BoE stress tests: all you need to know

The Bank of England has released the results of its latest round of its annual banking stress tests and its semi-annual financial stability report this morning. Used to measure the resilience of a bank’s balance sheet in adverse scenarios, the stress tests measured the impact of a severe slowdown in Chinese growth, a global recession […]

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Draghi: Eurozone will decline without vital productivity growth

It’s productivity, stupid. European Central Bank president Mario Draghi has become the latest major policymaker to warn of the long-term economic damage posed by chronically low productivity growth, as he urged eurozone governments to take action to lift growth and stoke innovation. Speaking in Madrid on Wednesday, Mr Draghi noted that productivity rises in the […]

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Asia markets tentative ahead of Opec meeting

Wednesday 2.30am GMT Overview Markets across Asia were treading cautiously on Wednesday, following mild overnight gains for Wall Street, a weakening of the US dollar and as investors turned their attention to a meeting between Opec members later today. What to watch Oil prices are in focus ahead of Wednesday’s Opec meeting in Vienna. The […]

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Banks, Financial

RBS emerges as biggest failure in tough UK bank stress tests

Royal Bank of Scotland has emerged as the biggest failure in the UK’s annual stress tests, forcing the state-controlled lender to present regulators with a new plan to bolster its capital position by at least £2bn. Barclays and Standard Chartered also failed to meet some of their minimum hurdles in the toughest stress scenario ever […]

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Barclays: life in the old dog yet

Barclays, a former basket case of British banking, is beginning to look inspiringly mediocre. The bank has failed Bank of England stress tests less resoundingly than Royal Bank of Scotland. Investors believe its assets are worth only 10 per cent less than their book value, judging from the share price. Although Barclays’s legal team have […]

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Archive | November, 2016

Bank of America: no easy answers

Posted on 31 January 2014 by

The joke is on us. Why would anyone think anything related to pre-crisis mortgage deals would be simple? A New York state Judge on Friday delivered a long-awaited decision on an $8.5bn agreement by Bank of America to settle claims by private investors over faulty Countrywide loans bundled into bonds. Questions over whether the settlement would stand have been an obstacle to BofA’s efforts to move past the financial crisis and catnip for BofA bears who believed BofA could be forced to pay a sum perhaps a few times higher. AIG led a group of investors contesting the deal as offering scant compensation. Everyone was expecting a thumbs up or a thumbs down, but that is not exactly what they got.

    Judge Barbara Kapnick approved the settlement, saying that the trustee for the bonds (BNY Mellon) did not act in bad faith. That seems straightforward enough. But then, a wrinkle. She excluded from her approval an issue over whether BofA must repurchase loans (packaged into bonds) whose terms the bank modified. So that could still be litigated. Attorneys for collateralised debt obligations (of course) called Triaxx have argued that the trustee failed to investigate modified mortgage repurchase claims worth about $31bn. BofA said it believed outstanding issues can be addressed “without undue delay”, while AIG is likely to appeal the broader approval.

    BofA has reserved for the $8.5bn. And it has made strides in resolving its legal problems, although issues remain. In the fourth quarter, litigation expense was $2.3bn. Investors these days seem more focused on when an economic recovery and higher rates can produce revenue and margin growth. Shares fell just a per cent on Friday. The punch line? Investors cannot put this pesky settlement completely in the past just yet.

    Email the Lex team in confidence at

    Banks accused of mis-selling EFG loans

    Posted on 31 January 2014 by

    Small and medium-sized businesses have accused banks of using a government lending scheme to reduce their own liabilities, in what campaigners claim is the next mis-selling scandal.

    The Enterprise Finance Guarantee scheme enables banks to lend to small businesses that lack the collateral to get a conventional loan. The taxpayer guarantees 75 per cent of bank losses, and the borrowing business pays a 2 per cent premium.

      But MPs and campaigners are concerned that the risks are not being fully explained to businesses and that banks may be exploiting EFG loans to liquidate viable companies and seize their assets.

      A survey for the Department for Business, Innovation and Skills (BIS) last year found that one in seven borrowers on the scheme believed their bank had not made clear that business owners were liable for the entire value of the loan.

      However, more than 80 per cent were satisfied with the loan. BIS said the programme was tightly audited to ensure the compliance of banks.

      “EFG does not provide insurance for the borrower. It is a mechanism through which BIS shares risk with the lender to enable the borrower to get a loan that would otherwise have been declined,” it said.

      Irene Graham of the British Bankers’ Association said: “The EFG is for additional lending to viable businesses when there is insufficient security. There is transparency and the terms are clear in the paperwork.

      “This is a guarantee to the lender not to the company. If something does go wrong the bank has to try to recover money from the business before it can claim on the government guarantee.”

      But Lawrence Tomlinson, the government adviser who likened RBS, the biggest lender to SMEs (small and medium enterprises), to a “vampire” sucking profits from small businesses, says he has received dozens of complaints about EFG.

      Bully Banks, the campaign group set up by businesses that were mis-sold interest rate swaps, is now taking up the question. “People are raising this as another case of mis-selling,” said Jeremy Roe, chairman of Bully Banks. “It is an issue we are looking at.”

      EFG loans are riskier than others, according to BIS statistics. The default rate in the first three years was 28 per cent, against 4 per cent for the average SME loan. The government has paid out £55.6m to banks under the scheme and collected £22.7m in premiums from small businesses.

      Jameson Smith, an advisory group, said it was receiving several calls a day from entrepreneurs in financial difficulty.

      Mike Smith, a partner, said: “Many of the [EFG] schemes marketed by banks have been oversold because of the complexities [of the scheme]: the upshot is a lot of entrepreneurs will mistakenly believe the EFG protects their personal assets in the event of the business becoming insolvent.”

      Mr Smith said: “Typically, what happens is [a business] overdraft is withdrawn often without notice.” He said that banks then put in place short-term finance linked to assets. This “gives the bank a charge over assets and a stranglehold,” he said.

      Since it began in 2009, banks have made more than 20,000 loans worth over £2bn under EFG. Business overdraft use has fallen by more than £5bn in the past two years.

      RBS said: “Some [business] customers have temporary overdrafts and over time they need to find alternative options to restructure that finance.”

      “We have helped over 8,000 SMEs, which would otherwise have struggled to obtain finance through this government scheme. We work with our customers to explain the finance they are applying for and inform them of the terms.”

      Guto Bebb, Conservative MP for Aberconwy, who has attacked banks’ treatment of SMEs, said he was concerned about the scheme. A profitable business in his constituency was put into administration after its bank rejected an application for an EFG loan. This worsened its credit rating and its overdraft was cancelled as a result, he said.

      One client, a removals business, had a £40,000 EFG loan from Lloyds and says it was told when signing up that the company “could claim the 75 per cent [from the government]” if it was liquidated.

      However, when the company did fail, the bank sought the directors’ personal assets through an individual voluntary arrangement.

      Lloyds said: “The customer received and signed the loan agreement as well as the declaration stating that they remained liable for the full amount of the loan.” The bank said it had received the highest rating from a government audit of the scheme.

      Clive May, whose bricklaying business was put into administration in December, says RBS used his EFG loan to pay off a £220,000 overdraft, worsening his cash flow. RBS said it could not comment without his permission.

      Mr May said he believed his company was the borrower, and that as a director his personal guarantees could only be called on for 25 per cent of the loan. He said banks wanted to get rid of overdrafts because they had to hold reserve capital against them.

      Investors pull $12bn from EM stocks

      Posted on 31 January 2014 by

      The four biggest global stock markets recorded sharp losses in January for the first time in four years, as weeks of turmoil in emerging markets spread to the developed world.

      Stocks in the US, UK, Europe and Japan have not posted simultaneous declines for January since 2010 when the eurozone debt crisis was at its height, prompting investors to warn the inauspicious start did not bode well for the rest of the year. US central bank tapering and a slowing Chinese economy are likely to weigh heavily on sentiment.

        The spreading gloom was prompted by a mass exodus from the emerging markets with investors pulling money out of the developing world at the fastest rate since 2011.

        The biggest losers from the turmoil – most intense in the Turkish and South African currency markets – included big dedicated emerging market investment groups such as Franklin Templeton, First State and Ashmore. All three have suffered outflows and redemptions, according to investment managers.

        Mark Mobius, Templeton’s top fund manager, refused to be rattled despite the hit to his portfolios, insisting the dive in some of the emerging markets offered opportunity rather than danger for his funds.

        “We’re happiest when markets are down,” he said. “We want to take advantage of any declines in these markets.”

        Others were less sanguine. “It has been a bloody week,” said a manager at an emerging market debt fund. “We can recover from one week. But if this goes on, then that will have big ramifications for our profit margins.”

        The exodus from emerging markets has been led by retail investors, according to fund managers, while institutional groups, such as pension funds, have held their nerve and stuck to their positions.

        “Retail investors are running for the exits. They see the turmoil, they read the newspapers and they have a shorter time horizon,” said Michael Ganske, head of Emerging Markets at Rogge Capital Partners, a fixed income fund with $59bn under management.”

        “Whenever investors are panicking, that is a good buying opportunity,” he added.

        The FTSE 100 finished down 3.5 per cent for January, the Eurofirst 300 was 1.9 per cent lower, the Nikkei 225 dropped 8.5 per cent and the S&P 500 fell 3.6 per cent over the month in New York.

        Emerging market equity outflows rose to $6.3bn in the week up to January 29, the biggest weekly withdrawal since August 2011, with a total for the month hitting $12.2bn, according to data from EPFR Global, which tracks investment flows.

        Emerging market bond funds also suffered, with $2.7bn in outflows over the past week and $4.6bn withdrawn so far this year.

        However, there have been winners from the volatility. Some hedge funds such as Moore Capital have been shorting emerging markets while M&G Investments and Aberdeen Asset Management have also hedged positions in Turkey.

        One emerging markets investor said: “A lot of funds saw this coming. Turkey has been an accident waiting to happen.”

        ICAP plans US electronic swaps venue

        Posted on 31 January 2014 by

        ICAP has applied to operate a US electronic swaps trading venue overseen by UK regulators, stepping up its moves to address sweeping US laws governing the over-the-counter derivatives market.

        The UK interdealer broker wants to turn its BrokerTec fixed income trading platform into a venue mandated to meet US swaps rules from London, according to documents filed with US and UK regulators earlier this month.

          The move, involving one of its biggest trading units, comes amid growing concerns that the vast off-exchange derivatives market is beginning to fragment along regional lines following the introduction of tough new US legislation.

          ICAP acts as a middleman in the market, moving large and illiquid blocks of assets such as swaps between buyers and sellers, often by telephone. To strengthen the swaps markets against systemic risk, US authorities have mandated into existence new electronic venues known as Swap Execution Facilities. Banks, brokers and investors have spent much of the past four months scrambling to understand and meet new daily trading and compliance procedures.

          But many non-US financial institutions have been worried by guidance issued by the Commodity Futures Trading Commission on cross-border regulation, and see the incoming rules as tantamount to an overseas land grab by the CFTC.

          A recent industry survey suggested most trading on Sefs in their four-month existence had been by US dealers, with European-based dealers wary of trading in the US market.

          More than 70 per cent of interest rate swap volume in the final three months of 2013 was US-dollar denominated business, according to the International Swaps and Derivatives Association, a trade body. ICAP wants a London-based Sef for customers who want access to the liquidity of a Sef from Europe.

          ICAP’s BrokerTec trades G7 public debt securities, with US dollar swaps trading among its profitable areas. The securities also remain largely outside the scope of the US Dodd-Frank Act.

          ICAP has filed papers at UK Companies House to rename its BrokerTec business ICAP Global Derivatives Ltd. It is intended to be US-registered and compliant with US rules, while remaining under the jurisdiction of the Financial Conduct Authority, the UK regulator. It plans to trade US dollar, euro and sterling interest rate products, with trades cleared via the Chicago Mercantile Exchange and LCH. Clearnet. Its chief executive will be John Nixon, the head of its Americas business.

          Trading on Sefs is due to become mandatory in mid-February and ICAP already has approval for a US-based Sef, which will be run by Laurent Paulhac, a former CME Group executive.

          Last year Michael Spencer, chief executive, confirmed ICAP was considering applications for both a US and a UK entities.

          Rules and regulations dog ETF managers

          Posted on 31 January 2014 by

          epa03920493 (FILE) A file photon dated 07 June 2006 showing European Union flag pictured in front of the European Commission Building, the Berlaymond, in Brussels. The president of the European Union's executive warned on 23 October 2013 that it is about to run out of money, and called on the bloc's governments and parliament to bury the hatchet over planned budget changes. He has told European Parliament plenary in Strasbourg that the commission will no longer be able to make payments from November if it is not provided with an extra 2.7 billion euros (3.7 billion dollars). The shortfall is due to lower-than-expected revenue from EU import duties. EPA/OLIVIER HOSLET©EPA

          Industry concerns: European Commission changes may result in transaction charges and legal costs for investors

          The reforms of regulation standards needed after the financial crisis have placed a heavy burden on the exchange traded funds industry.

          Although ETFs performed well throughout the crisis, with none of the problems associated with more complex financial products such as credit default swaps, ETF providers have found their operations and business models subjected to much greater scrutiny.

            Much of this regulatory work remains unfinished and some proposals, such as the European financial transaction tax, could prove extremely disruptive. However, it is also clear that the ETF industry is benefiting from other reforms, such as the UK’s Retail Distribution Review (RDR).

            US regulators are considering whether BlackRock and Vanguard – two of the largest players in the ETF industry – should be considered as systemically important financial institutions, (SIFIs) as they look to extend improved safeguards for large banks to fund managers with assets of more than $50bn.

            Asset managers are putting up fierce resistance as the implications of a SIFI classification would be significant, not least in raising operating costs. It would bring considerable additional scrutiny, more stringent reporting requirements, the creation of recovery and resolution plans known as “living wills” and additional capital to be set aside.

            But asset managers argue forcefully that the risks posed to the financial stability of a bank being “too big to fail” do not apply to their businesses. They also emphasise that they act as agents for their investors, unlike banks which can act as principals in risking their own capital.

            Bill McNabb, chief executive of Vanguard, says it is unclear what impact a SIFI classification would have but he emphasises that asset management is already a well regulated sector.

            “Smart regulation has been a good thing for the funds industry but we don’t want changes that make our value proposition less compelling to investors,” says Mr McNabb.

            US regulators are also debating whether to approve proposals for non-transparent active ETFs. This would likely attract a number of mutual fund managers that do not currently participate in the ETF industry. However, the timing of any changes in these regulations remains unclear.

            In Europe, requirements for clearer labelling of ETFs were introduced in 2012 by the European Securities and Markets Authority, the regional regulator. It also determined that ETFs should be treated equally with active mutual, establishing a level playing field for competition.

            Ted Hood, chief executive of Source, the London-based ETF provider, points to comments last year by Steven Maijoor, Esma’s chairman, suggesting regulators are struggling to understand why the adoption of ETFs by retail investors has remained relatively low.

            “There is a great deal that ETF providers and regulators could do in working together to help investors achieve their goals,” says Mr Hood.

            The UK is seen as an important test of retail appetite for ETFs after RDR banned commission payments, known as retrocessions, to financial advisers for recommending products to clients. This created a level playing field between actively managed funds and ETFs which do not pay retrocessions.

            The ending of retrocession payments in the US and the move to a fee-based model to financial advisers has proved hugely important in accelerating the adoption of ETFs.

            Retail investors only account for a tiny part of the European ETF market, but RDR-type reforms have also been introduced in the Netherlands and are expected to spread further.

            Mark Wiedman, chief executive of iShares, the world’s largest ETF manager, says the shift to fee- based accounts by financial advisers is no longer viewed as just an Anglo-Dutch experiment.

            Real movement is under way in Switzerland and Germany. Across northern Europe banks are starting to view fee-based pricing as inevitable. It is even rippling into Asian markets, starting with the Singaporean operations of large global banks, who are beginning to think about the implications for their businesses, says Mr Wiedman.

            He adds: “The inexorable growth of fee-based accounts will drive greater adoption of ETFs and other forms of passive investments, as has already been shown clearly in the US”.

            Just as RDR-type reforms are expected to promote greater involvement with ETFs by retail investors, so the second Markets in Financial Instruments Directive (Mifid II) should encourage more usage by institutions. These wide-ranging reforms of European securities markets, finalised last month, are expected to lead to improvements in Europe’s fragmented ETF trading infrastructure, which has hindered asset gathering.

            Currently, the majority of European ETF trading is done in private, bilateral over-the-counter transactions that go unrecorded. This makes it problematic to understand the true depth and liquidity of the market which has acted as a barrier for institutional investors. Mifid II will lead to the establishment of a “consolidated tape”, a single, complete record of ETF trading as well as fuller pre-and post-trade reporting that will provide a clearer picture of who is active in the market.

            The establishment of a consolidated tape will “turn on the light” for ETF liquidity, says Mr Wiedman.

            Another concern is the fallout from the scandal affecting the London interbank lending market. Reforms to Libor benchmarks have been widened to include to all financial indices that are widely used by ETF providers.

            Sven Kasper, director of regulatory, industry and government affairs for Emea at State Street says it remains unclear how the European Commission’s proposals on benchmarks might affect US and third country based index providers. In a worst-case scenario, ETF managers in the European market might need to change to a different index provider, resulting in transaction charges and legal costs without any clear benefit to end-investors, cautions Mr Kasper.

            But the regulatory “elephant in the room” remains proposals for a financial transactions tax in 11 European member states, including France and Germany.

            These proposals, says Mr Kasper, are still in flux so the final design and scope of the FTT remains unknown. However, Greece, the current holder of the EU presidency and Italy, its successor, are both supportive of an FTT and intent on implementation.

            Providers fear an FTT would mean every transaction required to create an ETF units would attract a charge. This, says Mr Hood would “demolish the appeal of the ETF as a wrapper” by imposing multiple charges on products offering eurozone exposures, said Mr Hood. He argues that the introduction of an FTT in Europe could be “a real disaster”, not just for the ETF industry, but for all savers and investors who will ultimately pay the costs of the tax.

            Top three keep smaller rivals at bay – for now

            Posted on 31 January 2014 by

            Pedestrians walk with umbrellas in front of BlackRock Inc. offices in New York, U.S., on Friday, April 12, 2013. BlackRock Inc. predicts Canadian 10-year benchmark bond yields may fall to the lowest since at least the 1950s as a sputtering economy douses expectations the Bank of Canada will increase borrowing costs this year. Photographer: Scott Eells/Bloomberg©Bloomberg

            Battle lines: BlackRock believes it can retain the top spot

            BlackRock, Vanguard and State Street have long dominated the US exchange traded fund industry, but their fast growing, smaller rivals are working hard to stage a revolution.

            Last year BlackRock, Vanguard and State Street pulled in $40.4bn, $55bn and $14.8bn respectively from US investors to their ETF ranges, and collectively account for 81.5 per cent of the US market, according to figures from ETFGI.

              But their grip on the US ETF industry has not deterred smaller or lesser known rivals from attempting to chip away at this stranglehold. The likes of WisdomTree, PowerShares, Guggenheim and Charles Schwab also managed to attract billions of new investment last year and narrowly increased their market share, but scepticism abounds as to whether they can seriously challenge the players at the top.

              Ben Johnson, an ETF analyst at Morningstar, the data provider, believes it will be difficult for any of the fast-growing players in the middle of the rankings to usurp one of the ‘big three’.

              He thinks any changes at the top of the league table are highly unlikely. “It is not strictly forbidden, but it’s a very steep climb. This is an area that is marked by low barriers to entry but very high barriers to success”.

              A problem for newer entrants to the US market is that the big three long ago established themselves as the go-to providers of traditional market cap weighted ETFs, which attract the bulk of new assets.

              Mr Johnson points out that some of the smaller players, such as Charles Schwab, have made progress with “me-too” type ETFs that similarly track market cap weighted indexes, “but they are still significantly smaller than the first tier players”.

              He adds: “The smaller second and third tier players will continue to make inroads around the edges and grow their businesses at a relatively rapid clip, but I think the incumbents are extremely well entrenched.”

              These dynamics, however, have not dented the optimism of ETF providers lower down the food chain. Vern Sumnicht, chief executive of iSectors, an ETF-focused investment manager, is confident the US ETF industry is about to undergo substantial changes.

              “The ETF industry is no different than any other industry in the US, [and] many of the big players today may not even exist in five years. WisdomTree and Guggenheim might merge with PowerShares to form a competitor to the big five, or even overcome and consume one or two of the big five,” he says.

              “The one thing to remember is that the ETF industry is still young, has a lot of money flowing into it and it will change. Five or 10 years from now, it would likely look nothing like it looks today.”

              Many of the up and coming ETF providers, meanwhile, are optimistic they can continue to build market share and gain a foothold among the top five providers – or higher.

              William Belden, head of Guggenheim’s ETF business, which attracted $7bn from US investors last year, says: “We have been a strong beneficiary of alternative approaches to capturing market exposure and we have seen dramatic improvement in the acknowledgment and usage of those strategies. Being a top-five provider is not a stated goal of ours, but there is no reason why we can’t be at that level.”

              Charles Schwab, meanwhile, is pinning its hopes for a leading position on its commission-free platform and low pricing.

              Can Schwab seriously contend with the biggest three players? “Absolutely,” says John Sturiale, senior vice-president of product management at Charles Schwab Investment Management, which attracted $6bn from US investors last year. He adds: “We have good products in very popular areas, low costs and a commission-free platform [which makes us] even more attractive. I wouldn’t say all of the big guys can claim to have all three.”

              Nonetheless the big three providers are cool – even generous – in their reaction to competition from the ETF upstarts. Kevin Quigg, head of sales strategy at State Street Global Advisors, says: “We welcome new providers as they contribute to advancing investor resources and solutions and promote awareness of ETFs in the marketplace.”

              Daniel Gamba, head of BlackRock’s institutional business at iShares, is similarly relaxed. “We compete with some of these niche players and it’s good – we support competition,” he says.

              But he adds: “We will continue to have the top position as we innovate and compete in most parts of the market.”

              Morningstar’s Mr Johnson, however, points out one headwind for the biggest providers.

              “The types of strategies [the niche providers] are increasingly bringing to market are not substitutes for traditional beta products, but substitutes for actively managed products,” he says. This, he adds, could give a serious advantage to creative ETF houses lower down the leagues.

              Source deal marks the maestro’s return

              Posted on 31 January 2014 by

              Lee Kranefuss, chief executive officer of iShares for Barclays Global Investors, speaks during an interview in New York, Wednesday, May 23, 2007. Photographer: Daniel Acker/Bloomberg News.©Bloomberg

              Global player: Lee Kranefuss of Warburg Pincus

              The purchase last month by Warburg Pincus, the US private equity group, of a majority stake in exchange traded funds provider Source has reignited hopes of a wider shake-up in Europe’s ETF market.

              The deal was led by one of the most important players in the development of the ETF industry globally, Lee Kranefuss, executive in residence at Warburg Pincus. Mr Kranefuss was chief executive of iShares from its launch in 2000 until 2010, by which time it had grown into the world’s largest ETF provider with assets of more than $600bn.

                “Lee Kranefuss is one of the true ETF pioneers. His views are highly influential,” says one industry observer.

                Mr Kranefuss has been planning his return for some time. He first mooted the idea of a company to consolidate “sub-scale” ETF businesses in 2011 before joining forces with Warburg Pincus late in 2012 to lead the $30bn global private equity group’s expansion into the ETF market.

                The capital provided by Warburg Pincus, says Mr Kranefuss, would “turbocharge” growth for Source, which he described as “a unique operation with a good suite of products and established distribution capabilities”.

                Emphasising that the partnership was intended as a long-term arrangement, Mr Kranefuss says Warburg Pincus wanted Source to become a global player and that further capital was available to fund that ambition if needed.

                But he played down the prospects of Warburg Pincus acting as an aggressive consolidator, noting that it was “only occasionally that acquisition opportunities make sense” and that ETF players “tend to follow an organic growth pattern”.

                The Warburg Pincus deal follows BlackRock’s acquisition last year of Credit Suisse’s ETF business, which was widely seen as the first step in a broader consolidation process in Europe’s fragmented ETF market. But no further deals materialised even though competitive pressures in Europe intensified in an environment of sluggish growth last year.

                Inflows into European listed ETFs (funds and products) fell 40.5 per cent last year to $33.3bn, according to ETFGI, a consultancy. This was a big disappointment, particularly in comparison with the more mature US market where a wide range of providers enjoyed substantial asset gains.

                The challenges facing domestic European players have mounted as their larger US rivals BlackRock, State Street Global Advisors and Vanguard have all gained momentum in Europe. One senior ETF market-maker notes that banks in Europe have made considerable investments in their capabilities for trading ETFs but it is unclear if the volume of business being done can justify that spending.

                Deutsche Asset and Wealth Management (DeAWM), ETF Securities, ZKB, BNP Paribas (EasyETF), Commerzbank, Swiss & Global all registered net outflows last year, due in part to heavy selling of gold ETFs.

                DeAWM insists that underlying momentum for its ETF operations is strongly positive, blaming last year’s performance on a limited number of big redemptions from ETFs linked to the German Dax index by institutional clients taking profits on long held positions.

                But others are reticent to discuss the performance of their ETF operations or their long-term plans.

                Amundi, the Paris-based asset manager, has indicated it would be willing to consider an acquisition to accelerate growth for its ETF operations but it is the only player to have stated such ambitions publicly.

                Mr Kranefuss says he is surprised at the “very muted response” of European providers to competitive threats to their businesses.

                “While it is relatively easy to build an initial pool of assets, it can be challenging to build a truly sustainable business when the ETF manager is effectively trapped as part of a larger organisation,” said Mr Kranefuss.

                Other private equity players with asset management investments are thought likely to look carefully at Warburg Pincus’ strategy but observers question if they will have the patience required as it remains difficult to create value quickly in an ETF business.

                Deborah Fuhr, founding partner at ETFGI, said many European banks were re-examining how they were using their balance sheets and would question if funding underperforming ETF operations was an appropriate use of scarce capital.

                “There are a number of European players who might be asking if they should proceed in the ETF business in the long term,” said Ms Fuhr.

                New entrants eye uneasy alliances

                Posted on 31 January 2014 by

                Fidelity Investments runs businesses in fields as diverse as retail banking and hydroponic tomatoes, but when it came to launching exchange traded funds, it saw fit to ally with one of its fiercest competitors.

                Other late entrants into the US ETF market are likely to forge similarly uneasy alliances, given that the three biggest providers – BlackRock’s iShares, State Street Global Advisors and Vanguard Investments – control more than 80 per cent of assets and boast first-mover advantage in tracking the major indices, allowing them to pare fees mercilessly.

                  “The Fidelitys of the world understand they cannot compete with iShares, State Street and Vanguard,” says Richard Keary, principal of the consulting firm Global ETF Advisors. “They know they have to find some other formula to get in.”

                  Fidelity’s formula entails leveraging its distribution might in exchange for product support from industry leader BlackRock. Since 2010, its brokerage business has sold iShares ETFs commission-free under an exclusive arrangement.

                  Last year, Fidelity expanded on the partnership by launching 10 sector equity ETFs subadvised by BlackRock – effectively marking Fidelity’s long-awaited arrival in the ETF market. Fidelity maintains the agreements merely filled a gap in its product menu – passive sector investment – that it did not want to fill itself, freeing up resources for active fund development.

                  “Partnering with BlackRock from the subadviser standpoint made a lot of sense for the customer in that iShares obviously has been managing ETFs for a number of years on the passive front,” says Anthony Rochte, president of Fidelity’s SelectCo sector investment unit. “And it really allowed us to focus on what we do well, which is active management, and really get in the market and quickly deliver what our customers are looking for.”

                  Fidelity is collaborating with BlackRock on the development of managed portfolios built on ETFs, which are expected to launch soon. The company has also filed to launch active ETFs investing in mortgage securities and corporate bonds. Mr Rochte declined to comment on the possibility that Fidelity might launch active ETFs in partnership with BlackRock or other ETF providers.

                  Mr Keary sees Fidelity’s BlackRock tie-up as a shrewd trade-off. “They are leveraging their strength in distribution to allow some of these ETFs on their platform and at the same time creating new ETFs based on what their clients are asking for,” he says. But it is a trade-off. Typically, subadvisers in such arrangements will claim a share of the fund fees, coupled with a cash payment for services rendered, says Mr Keary.

                  MFS Investment Management, another US mutual fund powerhouse that had shunned ETFs, entered the market this year as a subadviser to a suite of ETFs from SSgA, the second-biggest ETF provider. SSgA is handling marketing, distribution and branding.

                  MFS views the SSgA rollouts more as new mandates for its longstanding subadvising operation that happen to involve ETFs, rather than heralding a full-fledged entry into the ETF market. “MFS does not have plans to get into the ETF business directly at this time,” says spokesman James Aber. “MFS believes in active management and saw an opportunity to leverage an existing capability to take advantage of a developing trend in actively managed ETFs.”

                  SSgA has recruited subadvisers before – last year, it launched a senior loan ETF subadvised by Blackstone Group’s GSO/Blackstone Debt Funds Management – and probably will again.

                  “It’s not a new model for us,” says Jim Ross, global head of SSgA’s SPDR ETF business. “We look at it as a platform to bringing best-of-breed in the marketplace, and if we can deliver that through a partnership structure, we will look toward that model.”

                  MFS is of course perfectly capable of marketing its own products, just as Fidelity knows how to manufacture and manage index funds. Lack of ETF industry scale, however, is not their only problem. They both also need to learn about the mechanics of running ETFs, which differ from mutual funds in the creation-redemption process, says Kris Monaco, head of ISE ETF Ventures, a division of the International Securities Exchange.

                  “Even larger firms need assistance in entering the market,” says Mr Monaco, whose business unit provides capital to ETF roll-outs in return for a share of revenue.

                  “When you look at the examples of MFS and Fidelity, the overarching issue for larger firms is that they’re very capable of creating and having ETFs listed, but they’re not wired the right way from an infrastructure point of view to make sure they get the broadest distribution possible [and also] get the funds efficiently operated on a day-to-day basis; that’s infrastructure that has to be built.”

                  Lifting the lid on the secrets of ETFs

                  Posted on 31 January 2014 by

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                  Eye on the prize: ‘much of the information available [to the private investor] is not very reliable’

                  Imagine investing in an exchange traded fund is like buying a car. When an institutional investor walks into a showroom, he or she wants to know the precise technical specifications of the car while a retail investor wants to know basic facts, such as miles per gallon and acceleration.

                  Unlike buying a car, however, institutional investors are spoiled for choice when it comes to technical ETF data sources: they can choose from five to six robust providers. These provide just the kind of information they require, such as assets contained by the fund, the security lending policies, how closely the ETF tracks the underlying index and the fees.

                    But it is much harder for retail investors to find reliable sources of basic information on an ETF that would be the equivalent of a car’s fuel consumption. Providers are only just starting to target the independent financial adviser market specifically, while fund supermarkets such as Hargreaves Lansdown have begun to publish some simple information, such as ranking ETFs by popularity. Alan Miller, chief investment officer of SCM Private, says: “Not only is there a huge shortage of information available to the private investor, but much of it is not very reliable.”

                    Michael John Lytle, chief development officer at Source, says: “It’s not surprising the bulk of the research on ETFs is targeted at the institutional investors as they make up 90 per cent of the market in the UK.”

                    The introduction of the retail distribution review, however, is starting to change that dynamic. “There is more focus in the UK on the retail investors buying and owning ETFs but the actual trading and holding of ETFs is still quite small compared with a fully developed market like the US,” says Mr Lytle.

                    It is not as simple, however, as making the information that institutional investors use available to the retail investor. Mr Lytle says: “Retail investors do not want to spend days poring over a 50-page data heavy document; they want information that can be easily assimilated on the best product to implement a particular investment idea.”

                    Talking to retail investors requires a different approach. “Rather than an emphasis on geeky information like tracking error, retail investors need to know the ETF spread so they can work out the total cost of buying and selling the fund, yet many websites fail to show these spreads,” says Mr Miller.

                    Adam Laird, head of passive funds at Hargreaves Lansdown, agrees: “Retail investors do not have the ability to negotiate with providers on costs so it’s important to see all the costs of investing up front.”

                    Equally important is the reporting status of the ETF – if the fund does not have reporting status then any gains risk being treated as income rather than capital gains tax, adds Mr Miller.

                    But there are positive signs that retail investors will soon have access to more information. “Third-party companies like Morningstar are starting to provide independent research on these products for retail investors and give individual funds star ratings,” says Mr Laird.

                    Ben Johnson, director of passive fund research at Morningstar, says: “Over time the appetite for more in-depth analysis of ETFs has only increased, in particular from IFAs.”

                    Mr Laird expects the research to become more sophisticated over time: “Companies will provide filtering tools to allow investors to see the key features of the product to use in combination with star ratings to determine which of these products is best for them.”

                    Mr Johnson adds: “As retail investor interest in passive products increases and these investors become more comfortable with these products, there will be a growing demand for research about the best way to implement these ideas and impact these exposures will have on a portfolio.”

                    It is likely, however, that these tools will continue to be add-on services provided by funds supermarkets, platforms, or existing research companies rather than an independent website.

                    Anthony Christodoulou, independent ETF consultant, says: “The companies that currently offer in-depth screening and selection of ETFs are institutional brokers or platforms and that’s unlikely to change as it would be difficult to make money from offering that service alone.”

                    ETF providers are convinced retail investors will demand more research on these products and that demand will be met, as they continue their push into the retail marketplace and the full impact of the RDR is felt, at least in the UK.

                    Michael Gruener, head of wealth and retail sales for iShares Emea, says: “If you look at the US market, where 50 per cent of the ETFs trades are made by retail investors, they have a range of extremely sophisticated tools at their fingertips.”

                    Those tools include concrete ETF recommendations, comparing different ETFs, asset allocation advice based on a risk and return profile as well as providing complete price transparency.

                    Even though the European market is very different to the US, there are reasons to be hopeful that retail investors will soon find it as easy as their US counterparts to find data on an ETF that is the equivalent of a car’s energy efficiency and acceleration.

                    Short-term bets and a long-forgotten use

                    Posted on 31 January 2014 by

                    It is often forgotten that exchange traded funds were developed to offer a cheap and transparent way for investors to dip in and out of a particular asset class quickly.

                    Only recently have these investment vehicles become popular as buy and hold instruments, particularly among US retail investors, because they are transparent and, in many cases, have become as cost effective as standard index trackers.

                      Institutional investors, however, have continued to use ETFs in a manner very close to their initial purpose: to invest in an otherwise difficult to access asset class or to make a short-term tactical bet.

                      The use of ETFs by institutional investors is also growing because of the rising popularity of multi-asset strategies such as diversified growth funds among pension funds, which often use ETFs to achieve their asset allocation targets.

                      Trends in the institutional investor space often bleed through to retail investors so it would be logical to assume that this use of ETFs to implement an asset allocation strategy could be picked up by retail investors. That is already starting to happen.

                      Frank Spiteri, head of retail distribution at ETF Securities, says: “Over the past few years, retail investors have become more aware of the products available to them and the traditional portfolio mix has started to shift.”

                      Just as institutional investors use ETFs for asset classes that are hard to access, so, too, do retail investors. Deborah Fuhr, managing partner at ETFGI, says: “For example, in the past, most retail investors could not access commodities because they cannot participate in the futures market, but exchange traded products have allowed them to do this.”

                      Mr Spiteri agrees: “Retail investors have moved from a traditional portfolio where 60 per cent is allocated to equities and 40 per cent to fixed income, to switching a significant proportion of the fixed income funds to commodities”.

                      Much of this drive towards a more experimental approach to asset allocation originated with independent financial advisers. “IFAs are much more cost conscious and are now looking at passive investments as a way of building portfolios,” says Mr Spiteri.

                      In the UK at least, this cost awareness is a direct result of the retail distribution review. But the RDR has also had another interesting consequence – the emergence of the self-directed investor.

                      “There are a number of private investors who do not have enough assets to justify them hiring an IFA,” says Mr Spiteri. “ETFs are ideal products for these investors because they are cheap and easy to use. Once they become comfortable with the asset class, they start to branch out from simple equity trackers and be more experimental with their asset allocation.”

                      For many retail investors, however, a move towards a more sophisticated asset allocation is likely to happen at one step removed. Firms are starting to offer retail investors access to a diversified, risk-targeted portfolio that uses ETFs as the underlying investment.

                      Anthony Christodoulou, independent ETF consultant, says: “There is an emergence of online ETF portfolio management tools which enable retail investors to build their own risk-targeted model portfolios at the click of a button.”

                      Incorporated in those strategies is another trick from the institutional investors’ tool box: the use of automated rebalancing of those portfolios.

                      “The automatic rebalancing tool is the real beauty of these types of portfolio. It ensures that investors buy low and sell high, as well as ensuring your portfolio doesn’t drift from your risk appetite,” says Mr Christodoulou.

                      Asset allocation is not the only way that investors are becoming more sophisticated in their use of ETFs. Adam Laird, head of passive investments at Hargreaves Lansdown, says: “Strategies that five years ago only institutional investors would have used are now being used by those retail investors who have become comfortable with ETFs.”

                      Such strategies include the use of interest-rate hedged products, as well as short and leveraged products.

                      “There are now 14 per cent more sophisticated ETFs available on our Vantage platform than there were a year ago,” says Mr Laird. “By sophisticated ETFs, we mean short or leveraged products, specialist asset classes such as commodities or other strategies that would not qualify as Ucits retail products.”

                      While retail investors are just getting to grips with the benefits of using ETFs to access a broad range of asset classes and the benefits of going short, in the future they will go one step further and use these products for tactical asset allocation.

                      Michael Gruener, head of wealth and retail sales for iShares Emea, says: “As the retail market becomes more sophisticated, advisers and self-directed investors will want to implement trading strategies, and ETFs are the perfect tool for these types of investment.”