hatchets. 

Its shareholders are not complaining. Like a prize 

bull fatted for market, the carved up company is 

worth far more than on the hoof. Ian Williams 

considers the outlook for the industry. 

Philip Bowman, 

chief executive, Allied Domecq 

= bull 

run

TODAY’S SPIRITUOUS FRENZY is a return of an 

older cycle of trade. In the seventeenth and 

eighteenth centuries, the distillation of brandy and 

rum helped turn the engines of world commerce, leading 

to the development of the modern Atlantic economy. New 

Englanders traded their cod for molasses from the 

Caribbean, which they made into rum. Apart from 

drinking lots of it themselves, it was a major article of trade 

for the slavers. 

Alcohol was also a major source of early trade wars since 

the French and Spanish tried to protect their domestic 

brandy producers from colonial competition by banning 

the rum trade, and distillers worldwide used their 

domestic clout to ensure that foreign rivals were taxed at a 

much higher rate. 

People have always thought that tipple from across the 

sea was more exotic and chic than anything produced in 

their hometown distilleries. Colonial Americans, for 

example, oft times paid a premium for Jamaica Rum over 

their local New England variety, while their contemporary 

British paid more for sometimes-smuggled French brandy 

rather than locally produced gin or whisky. 

Eventually, that led to the development of global brands 

recognised across the drinking world. In more recent times, 

World Trade Organisation rulings and free trade 

agreements have now cut back on the previous tariff 

barriers that penalised foreign spirits, creating a real world 

market. Countries may tax drinking heavily, but they can 

no longer favour local distilleries. 

In the last ten years, as a result of these developments, 

the industry has steadily grown from a relatively high 

population of small family-owned enterprises to a much 

smaller group of massive international companies. And, 

just as in the buccaneering Rum era, French, British and 

American giants are now playing a modern form of poker 

across the Atlantic table. 

So far advanced is the process of consolidation that to 

stay one step ahead of the regulators, recent takeovers have 

involved shuffling brands between rivals so that each can 

maintain a balanced portfolio of products without 

developing a monopoly in any one sector. Because this is a 

global business, companies 

have to comply with Fizz and pop in the spirit world 

European and US anti- 500 

monopoly regulations, and 450 

400 

each merger and 

350 

acquisition results in a 300 

judicious reshuffle of 250 

brands as the companies 200 

150 

try to assemble the hands 

100 

they want to deal in each 50 

of the big markets. 

0 

Driving the present barroom 

brawl is the growing 

popularity, and even faster 

Allied Domecq Pernod–Ricard 

growing profitability, of 

Diageo Fortune Brands 

premium branded spirits. 

Apr-00 

Oct-00 


Apr-01 

Oct-01 

Apr-02 

Oct-02 

Constellation Brands A 

FTSE Beverages Index 

Data as at June 05. Source: FTSE Group/FactSet Limited (Price Index values in US Dollars) 

Once a heavily taxed luxury, rising affluence and declining 

relative prices have caused spirit consumption to soar – 

especially in the branded varieties where the wiles of 

marketers can persuade drinkers that there is enough 

virtue in a branded variety of pure ethanol and water to be 

worth five times the price of a generic equivalent. Young 

people in their twenties in particular are downing spirits. 

Sales in the US for example are rising by 4.1% a year, while 

beer drinking, at 0.5% annual growth, these days can 

hardly raise its froth above the glass. 

Marketers have successfully persuaded significant 

numbers of the bright twenties age group that only much 

more expensive super-premium brands have the necessary 

cachet. Furthermore, these days it is peer-group social 

death to be seen drinking lesser brands without the lore. As 

a result Impact Databank, the alcohol sellers’ bible, 

assessed the value of the world's top 100 spirits brands as 

rising 5% to $56bn last year. 

That price and worth are not necessarily identical is 

suggested by American Sidney Frank’s sale of the “Grey 

Goose”vodka brand to Bacardi for $2bn last September. It is 

perhaps symptomatic that Frank began his career making 

alcohol-based jet fuel. His “invention” of Grey Goose was 

based on sound economic principles. As he has explained,“A 

bottle of Absolut sells for $20 a bottle.Vodka is just water and 

alcohol, so if I sold a bottle for $30, the $10 difference is 

almost all profit.”He knew that there is nothing as easy as 

parting a snob from his money, and made Grey Goose in 

France, to tickle American consumers’sense of chic. 

There is indeed room for a little boy to do the emperor’s 

new clothes routine on drinks such as premium vodka. 

Dimitry Mendeleyev took time off from laying the Periodic 

table of Elements to draw up the specifications for vodka 

for the Tsar in 1894. It comprised 60% water and 40% 

ethanol. So the major difference in premium drinks is the 

label on the bottle – and the price. Since most of the 

drinkers add mixers or drink the vodka as part of a cocktail, 

any homeopathic differences between brands would need 

a gas chromatograph to identify. One envisages a world full 

of unscrupulous bar-owners decanting basic vodka into 

expensive bottles every evening. 

Apr-03 

Oct-03 

Apr-04 

Oct-04 

Apr-05 

But with the mysterious 

alchemy of branding, Grey 

Goose has left former 

premium brands behind, 

as mere cooking vodkas 

for the undiscerning. It has 

also triggered a chain 

reaction as other firms 

have sought to put alcohol 

and water in pretty bottles 

that attracted superpremium 

prices. 

Its very simplicity is 

what makes vodka perfect 

for this form of comodification. 

However, 

65

SECTOR REPORT: DISTILLERS 

66 

global companies need a full 

range of spirits, single malts 

and aged rums and brandies 

even before you get to the 

modern liquid candy 

confections striving for 

market share. Bacardi’s 

purchase of Grey Goose and 

other brands such as 

Bombay Sapphire and 

Dewars shows that it realises 

that the fairly generic white 

rum that it is usually 

associated with does not pull 

in the growth and dollars it 

wants. Bacardi, itself one of 

the world’s most recognisable brands, has also grown 

apace, but not perhaps as fast as its rivals, or indeed as fast 

as the family. There are constant hints that its 600-plus 

(and increasingly extended) family shareholders may want 

to go public so they can take a quick shot from the stock 

markets. Bacardi executives meanwhile are looking 

askance at their declining market share as the major, stockmarket-funded 

giants merge and acquire. 

And of course, to add a little spritz to the mix, Bacardi has 

been fighting its own grudge fight against Pernod-Ricard 

over the American rights to Havana Club. Pernod-Ricard 

has the worldwide rights, except in the USA, where the 

courts and Congress share the Bacardi family’s antipathy to 

Fidel Castro. 

Some cynics also suggest that Havana Club’s distinctive 

nose shows up the blandness of Bacardi – which might 

explain how, without selling a single bottle legally in the 

world’s biggest marketplace (i.e. the USA) Havana Club 

sales have been steadily rising until it is now 44th in the 

world’s top hundred spirits list. 

Among the quoted spirit companies meanwhile, the 

present reshuffle began when Edgar Bronfman Jr decided to 

pull out of the family’s Seagram’s spirits empire, whose 

success had been built on the proximity of Canadian 

distilleries to Prohibition-era America. Diageo and Pernod- 

Net turnover by business area % 

Year end figures, August 2004. 

Total £2,611m 

Spirits & Wine £m % 

1. North America 632 28 

2. Europe 734 28 

3. Latin America 268 10 

4. Asia Pacific 226 9 

5. Premium Wine 475 18 

6. Other 50 2 

7. Quick Service Restaurants 226 9 

Total 2,611 

“If Pernod-Ricard can pull off the 

Allied Domecq takeover, it will be selling 

77m cases of spirits a year, and own 20 

of the top 100 brands, even after 

divesting some of the Allied Domecq’s 

brand portfolio to Fortune brands. It 

would also double Pernod-Ricard’s share 

of the American market to over a 

quarter and make it the second biggest 

spirits company in the world.” 

Source: Allied Domecq’s Press Pack 2005. 

Ricard worked together to 

pick over Seagram in a $8.7bn 

vivisection that gave each of 

them the brands they wanted 

and they thought that the 

regulators would let them get 

away with.The effect has been 

to shuffle the pack of the top 

brands, and more cards are 

now about to change hands. 

Pernod-Ricard – eagerly 

building up its portfolio since 

it decided that its eponymous 

anise flavoured drink alone 

was not going to conquer the 

world – added Seagram’s gin, 

Chivas Regal and Martell Brandy to its cabinet to give it 12 

of the world’s 100 biggest spirits brands. 

In the end, while Bronfman would undoubtedly have 

been better off sticking with booze than chasing a dot.com 

dream with Vivendi, there is a distinct hint of bubble 

economy about the spirits fad. The Super Premium brands, 

creations of astute marketing as they are, require heavy 

investment in brand maintenance, especially as others try 

to recreate their success. No less than 130 new brands of 

vodka were launched last year, each of them hoping to 

knock Grey Goose off its precarious perch. 

However, high maintenance costs raise the entry 

premium for new brands, and in the modern world global 

brands tend to dominate. Size does matter in the booze 

business. Smaller brands wilt. The giant multinational 

drinks businesses often do not even make their own 

drinks, but market and distribute other companies’ 

productions, assembling brands to make up a balanced 

global liquor cabinet. 

That is the background to current takeover battles 

when, in April, Pernod-Ricard and Fortune Brands bid 

$14bn for the hearts and spirits of Allied Domecq, 

Diageo’s British rival. 

If Pernod-Ricard can pull off the Allied Domecq takeover, 

it will be selling 77m cases of spirits a year, and own 20 of 

Trading profit by business area % 

Year end figures, August 2004. 

Total £657m 

Spirits & Wine £m* % 

1. North America 183 29 

2. Europe 139 22 

3. Latin America 44 7 

4. Asia Pacific 68 11 

5. Premium Wine 98 15 

6. Other 16 2 

7. Quick Service Restaurants 86 14 

Total 634 

*Excludes £23m of Britannia Source: Allied Domecq’s Press Pack 2005. 


the top 100 brands, even after divesting some of the Allied 

Domecq brand portfolio to Fortune brands. It will also 

double Pernod-Ricard’s share of the American market to 

over a quarter and make it the second biggest spirits 

company in the world. 

Fortune will also double its US market share, and it is 

widely felt that the deal is its last chance to get within stalking 

distance of Diageo, the British company whose size haunts 

the spirit world in the US as well globally. It would make 

Fortune (whose flagship hooch at the moment is Jim Beam 

bourbon) the fourth largest spirits company in the world. 

However, the perception that Allied Domecq’s takeover 

and dismemberment will lock up market share for a long 

time to come has now prompted a counter-offer from 

American company Constellation Brands backed by 

Brown Forman. 

Constellation Brands lacks any major international 

spirits brands to balance its stronger beer and wine 

portfolio, while Brown Forman has been building up from 

its flagship Jack Daniels bourbon with Appleton’s rum and 

Finlandia vodka and could doubtless complement that 

cocktail with a few more international brands. 

To add to the tension, Diageo, Pernod-Ricard’s former 

partner in dismembering Seagrams, could not make an 

offer for Allied Domecq without bringing monopoly 

regulators crashing down on it. But it is hovering around 

offering spare cash to whichever bidder will allow it to 

cherry pick further brands from Allied Domecq’s cabinet. 

That would help it blunt the threat from the Pernod- 

Ricard/Allied Domecq merger which would bring the 

resulting company closer to Diageo’s hitherto unassailable 

position as the world’s number one barkeeper. 

And just to complicate the issue further, Bacardi, clearly 

trying to expand from its rum base was also rumored to be 

interested, whether in concert with the others, or even a 

direct bid of its own that would fulfill the desire of some of 

the family shareholders to get a stock market listing by 

inheriting Allied Domecq’s position in London. 

Of the interest in Allied Domecq’s overall portfolio, the 

keenest is perhaps in Allied Domecq’s premium brands. 

Although, they only make up a third of Allied Domecq’s 

sales, the premium brands contribute to half of its profits 

and have built the company up to its present size – thereby 

making it such a desirable prize. 

There may well be more mileage in the long run in the 

merely premium aged spirits but for now the attractions of 

a quickly made product selling at very high multiple of its 

production costs will certainly maintain attention on the 

white spirits, in particular vodka. It is a lot easier to add a 

fruit flavour to alcohol fresh from the still than to nurture 

a malt whisky or cognac for quarter of a century in 

expensive oak casks. 

While the “brown” spirits are steady earners, for the 

foreseeable future, the high spirits of the twenty something 

generation are going to be the effervescent force in the 

global liquor stakes. There are many more hands to be 

played, and brands to be reshuffled. 


Patrick Ricard, chairman and CEO of Pernod Ricard. 

SPIRITED PLAYERS 

AND THEIR HANDS 

When Allied Domecq folds, its hand includes 

Ballantine’s, Beefeater, Kahlua, Malibu, 

Stolichnaya, Centenario, Teachers, Tia Maria, single 

malt brands including Laphroaig, Glendronach, Scapa 

and Tormore and “fun” brands such as Midori, Caribe, 

which would go to Pernod-Ricard while Canadian 

Club, Courvoisier, Maker’s Mark,Teachers and Sauza 

would go to Fortune Brands. 

Fortune Brands already owns Jim Beam and Knob 

Creek bourbons, DeKuyper cordials, Starbucks 

Coffee Liqueur, The Dalmore single malt Scotch, and 

Vox vodka 

Pernod-Ricard already has Wild Turkey Bourbon and 

Seagram’s Gin and distributes Chivas Regal, Jameson 

Irish whiskey, Havana Club, Martell Cognac, Wódka 

Wyborowa, Viuda de Romero tequila, as well as its 

original Pernod and Ricard anises. 

Diageo’s hand currently includes, Smirnoff, Gilbey’s, 

Gordon’s Tanqueray gin and vodka, White Horse, 

J&B rare, Pinch (Dimple), Crown Royal, Seagram’s, 

Buchanan’s, Cardhu, Bailey’s, Myers, Captain 

Morgans, Hennessy, Romana Sambucca, José 

Cuervo, Don Julio, and an array of Classic Malts. 

Bacardi, apart from its own array of rums, has 

Bombay Sapphire gin and Martini & Rossi vermouth, 

Dewar's Scotch whisky, DiSaronno Amaretto and now 

of course, Grey Goose as well. 

67

DERIVATIVES REPORT: CME 

68 

CME 

Craig S. Donohue, 

CME CEO 

at the new 

frontier 

As market boundaries flounder in the wake of globalisation, stock and derivatives exchanges have 

oft-times struggled to redescribe their role in the new financial order. Not so the Chicago 

Mercantile Exchange (CME) which, since demutualisation back in 2001, has swelled in confidence, 

strength and reach. Armed with a $700m war chest, big could get bigger as the CME scouts for 

strategic acquisitions, joint ventures and growth. Chief executive officer (CEO) Craig S. Donohue 

talks to Francesca Carnevale, about the seemingly unstoppable force that is now the CME. 


NO SURPRISE THAT in Illinois, which now boasts 

an economy greater than that of Russia, 

testosterone-charged numbers are de rigueur at the 

Executives’ Club of Chicago’s early-bird monthly breakfast 

meetings. The sometimes biting elite of Chicagoan 

corporate society has gathered this day to hear Craig S. 

Donohue, the CME’s urbane CEO, explain why “The 

Future is in Futures”. In the sometimes catty table talk 

before his speech, more than one person pointedly remarks 

that the CME, which has a market capitalisation of some 

$7bn, is but only one of the top 25 companies in Chicago. 

Yet even this number-jaded clique, looks up in conceded 

surprise when Donohue eventually lobs his own fat 

statistics into the mix. 

Last year more than 800m contracts were traded on the 

exchange, with a gross value of $463trn. That is over 10 

times the current annual gross domestic product (GDP) of 

the United States (US). Put another way, in the first two 

weeks of January, the CME traded more in notional value 

terms than the New York Stock Exchange handles in a full 

year. It is an indication of just how far futures and options 

markets have come. Today it is a global growth industry 

which boasts “compounded annual growth of 38% during 

the last three years, compared with the relatively flat 

growth for the world’s stock exchanges,” according to 

Donohue. His well-practised delivery bears fruit, even 

among Chicago’s uber-moneyed city fliers. “He seems to 

know what he is talking about,” says one of the 

breakfasters, if a tad grudgingly. It is a back-handed 

compliment that Donohue would laughingly appreciate, 

with the sort of gracious ease that masks years of driving 

hard work and a sometimes ruthless strategic focus. 

A 17-year veteran of the CME, he does indeed know the 

business very well. Still barely in his forties Donohue took 

over as CEO of CME Holding and the CME itself only in 

January 2004, but to many market watchers, he was a 

natural choice for the job. He succeeded James J. McNulty 

who stepped down after steering the CME through 

demutualisation, an initial public offering (IPO) and the 

early rise of electronic 

trading via the CME Globex 

platform. Donohue 

entered as a general 

counsel back in 1989, with 

a list of academic and legal 

qualifications almost as 

long as this article. He 

joined from the local law 

firm of McBride Baker & 

Coles where he had 

specialised in corporate 

and securities law. Steadily 

working through one 

senior management 

position after another, in 

each role Donohue played 

an important part in 

400 

350 

300 

250 

200 

150 

100 

50 

Dec-03 


“Increasing Market Share at the Expense of the 

European Exchanges” – Chicago Mercantile Exchange 

vs. Deutsche Bourse and Euronext 

Mar-04 

Jun-04 

Chicago Mercantile Exchange Deutsche Bourse AG Euronext 

CME MONTHLY AVERAGE DAILY VOLUME (In Thousands) 

May 2005 May 2004 Percent 

Change 

CME PRODUCT LINE 

Interest Rates 2,385 1,878 27% 

E-Minis 1,205 1,238 -3% 

Equity Standard 102 95 7% 

Foreign Exchange 296 163 82% 

Commodities 53 45 16% 

Sub Total 4,041 3,420 16% 

trakrs 22 86 -74% 

Total 

VENUE 

4,063 3,506 18% 

Open Outcry 1,054 1,516 -30% 

CME Globex (Ex trakrs) 2,942 1,868 57% 

Privately Negotiated 45 36 25% 

Source: CME June 1st 2005 

setting the organisation’s vision and developing growth 

strategies to expand the exchange’s core business and 

global distribution. 

It is a particularly good time to be CEO at the CME. Over 

the last five years, it has morphed into the largest futures 

exchange in the US and the world’s largest clearing house 

for futures and futures options contracts. The exchange’s 

products have sounded a particular resonance to 

contemporary investors, providing as they do a means for 

hedging, speculation and asset allocation relating to the 

risks associated with interest-rate movements, equity 

ownership, and fluctuations in foreign currency (FX) values 

and the prices of commodities – including cattle, hogs and 

dairy. The CME launched the first of its stock index futures 

contracts based on the S&P 500, back in 1982. Today, it 

trades Eurodollar contracts and futures and futures options 

on an ever-widening variety of indices, including the 

NASDAQ-100, S&P/BARRA Growth and Value Indexes, 

Sep-04 

Dec-04 

Mar-05 

Data as at June 05. Source: FTSE Group/FactSet Limited, US Dollar price indices. 

and the Nikkei 225, as well 

as its electronically traded 

E-mini S&P 500 and Emini 

NASDAQ-100 

contracts, that are among 

the fastest growing 

products in the industry’s 

history. 

Most recently the CME 

added futures contracts on 

three of the largest and 

most popular exchange 

traded funds (ETFs – 

baskets of securities 

designed to track an 

index). The move is 

significant. The fast 

growing US ETF market is 

69


70 

reported to have combined 

ETF assets under custody 

of some $226bn (as of the 

end of last year), with the 

S&P 500, NASDAQ-100 

and Russell 2000 ETFs 

accounting for about one 

third of that amount. 

New CME ETF futures 

contracts that are based on 

those indices began 

trading on the CME Globex 

electronic trading platform 

in June. Futures on the 

S&P 500 and NASDAQ- 

100 indices continue to 

trade exclusively at 

CME. “Equity market 

CME Outperforming Peers 

participants want access to a broad array of products and 

markets, and the growth of our CME E-mini S&P 500, 

CME E-mini NASDAQ-100 and CME E-mini Russell 2000 

contracts makes the ETF products a natural addition,”says 

Donohue. The move also portends a broader long term 

marketing initiative by the exchange. The addition of the 

ETF futures means, “we will be able to attract more new 

customers, particularly sophisticated retail equity 

investors,”he adds. 

Aggressive accretion of market share, wherever it might 

be, has been a priority for the exchange since at least the 

turn of this century. Between then and now the CME has 

assumed a more uncompromising character. It is a 

transformation kick-started by demutualisation in 

November of 2000 and a subsequent successful IPO in 

December 2002 with shares priced at $35 (these days the 

exchange’s shares trade in a high low range of $181 to 

$235). Contiguous developments include virtually 

continual product and technology innovation, expanding 

global distribution and the establishment of strategic 

partnerships in Europe and Asia. 

The results are impressive. 2003 and 2004 were banner 

years. The exchange’s net revenues rose 37% last year to 

reach $733bn, with net income up 80% to $219m based 

on an operating margin in the year of 50.1%, compared 

with 38.5% in 2003. But 2005 threatens to outclass even 

that performance. The trend, for the moment is but one 

way. Donohue explains that record volumes across all 

major product groups were and are “spurred by the 

phenomenal growth of electronic trading.” In particular, 

the exchange’s performance reflected the additional 

revenues generated from clearing Chicago Board of Trade 

(CBOT) transactions (of which more later).“Not bad for a 

company that began modestly in 1874 with the 

establishment of a private association in Chicago to help 

butter and egg dealers,”he smiles. 

The CME also currently manages more than twice as 

many futures and options on futures contracts than any 

other futures clearing organisation in the world, and over 

Average Daily Volume (round turns, in millions) 

5 

4 

3 

2 

1 

0 

1Q 

03 

2Q 

03 

3Q 

03 

4Q 

03 

1Q 

04 

2Q 

04 

3Q 

04 

4Q 

04 

1Q 

05 

4.5 – CME 

3.5 – Eurex 

3.0 – CBOT 

2.0 – Euronext. 

liffe 

2Q 

05 

through 

May 

NOTE: Based on futures and options on futures. Excludes individual equity options. 

© Chicago Mercantile Exchange Inc. All rights reserved. 

90% of all US futures 

contracts. “Our electronic 

trading business 

continues to grow rapidly 

due to our focus on 

expanding functionality, 

capacity, distribution and 

access to our CME Globex 

trading system,” says 

Donohue. “As new 

electronic trading groups 

and individual electronic 

traders continue to emerge 

in markets globally, CME 

is competing to attract 

their business.” 

The CME has also 

ridden a flow tide of 

business. According to the most recent Futures Industry 

Association report, the volume of global futures and 

options trading grew 8.9% to total 8.89bn contracts in 

2004, with even more growth expected this year. Futuresonly 

volume, for example, topped 3.5bn contracts, up 

16.3% on the year. Options trading grew more slowly 

however, rising 4.6% to 5.4bn contracts, mainly due to 

lower levels of trading in Korea’s Kospi 200 index option. 

Although volume rose in all sectors, trading in FX grew 

the most, surging 35.4% to 105.4m contracts worldwide. 

The largest volume in this category was, in fact, the Bolsa 

de Mercadorias & Futuros’US Dollar futures contract (up 

42.7% to 23.9m contracts for the year). In context, 

volume on the CME’s Euro FX futures product almost 

doubled over the same period, rising 82.7% to 20.5m 

contracts in the year. 

Interest rate products apparently maintained their lead 

as the world’s most active futures contracts. And while the 

CME’s 3-month Eurodollar future gained an additional 

42.5% to 297.6m contracts to remain the world’s largest 

futures contract, in a countertrend, Eurex’s Euro-Bund 

declined slightly, down 1.9% to 239.8m contracts. 

Meanwhile, in the dynamic top ten derivatives exchange 

league tables, the CME moved past Euronext.liffe in 

December last year to become the world’s third-largest 

global derivatives exchange. 

Performance records aside, in the sedate setting of the 

CME’s South Wacker Drive’s offices, Donohue muses over 

the emerging view of the CME as a latter-day Galactico 

among global exchanges.“Conversion from a membership 

organisation to a publicly traded company fundamentally 

transformed us,” declares Donohue, though he concedes, 

the going has not been easy and back in 2001, nothing was 

certain. Though bullish on “the future of our industry,” he 

stresses “it was not always so.” “Everyone says,‘well, it was 

easy, or that it was well timed.’I tell you, it was not obvious 

to us. The risk of failure was real enough. It was out there.” 

Challenges were becoming apparent even as the century 

opened and the global financial markets began to assume 


a more sombre cast (well before 9/11 in fact). The 

competitive game in which the CME was playing was in 

flux. Competition between futures exchanges intensified 

and the stage became global, rather than national or 

regional. Although liberalising legislation via the 

Commodity Futures Modernization Act of 2000 (CFMA), 

had given the CME added impetus with which to face the 

future, advances in technology and a more favourable 

regulatory environment simultaneously encouraged 

European exchanges – namely Euronext.liffe and Eurex – to 

mount a competitive charge on the benchmark products of 

the US futures market. 

The CME found that it faced a clear and present 

danger, perhaps for the first time. The specialist 

derivatives media added to the pressure. Chicago’s 

exchanges were simply not up to growing competition 

from abroad, they said and CME would be forced to cut 

trading fees to non-economic rates to encourage more 

volume, or that its mix of users would change and alter 

its profitability. Ironically, all that did happen, but not 

quite in the way the doubters expected. 

The CME realised it needed to overhaul not only its 

business structure and strategy, but also its international 

ambitions. Its response was rapid, accelerating changes 

that were already in motion, such as migration to 

electronic trading and a reduction in trading costs. “We 

always thought about competition in terms of three major 

industry trends: deregulation, rapid advances in 

technology, and globalisation of intermediaries and 

customers,” explains Donohue. “We built the financial 

strength and critical mass necessary for executing our 

long-range strategy of expanding our core business, 

broadening our product range, providing third-party 

transaction services and exploring new business 

opportunities and that process continues.” 

Investment in technology was intensified, as a priority. 

”We spend more on technology today than was our entire 

operating budget five years ago,”says Donohue.“In the last 

8 years we have invested over $1bn in technology and gone 

from having 125 or so technology specialists five years ago 

to employing around 450 today … the processing 

capabilities that we have, the global distribution network, 

even the backup and disaster recovery facilities point to us 

being more attuned to technology than ever before.” 

“Today, we have marketing offices, telecommunications 

hubs and customer support capabilities in major financial 

centres, including London, Milan, Amsterdam, Frankfurt, 

Gibraltar, Paris, Dublin and Singapore,” expands 

Donohue. In preparation for that, over the last decade, 

CME has developed, enhanced and refined, its electronic 

trading platform. “Our order Return Delivery Time is 25 

milliseconds, among the fastest in the industry. CME 

Globex is also accessible virtually 24 hours a day, longer 

than any other electronic platform.” CME had launched 

the industry’s first electronic trading platform (or system), 

back in 1992. CME Globex revolutionised derivatives 

trading by delivering much faster trade execution and 


trading anonymity. It also eliminated CME membership 

requirements for traders. Originally based on a DEC 

platform developed by Reuters, CME upgraded to its 

present multiplatform environment in 1998 – the service 

is built on top of a heterogeneous environment of IBM 

and Tandem mainframes, Solaris and Linux systems. 

Investment in enhancing transaction rates means more 

than just faster processing.The company makes money by 

charging for executing trades and then charging to settle 

those trades. Therefore, the faster its systems are, the 

more trades it can handle, and the more profitable the 

CME becomes. 

Migration to electronic trading has also spurred 

efficiency. Late last year the CME estimated that the 

average rate per trade (an important profitability measure) 

is around 77 cents for CME Globex products, compared with 

52 cents for products traded via open outcry.The CME then 

simply earned 60% more revenue when a contract is traded 

on electronically than on the floor. Electronic trading is 

therefore elemental to earnings growth and simultaneously 

provides the CME with more room to compete with other 

exchanges on fees. As a consequence a number of fee 

cutting initiatives have been underway, particularly aimed 

at European customers, Asian banks and hedge funds. 

There are also other related initiatives. For instance, “we 

have expanded the market maker program to nonmembers, 

and non-member firms, so that an electronic 

proprietary trading group or electronic trading arcade that 

would like to meet our market making requirements can 

do so at very reduced fees,” acknowledges Donohue. 

Recent press reports would have it that around 80% of the 

market by transaction volume is trading electronically in 

CME Globex Eurodollars for between 14 cents and 18 cents, 

compared with prices anywhere between 50 cents and 80 

cents on the open outcry floor, because of brokerage costs 

and the scale of the trade. Donohue concedes that few, if 

any, exchanges can compete at its lower price levels. 

Outrageous fortune has not come without its slings and 

arrows. Eurex US which to date has not succeeded in 

setting up a strong foothold in the North American market 

filed a second amended antitrust complaint with an Illinois 

District Court against the CBOT and CME in March this 

year. Eurex US had also filed an antitrust action against the 

two exchanges back in October 2003 for alleged anticompetitive 

behaviour. The complaint included allegations 

that the CBOT and the CME have violated the Sherman 

Act by lowering transaction fees to predatory levels and 

allegedly attempting to keep Eurex from obtaining clearing 

services. The CME dismisses the charges. 

The move nonetheless illustrates Eurex’s frustration over 

the difficulties in breaking into the US market, particularly 

as it was the first foreign exchange to establish a US 

subsidiary and enter into direct head-on competition with 

the incumbent exchanges. Eurex has however succeeded in 

establishing partnerships with important local institutions. 

In its home market, Eurex has been a champion of vertical 

integration, but in the US it has railed against the vertical 

71


72 

silo created at the CME. However Eurex did not take the 

measure of the ruthless drive of the US exchanges to 

undercut any market solutions that Eurex was touting. The 

CME and the CBOT clearly understood their own turf and 

what they could and could not do to withstand any assault 

on their market. But, stresses Donohue, the picture is 

greyer than market watchers often paint it. Developments 

in the market have been utilised to cooperate with other 

exchanges as well as compete with them. Recognising, for 

instance, that demands for greater efficiency have a wider 

application that the CME can also leverage to mutual 

advantage, Donohue claims that the exchange has led the 

trend toward standardisation and consolidation. “For 

example, Euronext.liffe uses CME’s Clearing 21 System to 

clear and process the majority of their securities and 

derivatives products. In the area of risk management CME 

literally created the industry standards when it developed 

its proprietary SPAN Margining System,” he recounts. 

SPAN, which allows exchanges to monitor risk exposure, 

has now been licensed to some 47 exchanges and clearing 

houses, including the Shanghai Futures Exchange. It is, 

says Donohue “an important step for China in the process 

of moving toward global industry standards.”Not least, he 

points to the “historic clearing processing agreement with 

CBOT,” as an “example of our willingness to seek 

standardisation and consolidation benefits that have 

reduced performance bond requirements for market users 

by more than $2bn and has saved our joint clearing 

member firms more than $200m in capital”. 

Utilising CME’s own clearing house, it was officially 

launched at 7:00 p.m. on Sunday, November 23, 2003 when 

CME began providing clearing and settlement services for 

a number of CBOT products, including agricultural, Federal 

Reserve funds, swap, municipal and Dow futures and 

options on futures contracts. The CME clearing house is 

now the world’s largest derivatives clearing organisation. 

“The funds we hold in custody dwarf anything held by any 

of our nearest competitors by a wide margin,” claims 

Donohue.“We hold about $40bn in collateral, and we move 

about $1.5bn to $6bn of collateral each day. I am confident 

that the $2bn savings that we provide dwarfs what can be 

offered by our competitors.” 

It was an imperative for the CME to achieve vertical 

integration, for four elemental reasons: It creates value, 

maintains Donohue, “and the ability to manage every 

aspect of how we deliver value to our customers. The CME 

can now manage all elements without being dependent on 

third party partners or service providers,” he explains. 

Equally, he expands, “I do not want to see us outsource 

critical functions because we would deprive ourselves of 

the opportunity to create and leverage our intellectual 

capital and lose our innovator’s advantage.” Three, 

Donohue is content that the Clearing House means that 

“we now have every major financial futures and options 

product cleared in a single clearing facility.” Last but not 

least, it was an effective nuclear deterrent. Two exchanges 

that would rather cheerfully run over each other suddenly 

began talking and acting like long lost friends. Had they 

been to Damascus? Or had they realised either by luck or 

by judgement that the initiative was a highly effective 

counterpunch to Eurex’s planned product launch at the 

beginning of 2004? Donohue answers indirectly,“both the 

CBOT and the CME have increased market share at the 

expense of the European exchanges. There has been a sea 

change. We are now seen as setting the pace of growth.” 

Perhaps the clearest indication of the direction of the 

CME’s near term strategy came in mid-April of this year 

when it announced that it was enhancing its strategic 

planning and corporate development capabilities and 

appointing Ann Shuman and Kendal Vroman as co-heads 

of corporate development. The appointment of two heads, 

rather than one to replace the work of outgoing managing 

director Scott Robinson indicated that the CME was 

bringing strategy into greater focus. 

Both Shuman and Vroman played key roles in the 

clearing agreement with the CBOT and the distribution 

partnership to provide CME FX on Reuters, Donohue 

explained at the time. The announcement was given 

additional piquancy when the same release mentioned the 

appointment of Johannes Zhou, as director of Asian 

business development. Zhou previously served in high 

executive positions in the Hong Kong Futures Exchange. 

Undoubtedly his experience of the operation of Chinese 

markets and his contact book will come in very handy for 

the CME. 

Just how handy became clear last year as the CME began 

to establish a bridgehead in the all-important China 

market. A Memorandum of Understanding (MOU) was 

signed in June last year with China Foreign Exchange 

Trading System and National Interbank Funding Centre 

(CFETS), a subsidiary of the People’s Bank of China, the 

central bank. It was a canny move. Regulated by China’s 

State Administration of Foreign Exchange, CFETS already 

provides an electronic bidding system for matching spot 

trading of the Renminbi (RMB) against the world’s main 

currencies and also operates markets for RMB interbank 

lending and RMB bond trading. 

Under the MOU, CFETS provides CME with local 

market intelligence and in turn the CME helps CFETS 

become “more familiar with the international FX 

derivatives markets practices”, products and regulations, 

according to the CME’s press blurb. “Expanding global 

distribution of our products and adding new customers in 

Asia is part of CME’s long-term growth strategy,”explains 

Donohue. Another similar MOU, this time with the 

Shanghai Stock Exchange (SSE) followed in March this 

year. “China’s exchanges can gain enormous growth and 

acceleration benefits by collaborating with global 

exchanges like CME to utilise its extensive infrastructure, 

trading and clearing platforms, and industry standardised 

business practices,”says Donohue, acknowledging that the 

CME’s long-term growth strategy is to expand global 

distribution of its products and to add new customers 

throughout Asia. He adds “We had introduced an Asian 


Incentive Plan to make our products more attractive to new 

customers from the Pacific Rim. We also launched a 

telecommunications hub in Singapore designed to make 

our markets more cost-effective and accessible.” 

To unseasoned observers, these appear small steps to 

cross huge chasms. But the significance of the relationships 

has not been lost in the region itself, which has been awash 

with a growing network of strategic alliances including not 

only exchanges but also regulators and governments. It 

indicates that the CME is playing for big stakes in a 

politically very savvy regional league. Just a few examples of 

extant market-to-market arrangements are the MOU 

between the Online Commodity Exchange of India and 

Malaysia Derivatives Exchange, the strategic partnering 

arrangements between Singapore Exchange and Bursa 

Malaysia, and the understanding between Sydney Futures 

Exchange and Hong Kong Exchanges and Clearing Ltd. 

Each relationship sees itself as a major power hub with 

much broader regional pretensions. 

One of the forces driving this interest in regional 

agreements has been structural change in the exchanges. 

More and more institutions in the region have taken the 

demutualisation route and, at the same time, derivatives 

and securities businesses have been rationalised. Everyone 

in the Asia Pacific region, it seems, is learning to play the 

CME’s game. In Singapore, Hong Kong and Korea, for 

example, the separate exchanges have been combined into 

a single market operator. A similar example is the 

Australian Stock Exchange, which recently announced 

plans to move its futures, options and stocks products onto 

a single technology platform by 2006. This trend has 

encouraged these consolidated, for-profit entities to focus 

on the opportunity to grow their share of regional and 

indeed world trading. 

For the time being, in Asia, the CME is playing the role 

of learned benefactor. In a speech earlier in the year to the 

SSE, for example, Donohue had stated that the CME’s 

purpose “is not to threaten or overtake the internal 

development of China’s emerging futures markets.”Just so. 

It is an unusually benign statement from a highly 

competitive operator and most people agree that 

competition made the CME. The exchange’s ability to 

successfully respond to the challenge from its European 

competitors; its willingness to ruthlessly cut costs so that 

it could equally ruthlessly cut prices; and its single 

minded focus on global expansion, has forged the 

successful entity that it is today. A number of questions 

however, still hang over the exchange. Will it merge with 

the CBOT? Will it acquire in Europe or Asia, and if it does 

acquire, will it buy another derivative exchange? 

Donohue is not drawn on specifics and instead 

emphasises that the CME’s merger and acquisition 

strategy is not limited to exchanges, securities or 

otherwise.“We have a well thought out strategy and if we 

were to do something it would be to create shareholder 

value, not because of someone’s idea of what we should 

be.”That’s telling us. 


Looking South on Madison, Chicago 

73

DERIVATIVES REPORT: CDOS 

74 

Bill May, a managing director 

in Moody’s derivatives group 

CDOs GIVE 

HEDGE 

FUNDS A 

HEADACHE 

In 10 short years collateralised debt obligations 

(CDOs) have transformed the credit markets, 

allowing lenders and investors to manage their 

credit exposure as never before. But these 

complex securities, which reallocate cash flows 

from debt instruments in tranches exposed to 

different degrees of default risk, contain traps 

for the unwary – including sophisticated 

investors such as hedge funds. Neil A. O’Hara 

reports from Boston. 

HEDGE FUNDS TRADING the synthetic CDO 

market suffered a rude awakening in May when 

Standard & Poor’s dropped its rating on the debt 

of General Motors and Ford below investment grade. The 

so-called “correlation trade”– long the equity tranche of a 

CDO and short the mezzanine tranche – was supposed to 

be a sure bet. If defaults stayed low the return on the equity 

tranche would outstrip losses on the mezzanine, while if 

defaults ticked up gains on the short mezzanine position 

would more than offset equity losses.“The premise for the 

trade – that the two tranches will always be correlated in 

your favour – is particularly puzzling,” says Jeffrey 

Gundlach, president of TCW Asset Management Company 

and head of the firm’s fixed income operations,“It is flawed 

logic. There are outcomes where the equity goes to zero 

and the mezzanine does not.” 

CDOs are pools of debt instruments, often rated below 

investment grade, divided into senior, mezzanine and 

equity tranches entitled to cash flows from the pool that 

bear increasing exposure to the risk of default. The senior 

tranche can qualify for an Aaa rating because defaults must 

wipe out both the mezzanine and the equity before 

investors suffer any loss. The mezzanine layer, which has 

only the equity shield against losses, often carries a Baa 

rating while the unrated equity bears first dollar loss risk. 


CDOs trace their origins to the late 1980s but the market 

really took off in 1996; (see, for example, data for CDOs 

rated by Moody’s in Figure 1: CDOs: Dramatic Growth to 

Record Levels in 2004).The early transactions were cash flow 

CDOs that allowed financial institutions to lay off credit 

risk through repackaged high-yield bonds but the structure 

soon spread to other asset classes. In today’s market, the 

assets most commonly securitised are high yield corporate 

loans and asset backed securities, but collateral extends 

from investment grade bonds to bank and insurance 

company preferred stocks and real estate. 

Cash flow CDO transactions dominated the market in 

the United States until the past couple of years, according 

to Drew Dickey, managing director and head of the 

structured credit team at Babson Capital Management, 

LLC. The absence of actively traded cash collateral bred a 

synthetic market in Europe, where credit risk was 

concentrated in banks rather than bonds. A synthetic CDO 

holds high quality near cash collateral and adds credit 

exposure through a portfolio of credit default swaps, which 

are effectively put options on default risk. 

CDOs challenge the efficient market hypothesis: why will 

investors pay more when the overall risk in a CDO equals 

the sum of the risks in its collateral portfolio? The structure 

adds value by facilitating the transfer of credit risk. Bill May, 

a managing director in Moody’s derivatives group, cites 

CDOs based on middle market bank loans as an example. 

The individual loans are relatively small and unrated; an 

institutional investor cannot afford to monitor enough 

companies to build a diversified portfolio. The lenders, who 

do track the companies, repackage the loans into CDOs, 

although they retain some exposure to each loan so 

investors know the sponsor has some skin in the game if a 

loan goes bad. In effect, CDO investors outsource the credit 

research and monitoring.“It gives investors an opportunity 

to invest in an asset class that they could never do on their 

own,”says May,“And it gives these small companies access 

to capital they could otherwise never get.” 

Artificial restrictions that require many investors to hold 

only rated instruments contribute to the repackaging 

arbitrage. “These portfolios are fairly diverse,” says Sivan 

Mahadevan, executive director and head of structured 

credit research at Morgan Stanley,“You can get investment 

grade ratings for a lot of the tranches that have even a little 

bit of subordination.” Rated CDO tranches command a 

premium because they appeal to a broader market. 

Senior CDO tranches find a home among pension funds, 

insurance companies, banks, and conduits set up by banks 

that use the high-quality assets as collateral to support 

commercial paper issued to money market mutual funds 

and other cash market investors. The mezzanine notes go 

to insurance companies, banks, mutual funds and hedge 

funds. Equity tranches appeal to banks and insurance 

companies looking for assets that offer leveraged returns 

relative to their regulatory capital requirement. Other 

investors willing to accept the risk (including hedge funds) 

buy equity for the high potential return. 


Drew Dickey, managing director and head of the structured credit 

team at Babson Capital Management 

CDOs challenge the efficient market 

hypothesis: why will investors pay more 

when the overall risk in a CDO equals 

the sum of the risks in its collateral 

portfolio? 

The allocation of losses in a CDO pool turns the equity 

and mezzanine tranches into leveraged plays on default 

risk – with price volatility to match. Hedge funds 

compounded that volatility by trading on margin. When 

the expected correlation between the equity and 

mezzanine tranches broke down, margin calls loomed as 

funds faced mark-to-market losses on both sides. “If you 

buy something on mark-to-market leverage you tend to 

give up the freedom to have your own view of the world,” 

Babson Capital Management’s Dickey says, “You can 

think that pricing is completely absurd. It might be absurd. 

But that doesn’t really matter when you have to put up 

more collateral.” 

In theory, correlation refers to the probability that if one 

credit in a CDO pool defaults other credits will also default. 

In practice, correlation is not a measurable input to the 

pricing model, according to Dickey. Companies don’t 

default often enough to generate reliable data on credit 

75

DERIVATIVES REPORT: CDOS 

76 

correlation, and even if 

synthetic CDO typically 

they did the theoretical 

includes more than 100 

price would not match the 

reference entities so one or 

market price. “Correlation 

two downgrades have little 

is an observed plug 

impact on the CDO’s 

number that expresses 

overall credit risk.“GM and 

what's implicit in the 

Ford have not defaulted. 

model,”he says. 

There are no credit events 

Powell Thurston, vice 

associated with them,” he 

president and CDO 

says, “Investors have not 

product manager at 

lost a dime as long as they 

PIMCO, likens the role of 

don’t sell.” His attitude 

correlation in CDO pricing 

reflects Moody’s focus on 

to implied volatility in 

default probability and 

options pricing. Just as 

recovery after default, a 

options traders use 

service aimed at investors 

implied volatility to 

who buy and hold to 

account for the 

maturity rather than 

unexplained difference 

traders worried about daily 

between the theoretical 

mark-to-market value. 

price of an option and its 

For senior tranches, the 

market price, CDO traders 

default risk depends 

rely on correlation to express the residual value. mostly on the performance of the asset class represented 

“Correlation does not drive the market,”he says,“It is the in the underlying collateral; likewise the mezzanine and 

other way around: the market drives correlation.” 

equity tranches in a static CDO, for which the collateral 

The correlation trade encapsulates the view that credit pool is fixed at the outset. Dynamic CDOs have actively 

spreads will widen – causing the mezzanine price to drop – managed collateral, which introduces an additional risk, 

but not cause any defaults that would diminish the equity according to TCW Asset Management Company’s 

value, Thurston explains. “The hedge funds thought they Gundlach – manager performance. While some CDO 

could handle the mark-to-market risk,”he says,“In reality sponsors do their own collateral management, others farm 

they could not. They simply unwound their positions.” it out to third party managers such as Babson, PIMCO and 

A stampede to the exit drove prices to extremes. TCW.“The equity tranche holders are really exposed to the 

Desperate hedge funds not only dumped equity tranches manager,” he says, “If there is negative alpha they are 

but also chased up the price of credit default swaps that going to have a very bad outcome even if the premise of 

would hedge the affected credits. Meanwhile, the the asset class works.” 

“correlated” mezzanine price rose on short covering.“The Gundlach claims the rapid growth in CDOs is 

movements were largely driven by supply and demand and attracting collateral managers who lack experience. He is 

not by fundamentals,”says Thurston. 

not just talking his own book.TCW manages some CDOs 

The turmoil in synthetic CDOs highlighted the that include tranches from other CDOs in their collateral 

difference between cash flow CDOs and synthetics. The pool, so poor third party manager performance could 

secondary market in cash flow CDOs is much less active adversely affect TCW's own collateral.“We try to create a 

and prices didn't budge.“It is not a derivative market. It is diversified pool where we hope we can select managers 

a cash market where typically all parts of the deal are sold with high standards,” he says, “It is not that easy. The 

so there is no residual risk left,”explains Morgan Stanley’s CDO market has a lot of inexperienced, under-funded, 

Mahadevan,“It is fully distributed.” 

understaffed participants.” 

Notwithstanding the dramatic impact on some hedge Cross-ownership among CDOs reached a new level in 

funds, Standard & Poor's' move had minimal effect on so-called CDO-squared (CDO 

CDO ratings despite the widespread use of GM and Ford 

as reference credits in synthetic CDOs. While the agency 

had rated 561 synthetic CDOs in Europe covering 745 

tranches that referenced at least one of the affected credits, 

it downgraded just 10 tranches (1.3%) as a result, in each 

case by a single rating notch. It placed another 27 tranches 

(3.6%) on CreditWatch with negative implications, though 

it suggested they were likely to recover within three 

months in the absence of other negative credit experience. 

That came as no surprise to May. He points out that a 

2 Powell Thurston, vice president and CDO product manager at PIMCO 

) structures, in which 

existing CDO tranches represent the entire collateral for a 

new CDO. The underlying collateral pool is more 

diversified; if each synthetic CDO contains 100+ credits a 

synthetic CDO2 pool references indirectly thousands of 

credits.To compensate for compounded structural leverage, 

the rating agencies demand a larger cushion beneath the 

Aaa rated senior tranche and more equity under the rated 

mezzanine tranches. “We look at what tranches they are 

buying and how correlated those tranches are to others,” 

says Gary Witt, another Moody’s managing director, “Do 


they have a lot of overlap? 

Do they have the same 

credits in them or not?” 

100 

Senior Aaa and Aa 

90 

CDO2 tranches appeal to 

80 

insurance companies, 

conduits and banks in 

Europe and Asia, 

according to Dickey.“They 

are rating sensitive 

investors looking for 

things they believe have 

low credit risk but offer 

more spread,”he says. The 

extra structural leverage in 

70 

60 

50 

40 

30 

20 

10 

0 

CDO2 equity and 

mezzanine reduces the number of potential outcomes for 

those tranches: they become closer to all or nothing bets. 

Gundlach believes cross-ownership among CDOs 

creates a contagion risk.“The CDO market could fall victim 

to mad cow disease,”he says,“A lot of CDOs own equity or 

mezzanine in other CDOs. They are feeding on each other, 

so if a few go bad you’ll find it poisons a bunch of others.” 

Even though CDOs that permit cross-ownership often 

limit other CDO tranches to 10% of their collateral 

portfolio the problem could spread quickly if defaults 

increase across the board. 


Figure 1: Dramatic Growth to Record Levels in 2004 

$ Billions 

Others disagree. Witt 

sees more risk in the 

250 

collateral behind each 

200 

segment of the market. 

He focuses on CDOs that 

150 

hold asset backed 

securities, some of which 

100 

have 

concentrated 

become 

in 

50 

residential mortgage 

backed securities. “If 

0 

house prices go down 

those deals are not going 

to do very well,” he says, 

“But not because they 

bought other CDOs. It is 

going to be because their underlying risk is home loans.” 

Mahadevan at Morgan Stanley suggests investors have 

learned from the last downturn in the credit cycle from 

2000 to 2002, when they discovered more overlapping 

credit exposure among CDOs than expected; it turned out 

to be a key risk factor. Morgan Stanley believes default risk 

today is low among investment grade credits because 

corporations have healthy balance sheets and relatively low 

leverage. Spreads have widened across the credit markets 

in recent months, but until that translates into defaults 

Gundlach’s mad cow hypothesis will remain untested. 

1988 1989 1990 1991 1992 1993 1994 19951996 1997 1998 1999200012001 2002 2003 2004 

Rated volume (Left Axis) Number of Transactions (Right Axis) 

Source: Moody’s Investor Services, June 2005 

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77

BANK PROFILE: COMMERCE BANCORP 

78 

Vernon W. Hill II, 

the chairman and 

president of the company 

Executives with Citibank and Chase Manhattan 

Bank – heavyweights in the financial business 

worldwide – could be forgiven if they paid 

scant attention to a modest-sized New Jersey 

bank when it said, five years back, that it 

would open branches in their backyard, in 

New York City. They are probably paying 

attention now. Commerce is setting a new 

standard in customer care – can the big 

banks keep pace? Do they want to? 

Bill Stoneman reports. 

Bending the 

Benchmark of 

customer care 

COMMERCE BANCORP INC., which had just $7bn 

in assets when it announced its foray into New York 

in August 2000, now tops $32bn, placing it among 

the 40 largest banks in the United States (US). Although it 

is still a relative minnow when compared with the size of 

Citi’s parent, Citigroup (with $1.5trn in assets), or Chase’s 

parent, JP Morgan Chase & Co. (with $1.2trn), Commerce’s 

easy entry into New York, where it quickly picked up $16bn 

in deposits, is contributing big time to an extraordinary 

record of growth. 

Not only has the bank quadrupled in size over the last 

five years, net income has risen at an annual rate of 34% 

between 1999 and 2004, while earnings per share rose on 

average 24% over the same period. And so when Vernon W. 

Hill II, the chairman and president of the company, says (as 

he does regularly) that he intends to surpass $100bn in 

assets by 2009, he is hard to ignore. But perhaps the biggest 

reason to pay attention to Hill is that Commerce has 

achieved all of its growth in the slow-growing Northeast of 

the US and all that without an acquisition in years or ever 

a large one. In other words, Commerce gets pretty much all 

of its business by taking it from someone else. While other 

financial institutions talk about winning market share, 

constant mergers and acquisition make it difficult to tell 

which, if any, really do. 

Commerce, it appears, takes market share by following 

Hill’s retailing instincts and by rejecting big chunks of 

banking industry conventional wisdom. Not only does Hill 

shun mergers and acquisitions, Commerce does not even 

talk all that much about its lending business. Attractive 

rates on deposit accounts are not part of its value 

proposition. It does not endlessly try to “cross sell” 


customers additional accounts. On top of that, its expenses 

are well above industry standards. 

Instead what Commerce does is focus on attracting 

consumer depositors with an array of conveniences, 

gimmicks and services that other banks do not offer [or, at 

least do not make a big 

deal about]. Most visibly, 

Commerce keeps longer 

hours, including opening 

on Sunday, than virtually 

all of its competitors. It 

lures people into its 

branches with free coin 

counting machines. 

Branches are stocked with 

dog biscuits for customers 

who bring their pets in. 

And the bank will take care 

of all the rote work 

associated with moving 

online banking and bill 

payment from a 

competitor’s account. The 

many touches – or 

“extreme culture” and 

“fanatical execution,” in Hill’s words – seem to add up in 

the minds of consumers. 

“Commerce has differentiated itself from the other 

players,” says Charles B. Wendel, a banking industry 

consultant in New York. And that is something few other 

banks have done, he adds. While banks endlessly proclaim 

that they care about their customers or that they are their 

customers’ friend, Commerce is unusual in backing its 

words up with delivery of a distinctly different level of 

service, he explains. 

And that is exactly the idea.“The customer cares about 

the retail experience, rather than the highest rate,”Hill said 

recently, during a visit to a mid-town Manhattan branch 

that sits not much more than 100 metres from offices 

owned by the four largest US banking companies, Citi, 

Chase, Bank of America Corp. and Wachovia Corp. Indeed, 

seemingly illustrating the point, the branch, on Avenue of 

the Americas at 55th Street, has booked $267m in deposits 

since it opened in September 2001 – a large number for a 

mature office, let alone one less than four years old. In fact, 

beyond the results of one particular branch, Hill appears to 

be building a business around the premise that if a bank 

willingly, maybe even eagerly, pays for all the pieces of an 

attractive retail experience, then customers will not mind 

that the bank does not pay especially competitive interest 

on deposit accounts. With low-cost deposits flooding into 

new branches and flowing at a more measured pace into 

mature branches, Commerce is able to maintain relatively 

good interest-rate margins. Then, as long as overall deposit 

levels grow rapidly, earnings grow at a fast clip as well. 

US consumers, Hill asserts, are nearly universal in their 

dislike for their banks, making it rather easy to peel them 

350 

300 

250 

200 

150 

100 


The quest for growth – turning an “amazing customer 

experience” into an “amazing investor experience” – 

Commerce Bancorp vs. US Banks 

50 

0 

away. Even commercial business is drawn in by Commercestyle 

retailing, Hill says, explaining that owners of small and 

mid-sized businesses are not going to stay with banks 

where their spouses or children have bad experiences. 

Hill, 59, launched the bank in 1973 when he was only 27 

Apr-00 

Oct-00 

Apr-01 

Oct-01 

Apr-02 

Oct-02 

Apr-03 

Oct-03 

Apr-04 

Oct-04 

Apr-05 

Commerce Bancorp NJ Citigroup JPMorgan Chase & Co 

Bank of America FTSE US Banks Index 

Data as at June 05. Source: FTSE Group/FactSet Limited. 

years old, after running a 

site development business 

for a few years for retail 

chains such as 

McDonald’s Corp. In 

addition to his 4.46% 

stake in Commerce, he is a 

partner in a group that owns 

47 Burger King restaurants 

in the Philadelphia area. 

He says that he thought 

from the beginning that a 

government charter, 

effectively a license to 

accept deposits, nearly 

guaranteed that he would 

make money. He did not 

always expect that his 

bank would grow so large. 

But now he is so confident 

that he is practically daring competitors to stop him. 

With a base in the suburbs of Philadelphia, and now 178 

branches in the New York City area, Hill expects to open 10 

to 15 branches in and around Washington this year and 200 

over the next few years. He has said that either the Boston 

area or Florida will be next; analysts expect him to 

announce which it will be this summer. One of the big 

reasons that he can march into new markets, he says 

brashly, is that so many competitors do more to annoy their 

customers than please them with their constant mergers 

and acquisitions. “My competitors are in the cost-cutting 

business,”Hill says.“I’m in the top-line growth business.” 

Whether the characterisations are fair or not, Commerce 

has performed quite well. It has produced an annual 

average return to shareholders of 31% over both five and 

10 years through the end of March. That compared to 

compound annual average decline of 3% for the Standard 

& Poor’s 500 over the past five years and an 11% annual 

gain for the S&P 500 over a 10-year period. 

The big question for investors, however, is whether 

Commerce can keep up the pace – of apparently successful 

new branch openings, of entry into new markets and of 

continued growth in its longer-standing markets – or 

whether competitors learn to do a better job of holding 

onto their customers. At $28 in mid-May, the company’s 

stock traded on the New York Stock Exchange for about 16 

times the trailing 12 months’ earnings, suggesting healthy, 

but unspectacular, expectations of investors. 

A common view among analysts who follow Commerce 

is that the company has at least several good years of 

industry-leading growth ahead. “They are very good at 

taking market share,” said Claire M. Percarpio, an analyst 

79

BANK PROFILE: COMMERCE BANCORP 

80 

with Janney Montgomery Scott Inc. in Philadelphia, adding 

that unlike most banks, Commerce doesn’t depend on its 

own share price to fuel acquisitions and therefore growth. 

The bank attracts business, analysts said, because it 

stands apart from others in its hiring, its training and 

follow-through. Legend has it that job candidates are 

deemed unsuitable if they do not smile with the first 30 

seconds of an interview. At the other end of the process, 

“mystery shoppers” visit Commerce branches 100,000 

times a year, meaning that someone is sizing up each of 

more than 300 branches and writing a report about each 

one of them nearly every day. 

Not everyone, however, is convinced that the growth and 

market share gains are sustainable. For example, Thomas 

Monaco, an analyst with Moors & Cabot, a Boston-based 

brokerage firm, says that consumer deposit growth comes 

mostly from opening costly new branches. Once they are 

open a year or two, he said, consumer deposit growth trails 

off. That has been masked, he said, by a growing 

government deposit business. And the government 

business may have trouble ahead, he adds. 

Two Commerce executives were convicted in May of 

conspiracy charges in a municipal corruption case in 

Philadelphia. The executives were charged with helping a 

city official get personal loans on favorable terms in 

exchange for his steering city business to the bank. 

Whether Commerce backs off from pursuit of government 

business or local governments shy away from Commerce, 

the impact could be big, Monaco expands. Other analysts 

say they fear that additional improprieties in soliciting 

government business could surface, tarring the company 

directly next time around. 

In addition, analysts have expressed concern that a 

relatively unusual balance sheet could cause trouble if 

interest rates rise sharply. With loans on Commerce’s books 

totaling just 35% of deposits, the bank has a large portfolio 

of fixed-rate securities. The value of these securities could 

plummet if rates rise.That would deplete the equity that the 

bank needs to continue opening branches, Monaco adds. 

The biggest reasons for concern might be the possibility 

that the industry giants are getting their retail act together. 

NEW DEPOSIT ACCOUNTS – January 2005 

Wachovia 

12% 

Sovereign 

3% 

Sun Bank 

1% 

Commerce 

32% 

Metro Philadelphia 

Wilmington 

Trust 

2% 

Repeat 

Sales 

Credit U 

3% 

41,705 Accounts 

Fleet/BOA 

6% 

Citizens 

4% 

PNC 

9% 

Other 

28% 

Bank of NY 

2% 

North Fork WAMU 

2% 

3% 

HSBC 

3% 

Chase 

10% 

Citi 

7% 

Wachovia 

4% 

Metro New York 

Commerce 

31% 

87,450 Total Accounts 

Repeat 

Sales 

Fleet/BOA 

8% AFSB 

2% PNC 

2% 

45,745 Accounts 

Other 

26% 

DEPOSITS 

Billions 

$ 33 

30 

27 

24 

21 

18 

15 

12 

9 

6 

3 

0 

$5.6 

120 

39% 

A 

verage 

Deposit 

Growth 

$7.4 

150 

$10.2 

184 

2.38%* 2.84%* 2.25%* 

1999 2000 2001 2002 2003 2004 

# of Branches * Deposit Cost of Funds 

Analysts and consultants also say that banks that grew 

large through acquisitions have vastly improved their 

customer service in the last few years, partly in response to 

Commerce and other smaller banks taking business from 

them. Big New York banks just did not believe that 

Commerce’s approach to retailing would resonate with 

consumers, says Wendel, the industry consultant. 

Now, Washington-area banks appear to be gearing up 

for Commerce’s arrival. For example, PNC Financial 

Services Group Inc. of Pittsburgh, which just moved into 

Washington with an acquisition, said in April that it would 

extend its weekday hours and add Sunday hours in the 

nation’s capital. To be sure, just about everything that 

Commerce does to attract customers can be copied. In 

addition to keeping longer hours, a few other banks have 

installed coin-counting machines in their branches. 

Working in Commerce’s favour, however, is the strong 

possibility that creating a retail experience and a brand 

identity that complements that experience by imitating an 

original thinker is not so easy and that competitors are not 

really committed to it anyway.“Most of the banks that have 

tried to do this have implemented one, two, three or four of 

the kinds of things that Commerce does,” says Mark T. 

Fitzgibbon, co-director of equity research for Sandler 

O’Neill & Partners LP, a New York-based investment bank 

BRANCH PROFITABILITY ANALYSIS – Results in millions 

Fully allocated support costs approximate 1.50% of total deposits 

$14.5 

Average 

Average First Two 

Suburban Manhattan 

Branch Branches 

(annualized) 

Total Deposits $100.0 $250.0 

Total Income 5.2 12.4 

Total Branch Operating Expenses (1.3) (3.7) 

Net Pre-Tax Income $3.9 $8.7 

224 

1.34%* 

$20.7 

270 

42% 

.82%* 

$27.7 

319 

34% 

.84%* 


that specialises in financial companies.“But they have not 

implemented the other 65.” 

So, even when competitors borrow an idea, they do not 

necessarily pull it off with the same élan. It is one thing, 

for example, to install machines in branches that quickly 

count huge quantities of unsorted coins. Commerce’s 

machines look like arcade games, with sounds and 

flashing lights. And just to make it amusing, Commerce 

invites visitors to try to guess how much all their coins 

are worth. If they are close, the bank gives them token 

prizes, such as a plastic piggy-bank “C” in Commerce’s 

trademark red. 

But that is not all. Wendel discovered when he took his 

young son and a huge jar full of coins to a Commerce 

branch, intending to have some fun counting the money. 

The coin counting machine was broken the day they 

visited, but the branch manager was not about to let the 

youngster go home disappointed, Wendel said. Without 

missing a beat, the manager called another branch, to 

make sure its machine was in working order, and then gave 

Wendel money to cover a taxi ride to the other office.“That 

was an amazing customer experience,”Wendel says. 

Competitors might dispute Hill’s assertion that he is the 

only one pursuing revenue growth. They would be hard 

pressed to argue, however, that Commerce does not spend 

generously, on items large and small, in that pursuit. For 

example, Commerce only takes the best locations when it 

opens new branches, says Jacqueline Reeves, a bank stock 

analyst with Ryan, Beck & Co., a New Jersey-based 

brokerage firm, even though it invariably pays more for 

them than other sites around town. One such site gives Hill 

a chance to chuckle occasionally at Chase’s expense. A 

photograph in Commerce’s standard analyst presentation 

shows a building at the corner of Fifth Avenue and 14th 

Street in New York. Commerce signs adorn the windows on 

the first floor, immediately below Chase signs. Chase, Hill 

explained, gave up its lease on the first floor, presumably to 

cut its sky-high Manhattan occupancy costs, and held onto 

space it had on the second floor. Commerce moved into the 

first-floor space, which is more accessible to customers and 

prospective customers walking by. The Commerce branch 

ASSET QUALITY 

Non- Performing 

Assets 

Charge-offs 

Loan Loss Reserve 

12/01 12/02 12/03 

.17% .11% .11% .11% 

.19% .18% .16% .19% 

1.46% 1.56% 1.51% 1.43% 

Non-Performing 

Loan Coverage 398% 640% 515% 413% 

Credit Rating: A-2/P-1 


12/04 

Top 60 

Banks 

0.60% 

0.537% 

1.52% 

278% 

has $59m in deposits, more than thousands of bank 

branches around the US that have been open for many 

years longer than Commerce has been in New York. 

At the more modest end of the spectrum, where other 

banks tether a pen to a counter for customers to prepare 

routine forms, Commerce fills boxes with dozens and 

dozens of writing implements. Hill says the bank gives 

away 1m pens a month and would be happy to push that 

figure to 2m.“The average bank would say,‘How do we get 

our pen costs down,’”he says. Only time will tell how long 

Commerce’s high-cost approach to business can generate 

outsized earnings growth. Unless the model falters badly, 

however, it is unlikely that big banks will take Commerce 

for granted again. 

The Citis and Chases and Banks of America of this world 

regularly boast that their vast branch systems and even 

vaster networks of automated teller machines give 

unparalleled access to their customers’ accounts. But 

Commerce, which calls itself “America’s Most Convenient 

Bank”, appears to have neutralised that big-bank 

advantage and given clear meaning to what could easily be 

an empty slogan with a new costly program recently. The 

bank announced in March a wide-scale program to rebate 

automated teller machine fees that machine owners and 

other financial institutions charge its customers. It said it 

would cover the cost of using all machines, worldwide, for 

customers who have $2,500 in their checking accounts. 

Clever slogans are not necessarily hard to come by. But 

it certainly difficult for competitors to argue that cost-free 

access to customer accounts around the world is not 

pretty convenient. 

2004 SUMMARY 

Total Assets 

Total Deposits 

Total (Net) Loans 

Total Revenues 

Total Expenses 

Net Income 

Net Income Per Share 

$30.5B 

27.7B 

9.3B 

+34% 

+34% 

+27% 

$1,392.9M +28% 

938.8M +23% 

273.4M +41% 

$1.63 +26% 

81

INDEX REVIEW: CORPORATE GOVERNANCE 

82 

THE 

Building Blocks 

OF 

CORPORATE 

GOVERNANCE 

IN COLLABORATION FTSE and Institutional Shareholder 

Services (ISS) have created FTSE ISS CGI, the first global 

corporate governance indices. The series comprises two 

separate elements – a set of rankings, supplied by ISS, in 

which each company in the universe is scrutinised against five 

corporate governance themes, and a set of six equity indices, 

based on these rankings, covering developed markets. The 

ratings allow investors to understand corporate governance 

risk on a specific company, country and sector basis, while the 

overall index allows investors to see how corporate 

governance practice impacts their overall portfolios.The index 

series is the culmination of a full-fledged process that has 

harnessed FTSE’s expertise in index formulation with ISS’s 

specialist knowledge of the salient elements in corporate 

governance that have most relevance for today’s market. 

The index series is designed to raise awareness of 

corporate governance as an investment risk; encourage the 

collection and dissemination of accurate, high quality data 

on individual company corporate governance practices and 

highlight those companies working to high standards of 

corporate governance. 

Market research conducted by both firms throughout the 

whole of last year confirms a growing interest in the 

management of corporate governance risk. The majority of 

respondents (88%) from the various sections of the 

investment community expected interest in corporate 

governance to increase over the next two years. And it is 

the specific feedback from this consultation that has guided 

the construction and methodology of the new index series. 

These days corporate governance is an essential 

feature of the investment management process. 

A key business discipline contributing to the 

financial stability and growth of corporations, if 

ignored it can lead to the downfall of 

corporations both large and small. Carl Beckley, 

director, FTSE Group, examines the design, 

construction and performance of the FTSE ISS 

Corporate Governance Index (CGI) Series, and 

shows how it can be used by investors as an 

effective risk management tool. 

Designing the FTSE ISS CGI Series 

Six indices (please refer to Table 1: FTSE ISS Corporate 

Governance Indexes vs. Their Respective Benchmarks) have 

been developed in this initial phase, with the objective of 

closely tracking the structure and pattern of the FTSE 

Developed Index and the FTSE All-Share Index. The first 

step was to decide the universe of stocks which would form 

the FTSE ISS Corporate Governance Index Series. To 

ensure global coverage, the CGI family covers large and 

mid-cap stocks in developed markets. This universe 

currently contains over 2,000 companies. The FTSE All- 

Share Index (which contains large, mid and small cap 

stocks) was used as the starting universe in the FTSE ISS 

UK CGI. The FTSE All-Share index is the main benchmark 

for UK institutional investors and was a natural choice as 

the basis of this particular index. 

For each of the six indices ISS collates all of the raw 

corporate governance scores for each constituent. FTSE, in 

turn, use ISS’s raw data to produce a cumulative score for 

each constituent. In order to make the scores more accessible 

the cumulative scores are normalised so that all scores fall 

between 0 and 100. A score of 0 represents the lowest 

corporate governance rating, while 100 is the highest score 

that can be attained.This is referred to as the CGI Final Score. 

In each index universe every constituent is classified into 

one of the 18 Industry Classification Benchmark (ICB) 

Supersectors and within each Supersector each constituent 

is ranked by its CGI Final Score. Constituents representing 

only the top 80% by investable market capitalisation in 


each Supersector are eligible for inclusion in the index. Any 

remaining constituents in the lowest 20% by investable 

market capitalisation are excluded. This process is repeated 

for each of the Supersectors. Finally, Supersectors are 

combined to form the Regional or Country FTSE ISS 

Corporate Governance Index. 

This review procedure inevitably narrows the number of 

constituents in the FTSE ISS Developed CGI universe to 

1,350 constituents, down from the original 2,089 

constituents. In comparison, the FTSE ISS UK CG Index is 

focused on some 315 constituents (compared with the 578 

in the FTSE All-Share Index universe). 

During the market consultation exercise FTSE assessed 

various different methods of producing an appropriate 

index series that accurately reflected the corporate 

governance performance of the world’s listed companies. 

Three choices of methodology were available to the index 

design team. They could adopt an exclusion policy or they 

could retain all the traditional index constituents, but 

overweight companies with good corporate governance 

performance and underweight the poorer performers. 

Alternately, they could produce best and worst in class 

indices with a limited number of stocks. 

Before a decision was taken, each of the options was 

thoroughly investigated. Difficulties became obvious very 

quickly. The overweight versus underweight methodology, for 

instance, did not give major differences to the exclusion policy. 

The reason was simple. Removing a proportion of stocks is 

just another way of radically underweighting them, which 

then will automatically overweight the remainder. Any 

resulting performance would therefore be more reliant upon 

the particular mix of stocks that are included (or excluded) 

from the index. This mix relates to both relative market 

capitalisation sizes and then individual stock performance. 

The other issue on exclusion is that of turnover. The more 

constituents that are excluded from the index the higher the 

turnover can potentially be. This has an influence on 

deciding what level of market capitalisation could be 

excluded from the index. Removing a large amount of 

market capitalisation may have more influence on 

performance but would theoretically lead to higher turnover. 

Removing less than 20% would not have had a sufficiently 


useful effect, but removing more would begin to have 

implications for turnover. Having looked at this issue it was 

clear that an 80/20 split gave the right balance between 

inclusion and exclusion. 

Indeed it is this last point that ensured that at least in 

these early stages our third option of producing the “best” 

and worst”indexes could potentially lead to high turnover. 

In the end, the team opted for an exclusion 

methodology. The majority of participants in the market 

consultations process had suggested that for the first 

phase of the Corporate Governance Indices, investors 

were most interested in an index where constituents 

that tended towards poor corporate governance practices 

were excluded. 

Exclusion Performance 

The FTSE ISS CGI Series aims to track its underlying 

benchmark indices very closely. This is helped by its sector 

neutral approach and by removing only 20% of the 

underlying market capitalisation at review. 

As a result of using this methodology, we would expect 

similar historical correlations and performance as the 

underlying benchmarks. The main issue with looking at 

historical performance is determining constituent changes 

in corporate governance practices. 

FTSE used FactSet software to run a series of backcast 

index values to highlight any performance differences. The 

backcasts are based on a current set of constituents for each 

index and are calculated backwards for a period of five 

years. As this methodology does not take into account 

constituent changes throughout time the same 

methodology was applied to the relative underlying 

benchmarks to remove any calculation biases. 

The analysis is mixed as to whether corporate 

governance has an overriding effect on company 

performance. Equally, the evidence of a clear link between 

corporate governance standards and share price 

performance is mixed. The FTSE ISS UK CGI outperforms 

its equivalent FTSE index over one and three years, and the 

FTSE ISS Developed CGI, FTSE ISS Japan CGI, and FTSE 

ISS US CGI outperforms over a five-year period. The FTSE 

ISS Europe and Euro CGIs underperform their respective 

Table 1: FTSE ISS Corporate Governance Indices versus their respective benchmarks 

CG Index Stocks Net Market Net Market Benchmark Index Stocks Net Market Net Market 

Cap Cap (Local Cap Cap (Local 

(USD Bn) Curr. Bn) (USD Bn) Curr. Bn) 

FTSE ISS US CG Index 412 9,048 9,048 FTSE US Index* 743 12,216 12,216 

FTSE ISS UK CG Index 315 2,176 1,140 FTSE All-Share Index* 578 2,713 1,421 

FTSE ISS Japan CG Index 353 1,647 172,988 FTSE Japan Index* 479 2,077 218,217 

FTSE ISS Developed CG Index 1,350 17,600 17,600 FTSE Developed Index* 2,089 22,828 22,828 

FTSE ISS Europe CG Index 347 5,590 4,259 FTSE Developed Europe Index* 502 6,985 5,321 

FTSE ISS Euro CG Index 194 2,892 2,203 FTSE Eurozone Index* 277 3,516 2,678 

*Excludes Investment Companies Data as at 3rd March 2005 

83

INDEX REVIEW: CORPORATE GOVERNANCE 

84 

benchmark indexes although the underlying differences 

are marginal with high correlations. Each index is closely 

correlated to its underlying benchmark index. Over a fiveyear 

period the tracking errors are higher with the 

individual country indexes, while the regional indexes of 

FTSE ISS Developed, FTSE ISS Europe, and FTSE ISS Euro 

CGI show a five-year tracking error of 1.09%, 1.32%, and 

1.11% respectively. 

Although separate from the index methodology, analysis 

based around a sample portfolio containing the top 50 and 

bottom 50 constituents from each theme within the FTSE 

US Index universe has shown that the bottom 50 

underperform the top 50 in four out of five themes over a 

five-year period. The analysis based on equally weighting 

the portfolios on a daily basis using FactSet Software, 

shows this out-performance when using the overall 

company CGI rating. Apart from the theme Board Structure 

each bottom 50 portfolio also under-performs an equally 

weighted FTSE US Index. The Compensation theme 

interestingly has a negative performance over the period of 

one year, with the highest volatility of all the themes over 

the five-year period. 

Given the level of specific information available at 

present, there is no definitive link between corporate 

governance and stock returns. The performance analysis 

on the US is only a starting point, and by no means 

conclusive over a five year period. But, over reasonable 

time periods it is likely that governance factors will show 

themselves in investment returns. There are a number of 

reasons put forward for this. One is that sufficient 

information to make detailed decisions by all investors has 

The FTSE ISS Corporate Governance Index Series 

Review Universes 

Universe Index 

FTSE All-Share Index 

FTSE North America 

Index 

FTSE Developed 

Europe ex UK Index 

FTSE UK Index 

FTSE Developed Asia 

Pacific ex Japan Index 

FTSE Japan Index 

FTSE ISS CGI 

FTSE ISS UK CGI 

FTSE ISS Developed 

CGI 

The design process aims to capture 80% of the market 

cap within each Supersector 

not been available. Analysis of corporate governance is a 

skilled affair and the general investment community 

encompassing asset owners and managers does not have 

the necessary skills or resources to carry out such 

investigations across all of their investments. 

Further, corporate governance is not a one-off due 

diligence exercise. It is a continuous process. Having carried 

out the initial work on a company, the corporate governance 

risk then takes on the mantle of a watching brief. As a 

consequence, there is a requirement for continual 

monitoring of corporate governance due diligence. 

Another consideration is that there have been some high 

profile investment firms that take corporate governance 

very seriously and have done so for some years and applied 

their views to their investments. In the main however many 

investors (and legislators) only really began to tackle these 

issues in the wake of scandals such as WorldCom and 

Enron. Any corporate governance effect would only have 

been noticeable at some stage after these events. 

In short, it can be argued even now, that any corporate 

governance implementation will at best be applied in a 

somewhat unstructured way particularly across a number 

of markets. This will help to dissipate any potential “return 

effects”. Differing legislation and codes of practice can 

affect the returns within a country. If all companies within 

a country fall into line then the issues that the rules are 

meant to rectify will in effect be removed from that market. 

As time goes by it is fair to assume that a more cohesive 

implementation by market practitioners around the world 

will come into play. When this occurs there may well begin 

to be noticeable return effects. 

The FTSE ISS Corporate Governance Index Series 

Construction Methodology 

2 

3 

Oil & Gas 

Rank by Corporate 

Governance (CGI) Final Score 

Highest 

Lowest 

1 

Basic Resources 

FTSE Japan 

Oil & Gas Review Process 

FTSE ISS Japan 

CG Index 

Chemicals 

5 

Oil & Gas Basic Resources Chemicals 

6 

4 

Cumulative 

Investable Mcap 

Construction 

& Materials 

80% 

20% 

Construction 

& Materials 


FTSE Global Markets Company Directory 

Company Name Page Company Name Page Company Name Page Company Name Page 

ABN Amro 

ABN AMRO Mellon Global 

32 

Securities Services 36 

Agence France Trésor 61 

Agence France Trésor 57 

AIG Global Investment Corp. 8 

AIM 24 

Allied Domecq 64 

American Century Investments 14 

American International Group Inc. 8 

Archipelago Exchange 14 

Athens Organising Committee 25 

Athens Stock Exchange 25 

Babson Capital Management 75 

BancWest Corporation 32 

BancWest Corporation 32 

Bank of America Corp. 79 

Bank of Athens 25 

Bank of the West 32 

Bankers Trust Company 25 

Banque Paribas 30 

Baoshan Iron & Steel Co Ltd 22 

Barclays Capital 57 

Barclays Global Investors 6 

BNP Paribas 57 



BNP Paribas Securities Services 

Brown Brothers Harriman 

41 

(BBH) Ltd 36 

Burger King 79 

Bursa Malaysia 73 

Caldwell Asset Management 16 

Caldwell Financial Ltd 16 

Caldwell Management Ltd 16 

Caldwell Securities, Ltd 16 

Calyon 32 

CCF 57 

CDC Ixis 57 

CDP Capital 23 

Cedel International 45 

Cedel International 46 

Charles Schwab & Co., Inc 19 

Chase Manhattan 53 

Chase Manhattan Bank 78 

Chicago Board of Trade 70 

Chicago Mercantile Exchange 68 

China Asset Management Co Ltd 6 

China Asset Management Company 20 

China Foreign Exchange 

Trading System 72 


China Merchants Bank Co Ltd 22 

China Mobile 

China Petroleum & Chemical 

6 

Corp (Sinopec) 22 

Huaneng Power International Inc 

China Securities Regulatory 

22 

Commission 22 

China Telecom 

China’s State Administration of 

6 

Foreign Exchange 72 

Citibank 78 

CITIC 22 

Citigroup 

Citigroup Global Transaction 

78 

Services 42 

Clearstream 44 

Clearstream International 45 

CME Holding 69 

Cogent 31 

Commerce Bancorp Inc 

Commodity Futures 

78 

Modernization Act 71 

Commodity Research Bureau 10 

Community First Bankshares, Inc. 32 

Community First National Bank 32 

Conseil des Marchés Financiers 30 

Crédit Agricole 

Credit Agricole Indosuez 

32 

Securities Japan 32 

Crédit Suisse Asset Management 38 

Credit Suisse First Boston 57 

Debt Management Office 60 

Debt Management Office 57 

Delaware Investment 

Depository Trust & Clearing 

23 

Corporation 18 

Deutsche 57 

Deutsche Börse 25 

Deutsche Börse AG 46 

Deutsche Börse Clearing 

Dexia Banque Internationale à 

45 

Luxembourg 34 

Economist Corporate Network 8 

EFG Balkan Investments 25 

Eurex 71 

Euronext 25 

Euronext.liffe 71 

European Union 26 

Executives’ Club of Chicago 69 

First Chicago 53 

First Hawaiian Bank 32 

Ford 74 

Fortis 

Fortis Haitong Investment 

8 

Management Co. Ltd. 8 

FTSE Group 24 

General Motors 74 

Global Advisors 10 

Goldman Sachs 

Greece’s Capital Markets 

16 

Commission 25 

Haas School of Business 16 

Hellenic Postal Savings Banks 

Hong Kong Exchanges 

26 

and Clearing Ltd 73 

HSBC 57 

HSBC 32 

HSBC 38 

Illinois District Court 71 

ING Investment Management 8 

INSEAD University 25 

Instinet 14 

Janney Montgomery Scott Inc 80 

Japan’s UFJ Holdings 32 

JP Morgan 

JP Morgan Worldwide 

57 

Securities Services 36 

KPMG/CREATE 40 

Lehman Brothers 8 

London Stock Exchange 24 

Madison Capital Management 53 

Malaysia Derivatives Exchange 73 

Man Investments, Inc 18 

McBride Baker & Coles 69 

McDonald’s Corp 79 

McGill University 

Mellon’s Investment 

23 

Manager Solutions 41 

Mercer Oliver Wyman 

Ministry of National Economy 

45 

and Finance 25 

Moody’s Investor Services 77 

Moors & Cabot 80 

Morgan Stanley 75 

Morningstar 21 

Shanghai Securities News 21 

NASDAQ 14 

National Bank of Greece 25 

National Interbank Funding Centre 72 

New York Mercantile Exchange 10 

New York Mercantile Exchange 10 

New York Stock Exchange 14 

New York Stock Exchange 69 

Northern Trust 36 

Northern Trust 8 

Northern Trust Global Investments 57 

OMHX 

Online Commodity Exchange 

25 

of India 73 

OPEC 10 

People’s Bank of China 72 

PIMCO 76 

PNC Financial Services Group Inc 80 

PowerShares Capital Management 6 

RBC Global Services 42 

RBS 32 

Reuters 14 

Royal Bank of Canada 34 

Russian Standard Bank 30 

Russian Standard Group 30 

Ryan, Beck & Co 81 

Sandler O’Neill & Partners LP 80 

Schwab Institutional 

Securities and Exchange 

19 

Commission 14 

SEI Investments 23 

Shanghai Stock Exchange 72 

Shanghai Stock Exchange 22 

Sidney Frank 65 

Singapore Exchange 73 

Société Générale 30 

Société Générale 8 

Standard & Poor’s 74 

Standard Life Investments 23 

State Street Global Advisors 6 

State Street Global Advisors 22 

Sydney Futures Exchange 73 

T. Rowe Price 57 

TCW Asset Management Company 74 

TCW Asset Management Company 76 

Telecom Italia 57 

The Bank of New York 41 

TowerGroup 42 

Turk Economi Bankasi 32 

Union National Bank 53 

United California Bank 32 

United Safe Deposit Bank 32 

University of Athens 25 

University of California 16 

Wachovia Corp 79 

Wall-mart 53 

World Trade Organisation 23 

COMPANIES IN THIS ISSUE 

85

MARKET REPORTS BY FTSE RESEARCH 

86 

FTSE Global Equity Index Series – Global, Year to Date 

31st December 2004 - 31st May 2005 

FTSE Regional Indices Performance (USD) 

120 

115 

110 

105 

100 

95 

90 

FTSE Regional Indices Capital Returns (USD) 

% 

FTSE Developed Country Indices Capital Returns 

% 

31-Dec-04 

4 

2 

0 

-2 

-4 

-6 

-8 

FTSE Global AC 

FTSE All-World Index 

15 

10 

5 

0 

-5 

-10 

-15 

FTSE Large Cap 

31-Jan-05 

FTSE Mid Cap 

FTSE Small Cap 

FTSE Developed AC 

28-Feb-05 

FTSE Adv Emerging AC 

FTSE Emerging AC 

FTSE All-Emerging AC 

31-Mar-05 

FTSE Latin America AC 

FTSE Middle East & Africa 

FTSE North America AC 

30-Apr-05 

FTSE Asia Pacific ex Japan AC 

FTSE Japan AC 

FTSE Dev Europe AC 

31-May-05 

FTSE Emerging Europe AC 

FTSE Australia AC 

FTSE Austria AC 

FTSE Belgium/Lux AC 

FTSE Canada AC 

FTSE Denmark AC 

FTSE Finland AC 

FTSE France AC 

FTSE Germany AC 

FTSE Greece AC 

FTSE Hong Kong China AC 

FTSE Ireland AC 

FTSE Italy AC 


FTSE Netherlands AC 

FTSE New Zealand AC 

FTSE Norway AC 

FTSE Portugal AC 

FTSE Singapore AC 

FTSE Spain AC 

FTSE Sweden AC 

FTSE Swizerland AC 

FTSE United Kingdom AC 

FTSE USA AC 


FTSE Developed Europe AC 


FTSE Asia Pacific AC ex Japan 

FTSE Middle East & Africa AC 

FTSE Emerging Europe AC 

FTSE Latin America AC 

FTSE North America AC 

Dollar Value 

Local Currency Value 

Key: AC = All Cap, LC = Large Cap, MC = Mid Cap, SC = Small Cap, LC/MC = Large and Mid Cap 


FTSE All-Emerging Country Indices Capital Returns 

% 

70 

60 

50 

40 

30 

20 

10 

0 

-10 

-20 

FTSE Global All Cap Sector Indices Capital Returns (USD) 

% 

15 

10 

5 

0 

-5 

-10 

-15 

-20 

Stock Performance 

Best Performing FTSE All-World Index Stocks (USD) Worst Performing FTSE All-World Index Stocks (USD) 

Orascom Telecom Holdings 115.5% Doral Financial -76.5% 

Orascom Construction 101.7% Elan Corporation -71.7% 

Dacom Corporation 101.4% LG Card -60.0% 

Mitac International 95.7% TD Banknorth -59.9% 

Thai Petrochemical Industry 88.7% Pacifica Group -53.9% 

Overall Index Return No. of Value 1 M 3 M YTD Actual 

Consts Div Yld 

FTSE Global AC 7,793 299.66 2.0% -3.2% -2.0% 2.12% 

FTSE Global LC 1,102 293.78 1.5% -3.1% -2.5% 2.27% 

FTSE Global MC 1,868 392.94 3.0% -2.4% -0.2% 1.79% 

FTSE Global SC 4,823 352.51 3.3% -3.8% -2.0% 1.73% 

FTSE All-World 2,970 179.40 1.8% -3.1% -2.0% 2.17% 

FTSE Asia Pacific AC ex Japan 1,870 345.26 1.5% -4.9% 0.3% 3.02% 

FTSE Latin America AC 173 486.64 6.8% -5.7% 3.5% 3.73% 

FTSE All Emerging Europe AC 84 429.89 1.7% -13.6% 0.7% 2.04% 

FTSE Developed Europe AC 1,512 315.63 -0.2% -6.0% -3.1% 2.91% 

FTSE Middle East & Africa AC 171 393.05 -1.5% -9.4% -7.1% 2.75% 

FTSE North Americas AC 2,656 283.44 3.6% -0.8% -1.3% 1.71% 

FTSE Japan AC 1,327 300.90 -1.1% -5.4% -4.9% 1.16% 


Dollar Value 

Local Currency Value 

Capital 

FTSE Argentina AC 

FTSE Brazil AC 

FTSE Chile AC 

FTSE China AC 

FTSE Columbia AC 

FTSE Czech Republic AC 

FTSE Egypt AC 

FTSE Hungary AC 

FTSE India AC 

FTSE Indonesia AC 

FTSE Israel AC 

FTSE Korea AC 

FTSE Malaysia AC 

FTSE Mexico AC 

FTSE Morocco AC 

Mining 

Oil & Gas 

FTSE Pakistan AC 

Chemicals 

FTSE Peru AC 

Construction & Building Materials 

FTSE Philippines AC 

Forestry & Paper 

Steel & Other Metals 

FTSE Poland AC 

Aerospace & Defence 

FTSE Russia AC 

Diversified Industrials 

Electronic & Electrical Equipment 

FTSE South Africa AC 

Engineering & Machinery 

FTSE Taiwan AC 

Automobiles & Parts 

Household Goods & Textiles 

FTSE Thailand AC 

Beverages 

FTSE Turkey AC 

Food Producers & Processors 

Health 

Personal Care & Household Products 

Pharmaceuticals & Biotechnology 

Tobacco 

General Retailers 

Leisure & Hotels 

Media & Entertainment 

Support Services 

Transport 

Food & Drug Retailers 

Telecommunication Services 

Electricity 

Utilities - Other 

Banks 

Insurance 

Life Assurance 

Investment Companies 

Real Estate 

Speciality & Other Finance 

Information Technology Hardware 

Software & Computer Services 

Total Return 


87


88 

FTSE Global Equity Index Series – Developed ex US,Year to Date 


FTSE Developed Regional Indices Performance (USD) 

115 

110 

105 

100 

95 

90 

31-Dec-04 

% 

31-Jan-05 

28-Feb-05 

31-Mar-05 

30-Apr-05 

FTSE Developed Regional Indices Capital Returns (USD) 

8 

6 

4 

2 

0 

-2 

-4 


% 

FTSE All-Emerging 

FTSE Developed ex US 

FTSE Developed Europe 

FTSE Developed Asia Pacific 

FTSE Developed Asia Pacific ex Japan 

FTSE Eurozone 

FTSE Developed ex US Indices Sector Capital Returns (USD) 

10 

5 

0 

-5 

-10 

-15 

-20 

FTSE US 

FTSE Developed AC ex US 

FTSE Developed LC ex US 

FTSE Developed MC ex US 

FTSE Developed SC ex US 

31-May-05 

Mining 

Oil & Gas 

Chemicals 










Beverages 


Health 



Tobacco 





Transport 



Electricity 


Banks 

Insurance 



Real Estate 




FTSE Developed (LC/MC) 

FTSE Developed Europe (LC/MC) 

FTSE Developed Asia Pacific (LC/MC) 

FTSE All-Emerging (LC/MC) 

FTSE Developed ex US (LC/MC) 

FTSE US (LC/MC) 


ex Japan (LC/MC) 

Capital 

Total Return 




Best Performing FTSE Developed ex US Index Stocks (USD) Worst Performing FTSE Developed ex US Index Stocks (USD) 

Chiyoda Corp 65.1% Elan Corporation -71.7% 

Sembcorp Marine 51.6% Pacifica Group -53.9% 

Daido Steel Co 44.6% Paperlinx -52.3% 

Kingboard Chemical Holdings 44.0% Henderson Group -51.1% 

Sembcorp Industries Limited 37.6% Privee Zurich Turnaround Group -49.6% 

Overall Index Return No. of Value 1 M 3 M YTD Actual 


FTSE Developed ex US (LC/MC) 1,362 189.68 -0.2% -5.5% -3.5% 2.59% 

FTSE USA (LC/MC) 740 490.22 3.3% -0.5% -1.0% 1.75% 

FTSE Developed (LC/MC) 2,102 176.26 1.7% -2.8% -2.2% 2.13% 

FTSE All-Emerging (LC/MC) 868 264.95 3.4% -6.6% 0.7% 2.80% 

FTSE Developed Europe (LC/MC) 512 190.43 -0.3% -5.9% -3.5% 2.97% 

FTSE Developed Asia Pacific (LC/MC) 776 175.58 -0.7% -5.2% -4.3% 1.90% 

FTSE Developed Asia Pacific ex Japan (LC/MC) 298 289.98 -0.2% -4.1% -0.8% 3.50% 

FTSE Developed AC ex US 3,710 318.45 -0.2% -5.5% -3.1% 2.54% 

FTSE Developed LC ex US 527 299.21 -0.3% -5.4% -4.0% 2.70% 

FTSE Developed MC ex US 1,868 364.79 0.3% -5.5% -1.3% 1.79% 

FTSE Developed SC ex US 4,823 394.70 0.1% -5.9% 0.1% 1.73% 

FTSE Global Equity Index Series – Asia Pacific, Year to Date 


FTSE Asia Pacific Regional Indices Performance (USD) 

110 

105 

100 

95 

90 

31-Dec-04 

31-Jan-05 

28-Feb-05 


31-Mar-05 

30-Apr-05 

31-May-05 



Asia Pacific (LC/MC) 



FTSE Asia Pacific (LC/MC) 


Asia Pacific AC 

FTSE Japan (LC/MC) 


89


90 

FTSE Asia Pacific Regional Indices Capital Returns (USD) 

% 

FTSE Asia Pacific All Cap Sector Indices Capital Returns (USD) 

15 

10 

5 

0 

-5 

-10 

-15 

2 

0 

-2 

-4 

-6 

FTSE Asia Pacific AC 

% 


Mining 

Oil & Gas 

Chemicals 









Best Performing FTSE Asia Pacific Index Stocks (USD) Worst Performing FTSE Asia Pacific Index Stocks (USD) 

Dacom Corporation 101.4% LG Card -60.0% 

Mitac International 95.7% Pacifica Group -53.9% 

Thai Petrochemical Industry 88.7% Paperlinx -52.3% 

High Tech Computer 83.3% Privee Zurich Turnaround Group -49.6% 

Korea Investment Holdings 80.2% ReignCom -47.0% 

Overall Index Return 


Asia Pacific (LC/MC) 

Developed Asia Pacific 






FTSE Japan Index (LC/MC) 

FTSE Asia Pacific (LC/MC) 

FTSE Asia Pacific MC 

FTSE Asia Pacific SC 

FTSE Asia Pacific LC 



Beverages 


Health 



Tobacco 





Transport 



Electricity 


Banks 

Insurance 



Real Estate 




Capital 

Total Return 

No. of Value 1 M 3 M YTD Actual 


FTSE Global AC 7793 299.66 1.95% -3.15% -2.01% 2.12% 

FTSE Asia Pacific AC 3197 319.40 0.13% -5.15% -2.54% 2.03% 

FTSE Asia Pacific (LC/MC) 1335 180.93 0.26% -5.13% -2.94% 2.05% 

FTSE Asia Pacific LC 497 305.97 0.36% -5.18% -3.34% 2.11% 

FTSE Asia Pacific MC 838 352.57 -0.15% -4.96% -1.40% 1.82% 

FTSE Asia Pacific SC 1862 369.71 -0.91% -5.03% 1.63% 1.90% 

FTSE Developed Asia Pacific ex Japan (LC/MC) 298 289.98 -0.21% -4.05% -0.76% 3.50% 

FTSE Developed Asia Pacific Index (LC/MC) 776 175.58 -0.67% -5.15% -4.25% 1.90% 

FTSE All-Emerging Asia Pacific (LC/MC) 559 204.15 3.66% -5.13% 1.97% 2.59% 

FTSE Japan Index (LC/MC) 478 111.52 -0.88% -5.66% -5.78% 1.15% 



% 

% 

FTSE Global Equity Index Series – Europe, Year to Date 


FTSE European Regional Indices Performance (EUR) 

110 

105 

100 

95 

31-Dec-04 

31-Jan-05 

28-Feb-05 

FTSE European Regional Indices Capital Return (EUR) 

12 

10 

8 

6 

4 

2 

0 


FTSE Europe AC 

FTSE Europe LC 

FTSE Europe MC 

FTSE Europe SC 

FTSE Developed Europe AC 

FTSE All-Emerging Europe AC 

FTSE Developed Europe Sector Indices Capital Returns (EUR) 

20 

15 

10 

5 

0 

-5 

-10 


31-Mar-05 

FTSE Eurozone AC 

30-Apr-05 


ex UK AC 

FTSE Eurofirst 300 

FTSEurofirst 80 

FTSEurofirst 100 

31-May-05 

Mining 

Oil & Gas 

Chemicals 










Beverages 


Health 



Tobacco 





Transport 



Electricity 


Banks 

Insurance 



Real Estate 




FTSE Global AC (EUR) 


ex UK LC/MC (EUR) 

FTSEurofirst 300 (EUR) 

FTSE Developed Europe AC (EUR) 


FTSE Eurozone LC/MC (EUR) 


Capital 

Total Return 


91


92 


Best Performing FTSE Developed Europe Index Stocks (EUR) Worst Performing FTSE Developed Europe Index Stocks (EUR) 

Vestas Wind Systems 44.4% Elan Corporation -68.9% 

Allied Domecq 41.2% Henderson Group -46.2% 

Metso Corporation 39.4% Benetton -24.3% 

RCS Mediagroup 35.5% Invensys -24.2% 

Deutsche Boerse 34.9% Alcatel -22.5% 

Overall Index Return (EUR) 

No. of Value 1 M 3 M YTD Actual 


FTSE Global AC 7793 299.66 1.95% -3.15% -2.01% 2.12% 

FTSE Europe AC 1596 295.57 4.41% 0.94% 6.73% 2.90% 

FTSE Europe LC 211 329.86 4.11% 1.17% 5.69% 3.05% 

FTSE Europe MC 358 358.10 5.06% 0.88% 8.68% 2.54% 

FTSE Europe SC 1027 372.33 5.25% 0.78% 10.43% 2.40% 

FTSE Developed Europe AC 1512 294.36 4.38% 1.08% 6.67% 2.91% 

FTSE All-Emerging Europe AC 84 400.92 6.29% -7.08% 10.83% 2.04% 

FTSE Eurobloc AC 745 303.77 4.84% 0.46% 5.51% 2.88% 

FTSE Developed Europe ex UK AC 1031 305.64 4.92% 0.97% 6.17% 2.73% 

FTSEurofirst 300 300 1105.55 4.25% 1.25% 6.12% 3.01% 



FTSE UK Index Series – Year to Date 


FTSE UK Index Series Performance (GBP) 

120 

115 

110 

105 

100 

95 

90 

31-Dec-04 

31-Jan-05 

28-Feb-05 

31-Mar-05 

30-Apr-05 

FTSE All-Share Sector Indices Capital Returns (GBP) 

% 

20 

15 

10 

5 

0 

-5 

-10 

-15 

-20 

31-May-05 

Mining 

Oil & Gas 

Chemicals 









Beverages 


Health 



Tobacco 





Transport 



Electricity 


Banks 

Insurance 



Real Estate 




FTSE 100 



FTSE SmallCap 

FTSE All-Share 

FTSE AIM 

FTSE techMARK 

Capital 

Total Return 



FTSE UK Index Series - Capital Return YTD (GBP) 

4 

2 

0 

-2 

-4 

-6 



Best Performing FTSE All-Share Index Stocks (GBP) Worst Performing FTSE All-Share Index Stocks (GBP) 

Stanelco 388.4% AEA Technology -59.3% 

Oxford Biomedica 75.7% Homestyle Group -55.4% 

BTG 71.6% Danka Business Systems -54.7% 

Elementis 66.8% Games Workshop Group -53.6% 

Edinburgh Oil & Gas 57.8% Gresham Computing -52.7% 

Overall Index Return 

No. of Value 1 M 3 M YTD Actual Net P/E 

Consts Div Yld Cover Ratio 

FTSE 100 100 4963.97 3.4% -0.1% 3.1% 3.31% 2.11 14.33 



FTSE SmallCap 343 2827.00 0.9% -3.9% 2.5% 2.12% 1.50 31.41 

FTSE All-Share 693 2483.35 3.6% -0.5% 3.0% 3.21% 2.07 15.06 

FTSE Fledgling 323 3226.73 0.3% -6.2% 2.4% 2.27% -1.76 0 

FTSE AIM 673 957.57 -4.6% -16.4% -4.8% 0.53% 0.29 651.37 

FTSE techMARK 100 100 1159.80 7.2% -1.3% -3.1% 1.67% - - 

FTSE Xinhua Index Series 


FTSE Xinhua Index Series Performance (RMB/HKD) – Q1 2005 

135 

130 

125 

120 

115 

110 

105 

100 

95 

90 

85 

31-Dec-04 


31-Jan-05 


FTSE Xinhua Index Series 

FTSE Small Cap 

28-Feb-05 

Index Name Consts Value 1 M 3 M YTD 

Actual 

Div Yld 

FTSE/Xinhua 25 (HK$) 25 8105.44 -1.5% -7.6% -2.28% 3.20% 

FTSE/Xinhua China 50 (RMB) 50 3692.61 -10.8% -16.2% -11.73% 2.34% 

FTSE Xinhua All-Share (RMB) 995 2023.97 -7.6% -19.8% -17.28% 1.82% 

FTSE Xinhua 600 (RMB) 600 2185.26 -8.5% -19.1% -16.34% 1.98% 

FTSE Xinhua Small Cap (RMB) 395 1441.61 -2.4% -23.8% -22.25% 0.90% 

FTSE Xinhua China Bond Total Return Index (RMB) 29 94.23 1.12% 4.31% 7.52% 3.54% 



FTSE All-Share 

31-Mar-05 

FTSE Fledgling 

30-Apr-05 

FTSE AIM 

31-May-05 

FTSE/Xinhua China 25 (HK$) 

FTSE Xinhua All-Share (RMB) 

FTSE Xinhua Small Cap (RMB) 

FTSE/Xinhua China A50 (RMB) 

FTSE Xinhua 600 (RMB) 

FTSE Xinhua China Bond 

Total Return Index (RMB) 


93


94 

FTSE Hedge Index Series 

FTSE Hedge Management Styles (USD) – 5-Year Performance 

160 

140 

120 

100 

80 

60 

40 

May-00 

Nov-00 

May-01 

Nov-01 

May-02 

Nov-02 

May-03 

Nov-03 

FTSE Hedge 

FTSE All-World 

Directional 

Event Driven 

Non-Directional 

FTSE Hedge – Management Styles & Strategies (NAV Terms) 

Index Ann Return Volatility 

Level* 1 mth 3 mth (5-Year) (3-Year) 

Directional 2973.83 0.9% -2.1% 7.9% 5.0% 

Equity Hedge 2041.82 -0.1% -1.8% 7.4% 4.3% 

Commodity Trading Association (CTA) / Managed Futures 1983.03 1.3% -2.6% 10.5% 15.8% 

Global Macro 1848.44 3.4% -2.6% 6.5% 6.9% 

Event Driven 3064.03 0.2% -1.2% 3.5% 4.6% 

Merger Arbitrage 2014.21 0.5% 0.7% 1.8% 1.8% 

Distressed & Opportunities 2067.18 0.0% -2.8% 4.9% 7.6% 

Non-directional 2957.64 -0.2% -0.5% 4.0% 1.7% 

Convertible Arbitrage 1905.84 -0.1% -3.3% 7.5% 5.2% 

Equity Arbitrage 1971.36 -0.5% 0.1% 4.6% 2.7% 

Fixed Income Relative Value 2000.14 0.1% 0.5% 1.9% 1.3% 

* Based upon indicative index values as at 31 May 2005 

FTSE EPRA/NAREIT Global Real Estate Index Series 

FTSE EPRA/NAREIT Global Real Estate Index Series Performance (Total Return) – Year to Date 

120 

115 

110 

105 

100 

95 

90 

Dec-04 

Jan-05 

Feb-05 

Mar-05 

May-04 

Apr-05 

Nov-04 


May-05 

May-05 

FTSE EPRA/NAREIT Global 

Total Return Index ($) 

FTSE EPRA/NAREIT North America 


FTSE EPRA/NAREIT Europe 

Total Return Index (€) 

FTSE EPRA/NAREIT Eurozone 

Total Return Index (€) 

FTSE EPRA/NAREIT Asia 



FTSE EPRA/NAREIT Global Real Estate Indices (Total Return) 

Actual 

Index Name Consts Value 1 M 3 M YTD Div Yld 

FTSE EPRA/NAREIT Global Index ($) 274 2186.29 1.9% 2.6% 0.04% 3.98% 

FTSE EPRA/NAREIT North America Index ($) 134 2720.17 3.4% 6.6% 1.16% 4.65% 

FTSE EPRA/NAREIT Europe Index (€) 78 2292.34 7.0% 8.3% 11.99% 3.15% 

FTSE EPRA/NAREIT Eurozone Index (€) 30 2442.75 7.7% 11.5% 17.19% 4.15% 

FTSE EPRA/NAREIT Asia Index ($) 62 1517.22 -1.2% -3.1% -3.17% 3.28% 

FTSE Bond Indices 

FTSE Bond Indices Performance (Total Return) – Year to Date 

104 

103 

102 

101 

100 

99 99 

98 

97 

Dec-04 

Jan-05 

Feb-05 

FTSE Bond Indices (Total Return) 

Index Name Consts Value 1 M 3 M YTD 

Actual 

Div Yld 

FTSE Eurozone Government Bond Index (€) 252 152.90 1.09% 3.12% 3.79% 3.29% 

FTSE Pfandbrief (€) 312 175.90 0.89% 2.69% 3.08% 3.00% 

FTSE Euro Emerging Markets Bond Index (€) 42 200.47 1.68% 1.52% 2.77% 4.54% 

FTSE Euro Corporate Bond Index (€) 334 142.28 1.06% 1.76% 2.68% 3.66% 

FTSE Gilts Index Linked All Stocks (£) 9 1883.11 0.87% 2.56% 1.99% 1.78%* 

FTSE Gilts Fixed All-Stocks (£) 29 1848.96 1.65% 3.59% 3.11% 4.31% 

FTSE US Government Bond Index ($) 116 146.59 0.94% 2.26% 2.59% 4.12% 

FTSE Japan Government Bond Index (¥) 

* Based on 0% inflation 

220 111.00 0.07% 1.26% 1.21% 0.96% 


Mar-05 

FTSE Research Team contact details 

Apr-05 

May-05 

FTSE Eurozone Government 

Bond Index (€) 

FTSE Euro Corporate 


FTSE US Goverment 

Bond Index ($) 

FTSE Pfandbrief Index (€) 

FTSE Gilts Index Linked 

All Stocks (£) 

FTSE Japan Government 

Bond Index (¥) 

FTSE Euro Emerging Markets 


FTSE Gilts Fixed All-Stocks (£) 

Carl Beckley Bin Wu Gareth Parker 

Director, Research Senior Index Design Executive Head of Index Design 

& Development bin.wu@ftse.com gareth.parker@ftse.com 

carl.beckley@ftse.com +44 20 7448 8986 +44 20 7448 1805 

+44 20 7448 1820 

Jamie Perrett Andreas Elia 

Senior Index Design Executive Research Analyst 

jamie.perrett@ftse.com andreas.elia@ftse.com 

+44 20 7448 1817 +44 20 7448 8013 


95

CALENDAR 

96 

Index Reviews July-Oct 2005 

Date Index Series Review Type Effective Data Cut-off 

(Close of business) 

1-Jul TOPIX New Index Series Semi-annual review 28-Jul 17-Jun 

7-Jul TSEC Taiwan 50 Quarterly & annual review 15-Jul 30-Jun 

25-Jul OMX H25 Quarterly review 29-Jul 30-Jun 

1-Aug CAC 40 Quarterly review 1-Sep End of Jun 

12-Aug Hang Seng Quarterly review 9-Sep 30-Jun 

17-Aug MSCI Quarterly review 31-Aug 

31-Aug FTSE All-World Annual Review / Japan 16-Sep 30-Jun 

Aug/Sep NZSX 10 Quarterly review Sep 

Early Sep ATX Quarterly review 30-Sep 31-Aug 

Early Sep S&P US Indices Phase 2 float adjustment 16-Sep 

1-Sep SMI Index Family Semi-annual review 30-Sep 31-Jul 

02-05-Sep S&P MIB Semi-annual constituent review 19-Sep 

5-Sep DAX Quarterly review / Ordinary adjustment 16-Sep 31-Aug 

7-Sep FTSE/Hang Seng Asiatop Semi-annual review 16-Sep 31-Aug 

7-Sep FTSE UK Quarterly review 16-Sep 6-Sep 

8-Sep FTSE All-World Annual review / Developed Europe 16-Sep 30-Jun 

9-Sep NASDAQ 100 Quarterly review / Shares adjustment 16-Sep 

9-Sep FTSE techMARK 100 Quarterly review 16-Sep 31-Aug 

9-Sep FTSEurofirst 300 Quarterly review 16-Sep 2-Sep 

9-Sep FTSE eTX Quarterly review 16-Sep 2-Sep 

9-Sep FTSE Multinational Annual review 16-Sep 30-Jun 

9-Sep FTSE TMT Annual review 16-Sep 6-Sep 

13-Sep S&P MIB Quarterly review - shares & IWF 19-Sep 

14-Sep STOXX Quarterly review 16-Sep 1-Sep 

14-Sep STOXX Blue Chips Annual review 16-Sep 1-Sep 

14-Sep DJ Global Titans 50 Quarterly review 16-Sep 14-Sep 

14-Sep S&P US Indices Quarterly review 16-Sep 

14-Sep S&P Europe 350 / S&P Euro Quarterly review 16-Sep 

14-Sep S&P 500 Quarterly review 16-Sep 

14-Sep S&P Midcap 400 Quarterly review 16-Sep 

14-Sep S&P / ASX 200 Quarterly review 16-Sep 

14-Sep S&P TSX Quarterly review 16-Sep 31-Aug 

15-Sep Russell US Indices Quarterly review 30-Sep 31-Aug 

Sep/Oct CAC 40 Quarterly review Oct/Nov 

Oct Nikkei 225 Annual review Oct 

Oct TOPIX New Index Series Introduction of free float factors (Phase 1) 28-Oct 

13-Oct TSEC Taiwan 50 Quarterly review 21-Oct 30-Sep 

Oct/Nov FTSE/ASE 20 Semi-annual review 30-Nov 30-Sep 

24-Oct OMX H25 Quarterly review 31-Oct 24-Oct 

Sources: Berlinguer, FTSE, JP Morgan, Standard & Poors, STOXX 


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