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North America Securities Lending Summit - 12 May, Chicago

Slow and

steadyLord Hutton - the long term

Custody fees, CEE & Russia

US Senate sec lending hearing

... wins the race

FundamentalsSecurities Services & Securities Lending for Funds, Managers and Investo

ISSUE 03 SPRING 2011


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3/92 2011|Fundamentals| 1

Editor's Letter

Welcome to FundamentalsSpring 2011

GSL Summits remaining in 2011

Thu 12 May GSL North American Summit - ChicagoThu 15 Sep GSL Boston SummitThu 6 Oct GSL Dutch Summit - AmsterdamThu 3 Nov GSL London SummitThu 1 Dec GSL Middle East Summit - Abu DhabiTBC GSL Asian Summit - Tokyo

Save the dateThe 2011 Securities Lending Industry Awards3rd November, London

The sun has finally started shining in the UK, making it a

good time to shed light on what the Fundamentals team

has been up to over the first three months of the year.

It has been conferences galore, with our own London

and Nordic Securities Lending Summits and a host of

industry events.

One major event was the National Association of

Pension Funds Investment Conference in Edinburgh

and this issue features a heavy pensions focus as a

result.

We speak to Lord Hutton, architect of proposals to

overhaul the UKs public pension sector, while fromthe USA we feature an article on the funding problems

Stateside.

The theme of pensions carries through to the

securities lending section of the magazine, as lending of

pension fund assets was scrutinised by the US Senate,

while in investor services we have a heavy focus on the

Central and Eastern European region, outsourcing and

domiciles.

We have a look at various Asian issues, from clearing

in Hong Kong to the effects of the Japanese tsunami

on the countrys securities lending market and we have

a profile on State Streets Steve Smit and Brandes

Investment Partners.

I hope you enjoy the magazine as well as thesunshine.

Craig McGlashan, Editor

TheSecuritiesLendingIndustryAwards

eLInA

GSL2011
http://www.fundamentalsmagazine.com/northamericahttp://www.fundamentalsmagazine.com/bostonhttp://www.fundamentalsmagazine.com/netherlandshttp://www.fundamentalsmagazine.com/londonhttp://www.fundamentalsmagazine.com/middleeasthttp://www.fundamentalsmagazine.com/asiahttp://www.fundamentalsmagazine.com/asiahttp://www.fundamentalsmagazine.com/middleeasthttp://www.fundamentalsmagazine.com/londonhttp://www.fundamentalsmagazine.com/netherlandshttp://www.fundamentalsmagazine.com/bostonhttp://www.fundamentalsmagazine.com/northamerica


4/92| Fundamentals|20112

Contents

Contents EditorCraig [email protected] EditorsBrian BollenRoy Zimmerhansl

CorrespondentStephanie [email protected]

ContributorUgo Bonaugurio

DesignLuke MerryweatherSenior Account ManagerNeil [email protected]

SubscriptionsAfuah [email protected]

FinanceElliot [email protected]

Chief Technology OfficerPeter [email protected]

Editorial Advisory BoardChairmanClive [email protected]

Sales DirectorMarc [email protected]

DirectorJon Hewson

[email protected]

PublisherMark [email protected]

g

P.28Executive Profile:Steve Smit

P.30

Future trading

P.31

OTC Clearing focus

P.33

Russia gets ready

P.34

CEE outline

P.36

Corporate actionsautomation

P.38

Third-party clearing:Hong Kong

P.40

Regulation:Dodd Frank

P.42

Domiciles:On and off againGuernsey focus

P.48

Stock exchangeconsolidation

P.50

Sustainable investment

P.54

Outsourcingadministration

P.56

Wine custody

P.84

Glossary

P.86

Directory

P.88

Pensions: Dinnae tellme to retire...

P.3People Moves

P.4

News Round

P.7

Mandates

P.10

UK Pensions: Huttonreport

P.14

US Pensions provision

P.16

OTC derivatives

P.18

Fund manager profile:Brandes InvestmentPartners

P.20

EFSF bonds

P.22

Private Equity:

Endless-LiberataPearson-SEB

P.60US Senate hearing

P.66

Fixed income:Short sellingP.68

CCP: Eurex

P.70

CCP: Diana Chan

P.72

Market focus: Japan

P.73

Islamic bankingP.76

Repo: Asia

P.78

ISLA: Kevin McNulty

P.80

GSL Summit:Nordic 2011

P.82IMN Beneficial OwnersConference

FundFront InvestorServices SecuritiesLending

BackOffice


5/92

International Capital

Market Association

(ICMA) has named

Sberbank custody directorYury Dubin as chairman

of its newly appointed

regional committee for

Russia and the CIS.

ICMA also appoints Alfa-

banks Denis Soloviev

as managing director,

Sergey Shvetsov as

director of financial markets

operation, and MDM

Banks Ilya Vinichenko as

head of securities market

trade. Dubin and the newcommittee members will

build on ICMAs involvement

in Russias market.

Daiwa Capital Markets

has hiredAli Khan to head

up its Asian equity sales

unit as part of the banks

wider plans to expand its

non-Japan Asia business.

Khan joins Daiwa after four

years at Deutsche Bank as

head of Indian equity sales.Alex Lewis has also been

appointed as managing

director for Asia equity

sales.

International Standard

Asset Management (ISAM)

has strengthened its team

by appointingAlexander

Lowe to expand business

capabilities and drive new

product development,

while Riva Waller joins as

COO and Brian McHugh

joins the institutional sales

team in New York. ICAM

principal Rod Barker quits

the firm to join a new asset

management business.

John van Verre has

been named head of

global custody at HSBC

Securities Services (HSS)

to develop the firms global

product proposition and

drive the establishment of a

consistent global operating

model. He joined the bank

in 2008, acting as head of

HSS in Singapore and then

managing director for HSSIreland.

Matthew Pinnock has quit

Nomura, where he has

acted as managing director

of capital markets prime

services. The move follows

reports that the bank is

trimming its prime brokerage

staff to keep its business

in good shape. Most of

the cuts are expected to

occur in Nomuras Londonheadquarters.

Nomura has also made

key management hiresand established a new

office to improve the firms

management structure

across the group. David

Benson becomes vice

chairman of Nomura

Holdings and Masafumi

Nakada becomes president

of The Nomura Trust

& Banking Co, while

Hajime Usuki is hired as

president of Nomura Bank

Luxembourg.

Roger Harrold has resignedfrom his position as head of

domestic securities services

at Deutsche Bank due to

personal reasons. Howard

Topf replaces Harrold with

the full title of global head of

direct securities services.

State Street has re-hired

Phil McGowan as senior

vice president and EMEA

head of private equity and

real estate services afterleaving the bank in 2008.

McGowan, who was COO

for HFX Capitals alternative

investment distribution and

sales efforts from 2009 to

2010, will help continue

State Streets plans to

develop solutions for clients

changing needs.

RBC Dexia Investor

Services has appointed

Sebastien Danloyas its new managing

director for Luxembourg.

Luxembourg operations are

central to the promotion

of our onshore/offshore

strategy, says the firms

CEO, Jose Placido.

State Street Global

Markets has strengthened

its global portfolio solutions

team with the appointment

of four senior transitionmanagers. Brian Berg

and Brian Moniz join the

banks Boston team while

Tadateru Makino will be

based in Tokyo and Greg

Metzmacher in Sydney.

Bank of America Merrill

Lynch has snapped up

Stuart Hendel as its new

global head of prime

brokerage after he resigned

from UBS in March. Prime

brokerage executives

Jonathan Yalmokas andCharlotte Burkeman have

also quit, reports said.

BofA plans to expand its

prime brokerage team as

it continues to compete

with prime broking giants

Goldman Sachs and Morgan

Stanley.

Cornelia Keth has joined

State Street in Germany as

head of sales and account

management to help StateStreet to maintain its

strong position in German

outsourcing. Keth moves

from BNY Mellon.

SunGard Astec Analytics

has appointed Tom Kirdahy

and Bill Mauer to build on

relationships with beneficial

owners as they show more

interest in their securities

lending programmes.

The firm plans to developan experienced sales

team to empathise with

stakeholders.

David Becker has left the

Securities and Exchange

Commission (SEC) to

return to the private sector

after acting as the SECs

chief legal officer and

senior advisor since 2009.

Becker first joined the

Commission in 1998 beforeleaving in 2002 to go back

to the private sector. He has

helped shape many SEC

initiatives, the Commission

said.

2011|Fundamentals| 3

People Moves

People Moves

AliKhan

Matthew

Pinnock



News Round

NEWSThe top stories fromFundamentalsmagazine.comthis quarter

10th January 2011

Goldman Sachs last bigprop trader team has quitto start raising money fora new independent hedgefund in London. The team,led by Daniel Benatoff

andAriel Roskis, hasreceived a $300m (193.7m)investment from Brummer& Partners. Benatoff andRoskis are senior traders atGoldman Sachs PrincipalStrategies desk (GSPS)which has been forcedto wind down since theintroduction of the Volckerrule to limit banks on puttingcapital in speculative trades.

UK final salary pensionschemes are locking outboth new and existingmembers, according toNational Association of

Pension Funds annualsurvey for 2010. One infive UK final salary pensionschemes are restrictingfuture contributions fromexisting members, a 7%increase from the NAPFs2009 survey. The results

follow Lord Huttonsindependent review whichsays that public sectorpensions should no longerbe based on final salaries.

Brown Brothers Harrimanhas joined the mobile apprevolution by introducinga securities lendingapplication for smartphones,allowing lenders access

to information whileon the move. The app,which is available oniPhone and BlackBerry,provides access torevenues, balances andloan distribution, as well

as market news anddevelopments which mayaffect lending revenues.The product was createdin response to recentmarket events and volatilitythat have intensifiedclients need for financialinformation in real time.

7th January 2011

The Swiss regulator, FINMA,

has granted Newedgebranch licenses whichupgrade its representativeoffices in Zurich and Genevainto branches. The companywill now be able to expandthe scope of its executionservice, where its Swissclients will have globalcoverage through a singlelocal office. Newedge saysthat it is in the process ofhiring additional staff with

the aim of increasing itssales force by one third bythe end of the first quarterof 2011.

12th January 2011

Tiffany & Co andAdobeSystems have been namedas attractive targets fortakeover in 2011, accordingto research by Bernheim,

Dreyfus. Swatch Group andLVMH are likely acquirers forTiffany, while Adobe couldbe a target forApple andGoogle. The research saidthat both companies are inconsolidating markets and

that there is an intensefight for pole position in thesoftware market. Ingenicoand Meggitt were alsocited as possible takeovertargets.

The Australian securitieslending market needsfurther changes to attractfunds and avoid fallingbehind Asian markets,PeterMartin, chairman of

theAustralian SecuritiesLending Association(ASLA), said in anexclusive interview withFundamentals.While Martin callsASICthe front runner amongglobal regulators ondisclosure requirementsof short positions, he saysthat aligning Australianregulations closer to thosein neighbouring markets

such as Hong Kong, isnecessary for additionaltransaction flow.

17th January 2011

A survey from BarCapshowed that the majority ofinvestors and managers areoptimistic about 2011, withnew products, hiring sprees,and higher returns on the

horizon. Key findings were:60% of managers plannedto increase headcount; thebest investmentopportunities were in North

America; and investors werekeen on endowments and

foundations.

19th January 2011

BNP Paribas SecuritiesServices announced itwas the first custodian tooffer funds of hedge fundsan integrated liquiditymanagement solution.Fund managers now havea committed financing andFX hedging service which

is fully integrated withtheir asset servicing needsacross the entire tradelifecycle, said BNPP SS.

20th January 2011

A new survey fromFinadium found that USplan sponsors now viewsecurities lending as aninvestment product andrecognise that custody fees

rarely reflect the true costof service delivery.Through interviews andannual reports, the studygauged the opinions of 98sponsors handling morethan $2.33 trillion in assets.
http://www.fundamentalsmagazine.com/http://www.fundamentalsmagazine.com/http://www.fundamentalsmagazine.com/http://www.fundamentalsmagazine.com/


7/92

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News Round

26th January 2011

Short selling in the Indiancash market has risendramatically in recentmonths according to datafrom the National StockExchange (NSE) of India.

The volume of stocklending and borrowingrose by nearly 20 times inthe second half of 2010,where 900,000 lakh shareswere traded this Januaryalone. The results followsteps by the Securitiesand Exchange Board ofIndia (SEBI) last year toenable short selling, whereit removed the guidelineon valuing collateral in

securities transactions andextended securities lendingcontracts from 30 days to12 months.

28th January 2011

South Carolina has issueda $200m lawsuit againstBNY Mellon to recoverlosses from the banksalleged failure to stick toinvestment guidelines in a

securities lending contractwith the State. Statetreasurer Curtis Loftisclaims the bank invested inmortgage-backed securitiesthat contained riskysubprime mortgages, andmade allocations to debtinstruments in the LehmanBrothers investmentbank. Loftis added thatthe State plans to recoverevery penny due to South

Carolina citizens. A BNYspokesperson said that thebank believes the lawsuitis without merit and thatit intends to defend itselfvigorously.

31st January 2011

Deutsche Banks Asianprime finance businesshas doubled its share ofthe market by supporting

funds that have as muchas 20% of the Asian hedgefund market. David Murphy- co-head for the Asianprime finance unit - revealedin an interview that theBank plans to increase the

units headcount by up to10% this year in plans tocapitalise on the growinginterest and increasingnumber of hedge fundsin the region. He claimsthe recession providedDeutsche Bank with a pathinto Asias prime brokeragebusiness.

23rd February 2011

Finadium released a reporton the implications of BaselIII for the securities lendingand collateral managementindustries.The report is aimed ateducating professionalsabout the opportunitiesand challenges in theforthcoming Basel IIIregulations and looksat potential scenariosthat could have negative

consequences if notaddressed properly.

1st March 2011

State Streets securitieslending programme is stillunder investigation fromthe US Securities andExchange Commission(SEC), according to a filingmade by the company.The SEC is concernedwith the adequacy ofState Streets disclosuresregarding its collateral poolsat points when these poolshad fallen in market value,as well as the redemptionpolicy available to directlenders. The bank says itis cooperating with theinquiry but is unsure aboutthe potential outcome.

8th March 2011

Deutsche Bank releasedthe results of its ninth annual

Alternative InvestmentSurvey, which indicates astrong recovery in the hedgefund industry despite a

difficult market in 2010. Thesurvey reveals that investorspredict $210bn of netinflows into the hedge fundindustry in 2011 to bringthe total AUM to a record$2.2 trillion by the endof the year. Investors areincreasing their allocationsand hedge fund teams,and smaller funds will havegrowth opportunities where65% said they will invest in

hedge funds under $1bn.

9th March 2011

HSBC Securities Services

(HSS) has launched itsglobal Islamic securitiesservices offering in responseto a growing demand forstandardisation in theIslamic banking world.The new offering is spreadout among 17 markets

across the Middle East,Asia-Pacific, Europeand the Americas and isglobally consistent. HSBC

Amanah Securities Servicescomplies with Sharia lawand is available to Islamicinvestment managersand traditional investmentmanagers in charge ofIslamic funds.

11th March 2011

NorthernTrust hasexpanded its custodyand securities lendingbusiness that services UKlocal government pensionschemes, by winning $10bnof new client assets in 2010.The bank now providescustody to 36% of UKlocal government pensions,and provides securitieslending to 20% of UK local

schemes. Northern Trustclaims that local schemesare looking for tailoredsecurities lending solutions.Newedge has reinforced itsclaims to be a global leaderin multi-asset brokerage and

clearing.

17th March 2011

US senator HerbKohl,chairman of the specialcommittee on aging,has made a series ofrecommendations to howsecurities lending operatesin 401(k) plans during ahearing on the matter. Hesaid that securities lending

withdrawal restrictions aretroubling and that moreefforts should be made tomake the industry moretransparent. The economicdownturn showed thatsecurities lending is not afree lunch, Kohl said. Thehearing was held followinga three-month investigationinto securities lending in thelargest 401(k) plans in theUSA.

4th April 2011

The SalvationArmyssouthern division in the UShas filed a $22m lawsuitagainst the BankofNew

YorkMellon for lossesincurred in its securitieslending program. Thecharity claims the bank hadmismanaged its assets byinvesting the collateral usedfor securities lending inmortgage-backed securitiesand other risky investments,according to reports. TheSalvation Army says it nowcannot use those toxicassets for its projects. BNYMellon claims its actionswere appropriate.



Mandates

Deutsche Bank has signed a deal toprovide third-party securities lendingservices to the Missouri StateEmployees Retirement System(MOSERS), which has been a long-time participant in securities lending,according to sources. The bank claimsits approach addresses the evolvingneeds of investors who are lookingfor higher sophistication from theirproviders.

BNY Mellon Asset Servicing haswon a mandate from Standard LifeInvestments Global to service 8billion in assets in its Global SICAV.The bank will provide services tothe Luxembourg-domiciled SICAVincluding fund accounting, transferagency and custody. SICAV has assetssplit across 20 sub-funds.

Brown Brothers Harriman has won amandate to provide custody and other

services for a new series of fixed-income exchange-traded funds (ETFs)from PIMCO. The first two ETFs to belaunched, PIMCO Euro EUR EnhancedShort Maturity Source ETF and PIMCOEuropean Advantage GovernmentBond Index Source ETF, are Irish-domiciled UCITS recently listed onthe Deutsche Brse ExchangesXetra trading platform. BBH will alsoprovide accounting, administration andtransfer agency services.

J.P. Morgan Treasury & SecuritiesServices has snapped up a $1.5bncustody mandate from City Super, thesuperannuation fund for current andformer employees of Brisbane CityCouncil, Australia. Bryan Gray, headof TSS sales and client management,claims the new mandate strengthensthe banks position in the investmentand administration sector. Themandate win reinforces J.P. MorganTSSs commitment to the Australian &

New Zealand market after hiring morethan 100 additional employees during2010, many in senior positions.

BNY Mellon Asset Servicing hasbeen selected to provideVirtusInvestment Partners with mutual fundtransfer agency services. The firm willprovide shareholder services, financialand regulatory reporting, and moneymarket stress testing for the Virtus

Mutual Funds, which had $14.9bnin assets and 290,000 shareholderaccounts as of December 31, 2010.Virtus said it chose BNY Mellon for itsoperational efficiencies and technologyplatform, and that it can help it committo generating investor success.

Brazils state-run energy giant,Petroleo Brasileiro SA (Petrobas)has chosen BNY Mellon CorporateTrust to act as trustee, paying agent,registrar and transfer agent for $6bn

in bond issue. The new mandatebuilds on the longstanding relationshipbetween the two firms. Petrobas willuse the proceeds to pay for its projectto tap into and refine oil reserves inBrazil. BNY Mellon said it expectsmandate activity in Brazil, Russia, Indiaand China to increase in 2011.

NorthernTrust has been selectedto provide global custody, securitieslending and other services to theLothianPensionFund, which holds

$5bn (3.2bn) in assets. The bank saysthat the move brings Northern Trustsshare of the Scottish local governmentpension schemes (LGPS) market tomore than 60%, providing for sevenschemes. Lothian is one of the top10 LGPS by asset size in the UK withmore than 170 associated employersand serving more than 65,000members.

BNYMellonAssetServicing has

been selected by ChinaConstructionBank (CCB) as the global custodianfor the upcoming Yinhua QualifiedDomestic Institutional Investor (QDII)fund to be launched by Yinhua FundManagement Company. The new fundis called Yinhua Anti-Inflation ThemeFund (LOF). Chong Jin Leow, headof Asia, BNY Mellon Asset Servicing,says this win indicates that confidencein QDIIs is returning after being out of

favour for two years, and he expectsto see a steady increase in QDIIlaunches.

NorthernTrust has picked upa mandate to provide Stenham

AssetManagement with custody,fund administration, credit andforeign exchange services for $3.5billion in hedge fund assets undermanagement. Stenham will use HedgeFund Monitor, a Northern Trust onlineportfolio management tool, to provide

information and analytics, to its hedgefund of fund portfolios. The firmsclaim this will boost transparencyon the performance and liquidity ofStenhams hedge fund investments.

CitiGlobalTransactionServiceshas been awarded a new mandateby the online trading and investmentspecialist SaxoBankGroup toprovide global custody servicesfor cash equities and fixed-incomeinstruments traded globally by its

clients. The mandate is an extensionof Citis existing relationship with SaxoBank. Saxo also said that has plansto strengthen its global footprint andwiden its product range.

CIBCMellon has been selected toprovide custody, fund accounting,securities lending and performance& risk analytics to the CanadianChristianSchoolPensionTrustFund. The banks president and



Mandates

CEO, Thomas Monahan said he hasseen increased demand from otherpension administrators looking for anasset servicing provider to navigatethem through market and regulatorychanges.

NorthernTrustGlobalInvestments the asset management arm ofNorthern Trust has been appointedby the RoyalBoroughof Kensingtonand Chelsea in London to providetransition management services andrun an 80m index portfolio for sixmonths. This latest appointment addsto the banks existing asset servicingmandate with the Borough to providecustody services for around 450min assets. Northern Trust said thatit remains committed to the local

government pension sector.

RBCDexiaInvestorServices hasbeen selected by Beverly Hills-basedParatumInc to provide custody, fundadministration, shareholder services,domiciliary and financial reportingservices for a new Luxembourg-basedprivate equity SICAV-SIF fund. RBCDexia says this umbrella fund includesseveral sub-funds, the first beingthe US Renewable Energy FeederFund, designed to generate attractive

risk adjusted returns by investing, inrenewable power generation, cleanfuels and renewable energy. Paratumclaims it wanted to capitalise on thegrowing renewable energy market.

J.P. Morgan has been chosenby Maine Public EmployeesRetirement System (MainePERS)

to service the States $10.5bn inassets. The custodian will provideglobal custody, securities lendingand foreign exchange, among other

services. Andrew Sawyer, chiefinvestment officer for MainePERS,said J.P. Morgan was chosen for itscommitment to the public pensionmarket as the pension scheme looksto increase allocations to alternativeinvestments. The deal is the latest ina series of J.P. Morgans mandatesin the public pension space, whichreflects the banks commitment to thismarket segment.

Northern Trust has snapped up a1bn mandate to provide securitieslending services to ShropshireCounty Pension Fund, adding tothe firms commitment to the localgovernment sector. The fund, whichhas been a client of Northern Trust

since 2009, is now looking for alending solution to allow it optimisesreturns at the same time as managingrisk. The move follows increasingappetite for securities lendingsolutions, says Mark Snowdon, seniorsales and relationship manager forsecurities lending at the bank.

BNY Mellon has been selectedby Fatima Fertilizer CompanyLimited as the depositary bankfor its American depositary receipt

(ADR) program. Each Fatima ADRrepresents 50 ordinary shares andtrades on the over-the-counter (OTC)market under the symbol "FTMFY."

As the first Pakistan-based companyto begin trading on the US OTCmarkets, Fatima Pertilizer will be thefirst Pakistani stock available for retailand institutional investors. BNY Mellonhopes to offer the company enhancesexposure to the global capital markets.

BNY Mellon has been also been

selected as sole sponsoreddepositary bank by QBE InsuranceGroup Limited (QBE) for its ADRprogram. Previously, QBE tradedas an unsponsored ADR programserviced by multiple depositaries. BNYMellon said it will provide the companywith a comprehensive suite of supportservices to allow it to unlock the fullpotential of its sponsored DR program.The bank has also been mandatedto act as successor depositarybank for AIXTRON SE s (AIXTRON)

American depositary receipt (ADR)program. AIXTRON said that BNYMellons services will help it to furtherstrengthen our U.S. shareholder base,as well as increase visibility of its DRprogram. BNY Mellon said it workclosely with the company to broadenits outreach to global investors,leveraging its services and resources.

AIXTRON is a provider of depositionequipment to the semiconductorindustry.

BNY Mellon Trustee & Depositary(UK) has been appointed by DaiwaFund Asset Services, a divisionof Daiwa Securities Group Global

Asset Services, as a depositary forUK authorised funds within its fundhosting service. Daiwa Fund Asset

Services is extending its establishedhosting service for Irish-domiciledfunds to include UK domiciledcollective investment schemestargeted primarily towards institutionalor high net worth investors. Daiwasexperience in servicing the Irish fundsmarket provides a solid foundationupon which it can build its UK fundhosting solution, said Peter Craft,head of trustee & depositary forEurope, Middle East & Africa.

Kenmar Group, a Rye Brook-based $1.5 billion global alternativeinvestment firm, has selectedGlobeOp Financial Services toprovide an extensive range of fundadministration, risk and data centre-related services. The integrationof risk and customised reporting isa central operational requirement,Esther Goodman, chief operatingofficer of Kenmar. The company saidthat GlobeOps managed account, riskand technology expertise were key

elements in the selection decision.

Societe Generale SecuritiesServices (SGSS) has been mandatedby Ethias, a Belgian insurancecompany, to provide independentvaluation services. These servicescover a portfolio of complex structuredproducts. This additional mandatewon by SGSS illustrates the increasingneed among investors to obtaina precise valuation by third-partyspecialists of the complex financial

instruments held in their portfolios.Ethias ranks as the 4th largest insurerin the Belgian market, all sectorsincluded, with a 10.4% market shareas of December 2009.


11/92

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12/92

10 | Fundamentals|2011

UK Pensions: Hutton report

In the UK in March, Lord Hutton unveiled areport aimed at reforming the countrys publicsector pension system.

Hutton outlined his three main recommendationsduring a speech at the National Associationof Pension Funds Investment Conference inEdinburgh.

First, I am recommending that the current

defined benefit schemes are replaced bynew career average schemes... Second,I have recommended that thepension ages in most of theseschemes is linked to the Statepension Age... Third, I haverecommended that a clearcost ceiling is set for theseschemes going forward - Ihave suggested basing this onthe percentage of pensionable

pay paid by the taxpayer, hesaid.At a time of cuts and austerity

in the UK, many in the mainstreampress and a number of unions havederided the proposals (it should be notedthe government does not have to accept them).Hutton spoke to Fundamentals about some of theseissues.Just how worried is he that his proposals will get

caught up in the language of deficit reduction?Obviously I am concerned about that because I

dont think my reforms are anything whatsoeverto do with the current fiscal challenges the countryfaces, he explains.

These are long-term reforms and questions thatIm trying to address and they have implicationsover the next several decades. I understand the

background, I know how complicated and difficultthese issues are, but my reforms I hope will belooked at on their own merit. They are not aboutsaving money in the short term, and the switch

from final salary to career average schemes isnothing to do with current fiscal challenges or anyfuture challenges.

The reason I have made that recommendationis fundamentally about fairness and the way theseschemes work within the professions and acrossworkforces in the public services.

They are fundamentally unfair to the majority

of people whose careers dont follow thepath of a high flyer. So thats why I

recommending that we change thebasic financial model; its notbecause Im trying through

that vehicle to save money forthe taxpayer. I think its the

best way to achieve financialsustainability for what willbe very good defined-benefitpensions going forward.

Does he feel that some ofthe more negative headlinesand backlash have been down

to a general lack of educationabout financial matters in the UK,

something that should be addressed at theschool level?

I agree very much with that, he says. Itsvery clear to me that there isnt a great level ofunderstanding on some of the issues aroundpensions, which I understand because these areissues often one doesnt really turn to until later onin life. It would certainly help the reform processif there was an improved level of awarenessabout pensions. I think there is far too much lazy

journalism around this issue and that doesnt helpget some of the arguments across to people.

One particular detail of the report indicatedthat existing scheme members should be able tomaintain the final salary link for their past service.From an operational point of view, does Huttonforesee any potential difficulties in having two

Hutton: In it for the long termCraig McGlashan talks to Lord Hutton of Furness about his report on the future of publicsector pension provision in the UK; its benefits, potential problems and the risk of backlash

as some in the media and the public associate the reforms with the government'sunpopular austerity programme

I think there is far toomuch lazy journalism

around this issue

and that doesnt

help get some of thearguments across to

people


13/92

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UK Pensions: Hutton report

types of employee within the system?I think that there is an issue there, he

concedes, although its not an insurmountableissue, either on cost grounds or complexity ofscheme administration. We looked very carefullyat some evidence of that but Ive made that

recommendation with a very clear focus on theaccrued rights position and so in a sense that marksout the ground pretty clearly. You have to respectall of the accrued rights position.

Another area that Hutton investigated wassomething that attracted a large amount ofattention in December 2010. A report published bythe Royal Society for the encouragement of Arts,Manufactures and Commerce (RSA) suggestedthat the UK should look to the Netherlands andDenmark for inspiration, creating a collectivedefined contribution scheme that would allow risk-sharing between individuals and reduce costs.

Did Hutton consider this as an option? For thelocal government funded scheme I have madea series of recommendations about improvingthe operations of the funds, having fewer funds,looking at the opportunities to consolidate in thatarea, and I think that will lead to better governanceand better returns for schememembers, he explains.

So I think there are a rangeof things that should be looked

at within the funded area of thepublic sector schemes. I decidednot to go down the path ofcollective defined contributionschemes which is essentially as Iunderstand it the basic model inthe Netherlands. We set out thereasons why in the final report.

Of course, all of Huttons work will come tonaught if the government does not accept hisproposals. Some more cynical Westminsterwatchers have felt appointing Hutton - anex-Labour minister - was a canny move bya Conservative-Liberal Democrat coalition,already facing huge controversy over its austerityprogramme and unlikely to make itself any morepopular by changing public sector workerspension provisions.

But given all this, is Hutton confident that hisreforms will be taken on board? I havent reallyhad any feedback from ministers, he says. I hopethey will be able to take forward the set of reforms

Im proposing but I perfectly understand that thereare some very big ticket issues at stake here andthey will need to reflect on all of those.

My mission as I saw it was to find a way ofallaying and addressing the concerns of taxpayersabout the long-term costs of these pensions. I thinkthat we tried to show and most people understand

- I hope - that most of thepensions that are paid out arepretty modest. But we haveto address the underlying

pressures that are bringingproblems to bear within theseschemes and find a way formaintaining defined benefitfor the future. Thats how Idefined by task, my reforms aredesigned to help to do that.

If at all Ive been encouraged by thegovernments response to date. I was particularlystruck by what the chancellor said in his initialreaction to my report on 10th March when he saidhe wanted public services to set a gold standard, Ihope that is a very good indication of the directionthat ministers will take.

Hutton firmly believes that his proposals arethe best way for public sector pensions in theUK to move forward and it would appear thatthe government is in agreement. However, thecoalition still needs the political wind to blow in itsdirection and have the will to stay the course forthese recommendations to become reality.

I decided not to go

down the path ofcollective defined

contribution schemeswhich is essentially

as I understand it thebasic model in the

Netherlands


15/92

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In the 1930s, labour unions drew the battle linesbetween the owners of labour - the workers - andthe owners of capital. The unions fought to improvethe conditions for the workers at the expense of theowners, shifting a portion of profits from owners to

workers.Unlike the 30s, todays union workers

ARE the owners - through theirpension plans - and they are,in many cases, governmentemployees. These differences arenot trivial and can change who

bears the cost of improvingworker benefits from the Usversus Them argument of the1930s. Lets use teachers as anexample.

The conflict betweenpoliticians (school boards,mayors, governors - the ownersof the schools) and teachers iscoming to the fore for one very simplereason: teacher pension plans are massivelyunderfunded.

According to an April 2010 report by the ManhattanInstitute for Policy Research, the 59 pension fundsthat account for most teachers pensions in the UnitedStates are underfunded by between $332bn and$933bn, depending upon the assumptions you make

about the appreciation of existing assets. Only five ofthe 59 are better than 75% funded.

These pension plans receive funds from twosources: teacher contributions and school districtcontributions, and the contributions are primarilyinvested in US debt and equity instruments. As aresult, the teachers own portions of US companies,and lend money to US companies and USgovernmental entities.

Thus, there are only three ways to make up theshortfall in the pension funding so that the teachers

can get the benefits they have contractually beenpromised when they retire:

1. The returns on the invested assets canimprove to make up the difference between

pension assets and liabilities.2. The school districts can contribute

more money to the pension.3. The teachers can contribute

more money to the pension.

Ill discuss these ideas in turn.

1) Increased asset returns

Asset appreciation is the

least painful way to make upthe pension shortfall as no onehas to pay any more than they

already are; the problem is it is veryunlikely to happen.

The head of the California StateTeachers Retirement System has said: In order

to fully fund the [defined benefit] programme in30 years, investment returns for the next five yearswould have to exceed 20% per year, a rate of returnthat is 2 times the assumed investment return. (TheCalifornia pension system is about $100bn short and

is in the worst shape in the country).Returns on investments are limited to what isavailable in the marketplace: 30-year government

bonds are yielding about 4%; equity returns for thelast 10 years have been approximately flatand it isan open question what they will do the next ten years.While the Federal Reserves efforts to keep interestrates low have benefitted borrowers, those same lowrates have hurt lenders like the pension plans.

Efforts to raise taxes on corporations to increaseGovernment revenue hurt the profitability of thesecompanies and, by extension, their owners - the

Us vs Us:a cold look at the future ofpension provision - who benefits, and who pays?

Jeff Muhlenkamp, Investment Analyst at Muhlenkamp & Company Inc, a Pennsylvania,USA-based independent investment firm, uses the example of teachers to describe thechallenges facing the future funding of pensions

In order to fully fundthe [defined benefit]

programme in 30

years, investment

returns for the nextfive years would have

to exceed 20% per

year, a rate of returnthat is 2 times theassumed investment

return




pension plans - and reduce the possibility of asset

appreciation. It seems clear that federal governmentaction going forward will impact the returns availableto the pension plans and their beneficiaries, theteachers.

2) Increased school district contribution

What happens if the school districts increase theirpension contributions? Over the last 20 or 30 yearsschool district revenues have generally increasedwithout an increase in tax rates as property valuesgrew - but the last few years have seen a decline inproperty values, not an increase, and aturn in the housing market does notseem imminent. The easy historicaloption of allowing rising propertyvalues to increase school districtrevenues is not currentlyavailable to decision makers.

Now, in order for the schooldistricts to contribute moreto the pension plans, theywill have to get the money byeither reducing costs or raisingrevenues.

(Remember, school districtrevenues are residents propertytaxes, so raising revenues meansraising taxes; without property valueincreases, it means raising tax rates).

Who would benefit and who would pay? The retiredor retiring teacher would benefit as the promisesmade to them about their retirement plan would bekept.

Any teacher laid off or not hired as districts reducecosts, any teacher with a greater work load and fewerresources because of budget cuts, and any teacherwith her own children in the school would pay theprice - as would all the residents of the district as theirtaxes went up.

In the long run, communities may decline asresidents move elsewhere looking for lower taxes andhigher quality education.

At the extreme, this becomes a self-reinforcingprocess as higher taxes and lower quality educationfails to attract new residents or even chases existingresidents away, requiring increased taxes to fund the

pensions, driving more residents away in a spiral of

community decline and decay.

3) Increased teacher contribution

If the teachers contribute more of their salary to theirown pension, who benefits and who pays? This ispretty straightforward - the teacher benefits and theteacher pays.

A couple of examples of current payment levels maybe useful: Chicago teachers pay 2% of their salary totheir pension while the district contributes 7 percent.In Cleveland, teachers pay 10% of their salary to

their pension and the district contributes 14percent. A big spread, but it gives you an

idea of the numbers.

In conclusion

Debates are now occurringacross the country as everystate and community tries tofigure out how to resolve thedifference between what has

been promised and the assetsavailable to keep the promises.I suspect there will be a broad

spread of solutions in the end.The key point Id like to make is

that the teacher - the worker - is now also theowner through his/her pension plan.

For the teacher to benefit in their role as workerthey will pay in their roles as owner, taxpayer, andconsumer. Hence, the statement that it is no longerUs versus Them, but now Us versus Us.

This reality does not appear to have sunk in yet, and

it is noticeably absent from the rhetoric of the partiesinvolved in the discussion.

When this reality sinks in to the participants in thedebate, I think it will lead to more fruitful discussionsand, hopefully, more acceptable solutions.

A full version of this article appears at Muehlenkamp &Co (http://www.muhlenkamp.com/)

For the teacher tobenefit in their role

as worker they will

pay in their roles as

owner, taxpayer, andconsumer. Hence,

the statement that it is

no longer Us versusThem, but now Usversus Us.



OTC derivatives: over the top?

Could the proposals to force pension funds to

clear OTC derivatives centrally represent a classiccase of the law of unintended consequences inaction? If the low, growling rumblings emittingfrom the industry are as well informed as theyseem to be, this might well turn out to be the case.The central clearing measures dictated from onhigh with the intention of making financial servicessafer might well in reality very quickly increaserisk levels.

This emerges as one of the key issues to presentitself in even the most cursory examination of theDodd-Frank and EMIR proposals to improve the

safety of OTC derivatives, and ultimately thevalue of pension funds.

Apologists for pension funds arguethat the funds should be exemptedfrom the central clearingrequirement on what are ineffect the same grounds usedto argue for the exemptionof corporates which usehedging as an intrinsiccomponent of their businessmodel. It is exceedingly well

documented that pensionfunds which pursue liability-driven investment strategies needto use hedges of one kind or anotherto enable them to meet their liabilities,especially over the longer term. There is nosingle standard in this process, and the extent of eachindividual pension funds customised needs wouldcreate the mother of all challenges. Central clearingwould become, if not an absolute nightmare, at leasta very, very bad dream.

The impact would be felt not only on the technical

side of the business. It would also affect the financialarithmetic. Central clearing will mean additionalcosts (widely estimated at the equivalent of 100-200 basis points lower performance), making it acertain drag on income. This could in turn nudge afund into taking a riskier approach to investment,or demanding more support from its sponsoringcompany.

If a pension fund is using OTC derivatives werecommend that they hold 20% of their assets incash or gilts to post as collateral with the bilateral

counterparty, says Ben Clissold, deputy chief

investment officer at P-Solve, which is part ofthe Punter Southall Group and was founded inMarch 2001 to provide advice to liability-drivenorganisations such as trustee groups, corporations,charities and insurance companies. If theyare required to switch from collateralised OTCderivatives to central clearing it will reduce capitalefficiencies by requiring them to post initial marginwhich are not needed in bilateral transactions.This could cause a drag on overall performance byrequiring the amount of assets that would need to beavailable as collateral by a further 6%, he calculates,

as cash will return only Libor. The other 74%of assets will have to work even harder

to compensate, so paradoxically therequirement to post margin to a

central counterparty to reducerisk could actually increase risk,reduce income, or both, hesays.

Tony Kirby, director,regulatory and riskmanagement at Ernst & Youngand chair of the MiFID Forum

Best execution and TradingGroup, predicts that there will

be what he calls a rolling wave ofhigher costs all the way back to the

buy side. In a worst case scenario,a whole range of costs will increase, and the

increases will be worse if there is initial and variationmargin segregation on top, he says. These will all

be passed on to the buy-side as fees. Little good,moreover, will come of it, he argues. Will it makethings safer? Are the measures proportionate?Do they tackle the problem of speculation? No.

Speculation is the flip side to hedging, yet someregulators think hedging is good, while speculationis bad. They have to be careful not to stifle growth orpension funds wont be able to plug their deficits.

Neill Pattinson, chief strategy officer, global rates,at HSBC Investment Bank, could scarcely agreemore. What will be the impact of using a centralcounterparty? It will clearly be a drag on investmentreturn if they continue to use derivatives in the waythat they have done until now, he says. Not onlywill pension funds have to post initial margin that is

Over the top? Brian Bollen examines the knockon effects that could entail fromforcing pension funds to clear OTCderivatives centrally

If they are requiredto switch from

collateralised OTC

derivatives to central

clearing it will reducecapital efficiencies by

requiring them to post

initial margin which arenot needed in bilateraltransactions



OTC derivatives: over the top?

not currently required in bilateral OTC transactions,but they will have less flexibility in the assets theymust post. They will have financing needs for theclearing house eligible collateral, which will representan ongoing cost.

He concedes readily that clearing will provide

certain benefits, but adds that there are other waysof mitigating risk. No-one in the fund managercommunity is looking at clearing as an immediateimperative; they feel that their existing bilateralfacilities give adequate credit protection."

Whatever the philosophical and theoreticaldebates, a sense of acceptance and readiness toadapt abounds. Says Stefan Gavell, executive vicepresident of State Street Corporation, for example:Clearing of derivatives is going to be a reality -aswell as enhanced requirements for OTC contracts.While there are overall benefits from clearing in

the reduction of systemic risk, it will alsorequire major changes to how marketparticipants, including buy-sidefirms, execute, settle, collateraliseand report on trades. A word ofcaution comes, though, fromPhilippe Rozental, head of assetservicing at Societe GeneraleSecurities Services. Its thepre-trade area that pensionfunds must still concentrateon when making a decision

whether to invest in OTCderivatives, not the post-tradeprocesses, however sophisticatedthey might be.

We return to Mr Clissold of P-Solve.He believes that the worst of all possibleworlds would be to require pension funds to clearderivatives before central clearing counterparties candeal with all the types of derivatives pension schemesuse. Making it possible to clear some transactionscentrally but not others would defeat the objectiveof the exercise, he argues. It would reduce the

efficiency of the system while raising costs for itsparticipants.

Kevin Neville, head of prime services and securitiesfinance at Rule Financial, challenges the assertionthat new costs related to central clearing willcause unintended consequences, such as reductionin performance and riskier investing. I rememberreading recently that broker dealers were concernedthat with central clearing they would lose a hugeprofit stream in the spread they charge the buy-sideover these bilateral agreements, he says. If my

memory serves me, I recall the numbers quoted weresome $30bn of current revenue which was predictedto reduce to $6bn. I dont know how or where theyget the numbers, and of course what rigour wasapplied to discover them, but what is certain is thatthe lost revenue to brokers has to end up somewhere;

yes, mostly back in the pockets of the buy-side clientswho will now be able to see prices centrally, have

better visibility of what the market is doing, and willtherefore achieve a tighter spread.

Now, I know it is not a completely zero-sum-game,since new technology has to be put in place andhigher capital requirements are needed, but I imaginethe visibility gained by a centrally cleared OTC willgreatly mitigate the cost of providing it. I rememberin 1986 (pre big bang at the LSE), where naysayerswere claiming that going visible on electronic marketswould kill prices, cost too much and that liquidity

would plummet. Well, have we learnt a lessonyet?

There is that other wee side effect the one that regulators are pressing

for and that is insurance. Ibelieve CCPs will provide a

degree of insurance that willprotect us from a repeat ofthe crash recently suffered.We all know to our detrimentthat insurance costs money,

but the upside is that almost

every single country west ofChina would have avoided the

depths of depression that we havestooped to. We would not haveto nationalise our banks, have no

ballooning unemployment and poor GDPetc. And the buy-side simply cannot complain that1-2% of performance will be lost due to these costs. Ithink the ensuing crash, the failure to understand therisks, resulting in a worldwide crash has had a rathermore significant cost than an annualised 2%.

Finally, taking the last word from Mr Clissold, I

simply do not agree that unless every instrument isable to be cleared centrally then we shouldnt startclearing any of them. We know that $450 trillionof OTC Swaps are traded, and $6 trillion of OTCequities, and the same in OTC repos, and maybe afew others so why dont we start with swaps andget 90% of the game covered? Simple.

What will be theimpact of using a

central counterparty?

It will clearly be a drag

on investment returnif they continue to use

derivatives in the way

that they have doneuntil now



Fund manager profile

In 1972 Charles Brandes worked for a small, now-subsumed brokerage firm in La Jolla, California. Hewas a young guy and had been in university whenthey were still teaching Securities Analysis as atextbook in the finance classes, which was writtenby Benjamin Graham and David Dodd, and TheIntelligent Investor which came out a few years later,which was also written by the two of them.

Who walks into the office on that day that brokeragefirm on Wall Street, which was about six houses long indowntown La Jolla, but Ben Graham, retired after 30 or

so years at Columbia University. He spent six monthsa year in La Jolla and was writing the fourth edition ofThe Intelligent Investor.

Interestingly, after Charles had finished college theybegan teaching modern portfolio theory and they quitteaching the various books written by Ben Graham andDavid Dodd, so the fact that he had even read this stuffwas interesting.

Having recognised that this who was in front of him,he said: I really liked what I read in your books and itreally seems like the way I think you ought to approachinvesting. So for the next couple of years Charles

would pursue Ben Graham for donuts, lunch or coffee;any pretext to sit down and talk about investing.

They developed a mentor/student relationship overthe next couple of years and Charles became imbuedwith the rightness of this theory of managing moneyand not with the types of things that were beingadvocated by the brokerage firm he worked for.

He quit his job and took all the money he had inthe world which wasnt much and set up BrandesInvestment Partners in the next beach community northof La Jolla called Del Mar, above the Double ChineseHappiness restaurant (editors note - for anyone inthe area the restaurant is still there, although Brandeshas - not surprisingly - moved) and laboured there byhimself for the next 10 years.

Grahams work is known for his applying valueprinciples to domestic US securities. But the first clientat Brandes was a Canadian multi-national, who said: Ireally like this whole value idea, but why cant you doit with both US and non-US stocks as well? So Charlesstarted applying the principles to a global portfolio forthe very first client.

So it could all have gone differently if someone elsehad walked in that first day.

In terms of applying these principles to non-US stocks,there has been an evolution. Even in the 1980s it washard to get US GAAP comparable data out of a lot ofcompanies and so there was more of a bias towardslarge cap, but over the years non-US firms wantedaccess to US capital and the only way to get that wasto open up the books, or come up with US GAAPcomparable financials.

You also have the evolution of custody. It used to bethat youd find a lot out about a firm but trading it wasa nightmare, as were the expenses on top of that, but

now you can trade non-US securities extremely cheaplyfrom an institutional standpoint.

As we talk to our elder statesmen here about howit was in those days, they wouldnt get a lot ofinformation but they would get a sufficient amount tostart developing the models compared to what we canget today on companies.

The interesting thing is non-US companies arentrestricted in terms of what they can talk to you about,versus what happens in the US now. In the US acompany cant tell you anything more than they tellthe public so it gets pretty difficult to get additional

information.You can find out more from the competition on

another company than you can from them if theyhavent released it, because they can talk about otherfirms; they just cant give you information aboutthemselves thats not published. You dont have thatrestriction on the non-US side.

In the present day, the firm itself is a partnershipand we have a 100-year vision of remaining employeeowned. Charles still has a substantial ownershipinterest or partnership interest but there are 21partners currently and the 100-year vision is to remain

employee-owned because if you look at the way weinvest, it does not sit well with a corporate parent.The reason for that is Graham talked about value

investing as thinking differently from the herd. Themarket itself is a manic depressive and cant beanticipated in terms of how its going to behave, andits really the sum total of a lot of irrational behaviour.

First and foremost were a research boutique. We donthave a top down view or an economist on staff, weresearch businesses as an investor or an entrepreneurmight look at a company.

When we develop a valuation of a security we look at

The Brandes BrandDebra McGinty-Poteet, Director of Mutual Fund and Subadvisory Client Services atBrandes Investment Partners, explains the firm's history and investment principles


21/92 2011 | Fundamentals| 19

Fund manager profile

its history. It might take 10 or 15 years worth of data tocome up with the cash generative properties of a firmas it goes through the various market cycles. Were notsaying its a good firm or a bad firm, were looking atfundamentals and how it performs over time.

Next, we only get interested in purchasing a name ifyou can purchase it at a discount. Graham pointed to

a 20-35% discount if you can purchase names in thatrange youre going to do better than the market andsometimes the reason for that discount can be veryuncomfortable it can be headline risk of factoriesbeing destroyed, it can be problems with regulators,and so on.

We are looking for that sweet spot at 20-25% discountof what we think it is worth. Graham called that themargin of safety and the valuation the intrinsic value.

The next tenet of value investing is to take a long-term view. Our typical portfolio is three to five years,although well have outliers that will be in the portfolio

for seven to nine years before they reach their valuationtarget.

Thats the philosophy, but where we are unique is inthe way we render our valuation philosophy. We donthave a star system, legitimately. All of our buy, sell andallocation decisions in our portfolio are actually madeby an investment committee.

We have four investment committees large cap, mid-cap, small-cap and emerging markets products.

We have 35 researching analysts who are responsiblefor putting together these valuations. They might spendanywhere from four to six weeks or more comingup with the valuation of a company. They bring thisresearch report to investment committee and everybodywho sits on a committee is either currently a researchanalyst or has been one in the past.

Once a research report is ready it is brought to the

investment committee who will opine on any issueson the report. They can request anything they wantand send the analyst back many times until they arecomfortable.

Then the committee will discuss what the valueshould be. Part of what we do to ensure it is trulya committee decision is that when comments are

requested of the committee members the most juniorpeople have to speak first so you dont have the mostsenior people intimidating the newer members. Wewant the intellect of everybody to be rendered equally.

We like to call our valuations a neighbourhood ratherthan an address; we dont say a firm is worth say $30 ashare. We might say as a committee that it is worth $30to $32 a share.

Then lets say its trading at $15, the committee willdecide whether that current market price is cheapenough. If it is, the committee will say the currentmargin of safety is acceptable and we would like to put

2% of the stock into our cash flows and then we putthat into our computer systems to look around all ofour portfolios and look for cash opportunities.

So in our portfolios were looking to have an averagemargin of safety of 20-35% across the board and to theextent there are no cash flows well look for situationswhere names are approaching their intrinsic value.Lets say they were purchased three years ago, it is40% margin of safety and now theyre only 10% away,so we might pick up cash from those names that areapproaching their intrinsic value.

Our portfolio managers dont have discretion becausethe investment committee itself does all buy, sell andallocation decisions.

Watch a videointerview with Debraat the IMN BeneficialOwners' SecuritiesLending Summit atFundamentalsmagazine.com/videos
http://fundamentalsmagazine.com/video/4174/imn-beneficial-owners-conference-feb-11-debra-mcginty-poteet-brandes-investment-partnershttp://fundamentalsmagazine.com/video/4174/imn-beneficial-owners-conference-feb-11-debra-mcginty-poteet-brandes-investment-partnershttp://fundamentalsmagazine.com/video/4174/imn-beneficial-owners-conference-feb-11-debra-mcginty-poteet-brandes-investment-partnershttp://fundamentalsmagazine.com/video/4174/imn-beneficial-owners-conference-feb-11-debra-mcginty-poteet-brandes-investment-partnershttp://fundamentalsmagazine.com/video/4174/imn-beneficial-owners-conference-feb-11-debra-mcginty-poteet-brandes-investment-partnershttp://fundamentalsmagazine.com/video/4174/imn-beneficial-owners-conference-feb-11-debra-mcginty-poteet-brandes-investment-partnershttp://fundamentalsmagazine.com/video/4174/imn-beneficial-owners-conference-feb-11-debra-mcginty-poteet-brandes-investment-partnershttp://fundamentalsmagazine.com/video/4174/imn-beneficial-owners-conference-feb-11-debra-mcginty-poteet-brandes-investment-partnershttp://fundamentalsmagazine.com/video/4174/imn-beneficial-owners-conference-feb-11-debra-mcginty-poteet-brandes-investment-partners



EFSF bonds

The European Financial Stability Facility (EFSF) isone of the many acronyms we have come across in thelast few years identifying programmes to safeguard thestability of the financial system, provide liquidity andrestore markets under stress.

Like other initiatives implemented on both sides ofthe Atlantic it is temporary in nature but unlike themit can have permanent consequences on the Europeangovernment bond market. To raise funds to provide aidto countries in financial difficulties, the EFSF issues bonds

backed by the guarantees of the Euro-area member states.People familiar with the political debate in Brussels can

easily recognise that the structure of this newfinancial instrument resembles that of thecommon European government bond,

brought up initially by think tanksand consultants, and more recently

by policymakers as a panacea forthe sovereign debt crisis in theeurozone.

The EFSF was created on the basis of Article 122.2 of theTreaty on the Functioning of theEuropean Union, which allows for

mutual support when a eurozonemember country is in difficultiesor is seriously threatened with severedifficulties caused by exceptionaloccurrences beyond its control.

This special purpose vehicle is backed bya guarantee of the eurozone countries of EUR 440

billion and was formed as a part of the EUR 750 billionFinancial Stabilization Mechanism (ESM) approved byEuropean Finance Ministers on 10th May 2010. In additionto the EFSF, the plan includes EUR 60 billion provided

by the European Financial Stabilization Mechanism(EFSM) and up to EUR 250 billion from the International

Monetary Fund (IMF) that commits to contribute up to50% of the loans made by the EFSF and EFSM.

The main objective of the ESM was to provide a backstopagainst speculation on the sovereign debt of Europeanperipheral countries, and many market participantsexpected that the facility would have never been tapped.However, in November 2010, under increasing marketpressure, the Irish government agreed with the EuropeanUnion and IMF an official bail-out package.

As a consequence, the first EFSF bond was issued on 24thJanuary 2011 for a notional amount of EUR 5 billion, and itattracted an extraordinary demand with a strong interest

particularly from Asian investors. The five-year maturitybond was priced at a yield of 2.89%, giving subscribers a48 bps yield pickup over the German Bund of the samematurity while holding a AAA-rated top notch bond.

The success of the pre-placed issuance rewarded themarketing efforts of Klaus Regling, EFSFs CEO, andsignaled a commitment of Asian countries to support theresolution of the sovereign debt crisis in the eurozone.The benefit of an higher yield over the bund, however,came at the cost of a lower liquidity of the EFSF bond,for which a secondary market is currently non-existentand trading activity is limited to satisfy dealers market-

making requirements.Nevertheless, the issuance of the first EFSF

bond is a key milestone for the EuropeanMonetary Union that could initiate

a substantial move toward a fiscalco-operation among eurozone

countries, including the issuanceof a common sovereign bond.

Germany has strongly opposedthe project but as Simon Penn,executive director and globalhead of strategic content at UBS

AG said: Providing funding tocountries that have lost access to thecapital markets is only a temporary

measure that will not eliminate thestructural imbalances among EMUcountries exposing the eurozone to the

recurrence of the sovereign debt crisis in the future.A possible solution to the debt crisis would be to learnfrom the crisis resolution mechanisms adopted by LatinAmerican countries at the end of the 1980s and take theBrady bonds scheme as a template.

Brady Bonds provided bond holders the option toreceive a recovery rate on their investment or newly

issued bonds in exchange of the defaulting ones with ahaircut that depended on seniority and maturity of theoriginal claim. If such an initiative were undertaken inEurope, continues Penn: The EFSF would buy bondsof troubled countries at a discount and issue AAA-rated

bonds allowing countries such as Greece and Ireland torestructure their debt without causing any credit event.

As suggested by Austria and Greece, the money raisedthrough the issuance of the EFSF bonds could be used tofinance infrastructure projects of common interest for the

Common stabilityUgo Bonaugurio investigates the European Financial Stability Facility:A temporary initiative for the issuance of the first common bond in the Eurozone

A possible solutionto the debt crisis

would be to learn from

the crisis resolution

mechanisms adoptedby Latin American

countries at the end

of the 1980s andtake the Brady bondsscheme as a template

continued overleaf


23/92

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Private Equity Endless-Liberata

Private equity deal focus:Endless - Liberata

It might be the mother of all clichs, but one personschallenge is anothers opportunity. Some mightfeel that that clich could be about to be tested todestruction as private equity turnaround specialistEndless steps into the age of austerity being usheredin by the UKs Conservative-dominated coalitiongovernment. We are all in this together, the

chancellor of the exchequer likes to remind the UKspeople on a regular basis as he refers to his belovedspending cuts, sneering and baring his teeth as he doesso. Some of us, though, see the opportunity to make aprofit out of it.

Garry Wilson, managing partner at Endless, is afounder member of that latter group. This helps explainhis almost tangible enthusiasm for the firms mostrecent purchase, of Liberata Limited, a leading supplierof business process outsourcing services to the publicsector. He argues strongly, and convincingly, that thekey to understanding the merits of the transaction isto look through the right end of the telescope. Doing

so shows that Liberata will in fact benefit from publicspending cuts, not suffer. I can see that local authoritiesand central government will be under huge pressure tomake cuts, and that that pressure should create hugeopportunities for Liberata, says Wilson. Its businessmodel is to provide public sector bodies with outsourcedservices; we can save them a lot of money.

Endless is backing the incumbent management teamof Dermot Joyce and Martin Trainer, who act as CEO andCFO respectively of the group. First contact betweenthem and Liberata dates back to early October lastyear. Ernst & Young were assisting the company inan accelerated M&A process, recalls Wilson. We met

Here's the deal:

Private equity turnaround specialist

Endless has committed more than 20m

in the acquisition of Liberata, a provider ofoutsourced services to local and central

government bodies in the UK.

The Endless team was led by Garry Wilson

and Chris Clegg. James Woolley and

Kerry Swain completed the in house due

diligence and Simon Mason supervised

the legal documentation whilst Ian Plumb

dealt with the Pension Scheme restructure.

Endless was advised by the London office of

Eversheds.

An IT due diligence team and Pensions team

from PwC also advised Endless. A team

from the London office of Ernst & Young

Transaction Advisory Services advised

Liberata on the accelerated M&A process

and introduced the deal to Endless.

victory in 1997 until its defeat in 2010

European community. A first step in this direction hasbeen taken with the deal agreed by government leaders ofthe eurozone countries on 12th March 2011 that increasesthe lending capacity of the EFSF and gives the EFSF theability to purchase bonds in the primary market.

The theoretical idea of a single eurozone debtinstrument first considered in a report published by the

Giovannini Group in 2000 as one possibility to further

enhance the integration in the government bond marketis progressively becoming more concrete, and Europeanpolicymakers now have the unique opportunity to makeit happen.

Brian Bollen takes a look at two major private equity deals - first, the purchase ofbusiness process outsourcing services firm Liberata by Endless and overleaf, the PearsonGroup's acquisition of the learning division of one of Brazils leading education companies



Private Equity Endless-Liberata

the management team on 4th October and we knew atonce that it was a transaction well suited to the Endless

business model. I was very impressed with Dermot andMartin, who had already taken the company a long waythrough the turnaround process.

Two big obstacles remained, however, to makeLiberata truly attractive. One, the company was running

out of cash, as its modest profits were too low to servicethe debt taken on by General Atlantic to fund itsprevious private equity purchase, and General Atlantichad reached the limits of its appetite to provide furtherfunding. Two, Liberatas defined benefit pension fundhad a deficit in excess of 100m that had to be addressed.

On the cash front, we knew we had until Christmas,Wilson continues. That made it a tight timetable, butone that is within our usual norms. On the pensionfront, the management team had already been indiscussions with the fund trustees and the UKspensions regulator. Those discussions had very handilypinpointed a groundbreaking way forward, which was

to place the fund in the care of the countrysPension Protection Fund. At a stroke,using a Regulated ApportionmentAgreement, and handing over a cashsum in excess of 10m, the pensionliability vanished. The exchangeof contracts took place on 26thNovember, and although theformal public announcement didnot take place till early January,completion followed on 24thDecember, delivering yet anotherclich opportunity. Yes, it was a

nice early Christmas present forus, agrees Garry Wilson.

The total of more than 20mcommitted by Endless includes thepremium paid to the PPF. The firmpaid a nominal sum for the business itself,which is now debt-free, leaving around 10m forworking capital as Endless gets on with doing what itdoes best. What struck me most on meeting Dermotand Martin was that despite having been through atough time their primary concern was about providinga secure base for employees and customers alike, saysWilson. Those principles are very closely aligned to

our own. Harnessing the motivation and support ofLiberatas employees and customers will mean a brightfuture ahead. The company is already making modestprofits, and we hope to improve the level of thoseprofits. At the time of acquisition, Liberatas annualrevenues of around 110m were generating around 5mof ebitda [earnings before interest, taxes, depreciation,and amortisation], he adds. Turnover is underpinned bycontracts with the UKs Ministry of Justice and several ofthe countrys largest local authorities.

The transaction has seen the financial position atLiberata strengthened considerably. For the first time in

years the business has a positive balance sheet which itcan be proud of and unlike many competitors has zero

bank debt. Furthermore the cash injection from Endlessof over 20m has given the business substantial cashheadroom. Many employees have asked why Liberatawas acquired by a Turnaround Fund and the reasons liein the historic debts and weak balance sheet which were

unsustainable.The acquisition marks the first deal from the firms

new London base in Curzon Street, Mayfair, and the 11thin Endless Fund II. Liberata employs over 2,000 peoplein 20 business centres across the UK and its core focus ison improving and streamlining operational processes todrive costs savings and improve administration at LocalAuthorities and Central Government Departments.

Liberata describes itself as one of the UKs leadingproviders of business process services having supportedclients for over 35 years in improving their operationalcost management and service performance to deliver

business and social benefits and improve their

customers experience. Its origins lie in a businessfounded in 1975, by the Chartered Institute

of Public Finance and Accountancy(CIPFA), called CIPFA Services

Ltd. CIPFA was acquired by itsmanagement in 1989 and renamed

CSL. CSL provided managementconsultancy services, BusinessProcess outsourcing (BPO)and corporate finance advice,predominantly to localgovernment until 1993, whenit was acquired by Deloitte &

Touche and renamed Liberata.BPO services became the focus of

its activities resulting in a numberof partnerships with local authoritiesand governmental agencies for the

provision of services including Revenues &Benefits, Finance & Accounting Management, ICT,

Human Resources & Payroll and other transactionalservices. Recent successes include contracts for theprovision and management of business support servicesfor the London Borough of Bromley and North SomersetCouncil and the Local Government Association.

Endless understood the financial restructuring that

was required and that is one of the final pieces in aturnaround strategy already well advanced by the teamat Liberata, says Garry Wilson, bringing the currentchapter of the story to a neat conclusion. Now that thedeal is done all stakeholders can look to the future withLiberata as a financially strong, independent company. Iam very much looking forward to seeing the team takethe business forward for years to come.

A possible solutionto the debt crisis

would be to learn from

the crisis resolution

mechanisms adoptedby Latin American

countries at the end

of the 1980s andtake the Brady bondsscheme as a template



Private Equity Pearson-SEB

Education. Education. Education. The one-time

favourite election campaigning mantra of AnthonyCharles Lynton Blair could also double as a modernmission statement for the Pearson Group. In the early tomid-1980s the company was little more than a de factoinvestment trust with a ragbag assortment of holdingsranging from the Financial Times to Lazards to MadameTussauds to Penguin books. Today Pearson describesitself with no false modesty as the worlds leadingeducation company, providing learning materials,technologies, assessments and services to teachers andstudents of all ages and in more than 60 coun

fundamentals 03

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