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Eurex Group May 2014

InstitutionalInsights

Changing seasons, changing markets

Welcome to the first edition of InstitutionalInsights for 2014 – a new year and in facta new editor! We have left the dark throesof winter and brighter days are now here.As with the seasons, the markets move intheir cycles and we continue to see changesin sentiment, investor appetite and trends.The first few months of this year have notbeen any different – equity markets haveexperienced a good run but now we areseeing signs of fixed income bouncing

back, as are emerging markets after a tough few months, helped somewhatby the recent volatility spike in the region.Developments in regulation continue toroll out and the industry is on the steeplearning curve, adjusting and adapting.As always, the markets do not disappointin providing points for discussion and debate and we hope to cover a number ofkey, current aspects in the following pages.

In this edition, Katy Kaminski returns witha piece looking at the fast growing worldof ETFs. Since their introduction in 1993,the ETF market has seen rapid growthand not just in the U.S., as is the commonmisconception – interest and growth inthe European ETF market has explodedwith roughly USD 400 billion invested

EditorialCatherine Alexander

Andrew McCafferyGlobal Head of Alternatives,Aberdeen Asset Management PLC

Renaud HuckHead of Buy SideRelations, Eurex Group

Kathryn M. Kaminski, PhDDeputy ManagingDirector, Institutefor Financial Research (SIFR),Affiliated Faculty,Stockholm Schoolof Economics

Valeri SokolovskiPhD candidate in finance,Stockholm Schoolof Economics

Catherine Alexander Vice PresidentBuy Side Relations, Eurex Group

What is inside(tap to get there)

Editorial 1

Thought leadership 3

The short on shorting ETFs:The art of create to lend

Trading insight 7

Clearing insight 9

In conversation 11

Renaud Huck andAndrew McCaffery aboutthe impact of EMIR and other regulations

Market insight 17

Market insight 16

Simon MarksBrussels Correspondent, MNI

Institutional Insights May 2014

www.eurexgroup.com 2

and looks to continue that way. In partic-ular, Katy explores the concept of “create-to-lend” in the ETF market whereby ETFshares can be created and sold short,which offer several unique features thatprovide an incentive to invest and con-sequently is fuelling demand for ETFs.

For our interview in this issue I am de-lighted to welcome Andrew McCaffery,Global Head of Alternatives at AberdeenAsset Management, and Renaud Huck,Senior Vice President Buy Side Relationsat Eurex Exchange. Andrew was kindenough to join our Hedge Fund LionsDen initiative in 2013, as an industry“Lion” – listening to pitches from threeemerging managers and providing con-structive feedback and advice on how tosurvive in this ever complicated and com-petitive industry where greater barriersto entry in the form of regulation nowexist. Regulation seems to be the oneconstant in the industry right now; weknow it is here to stay; it is more a matterof how to deal with it. As a leading assetmanager, Aberdeen has to be aware ofall the new rules and Andrew discussesthe impact of EMIR and other regulationson his company and the industry as a whole, while highlighting the strategieshe thinks will be the flavour of 2014 –an insightful interview with a leading figure in the industry.

In “Trading insight”, Renaud Huck returnsto the fixed income world, specificallythe Euro-Bund, Bobl and Schatz Futures in our product suite since they are rankedamong the most liquid fixed income derivatives in the world and create many trading opportunities for marketparticipants.

In “Clearing insight”, Renaud looks at thehot topic of segregation and portability,which is a sensitive issue for investorsfollowing such high profiled defaults asLehman and MF Global. Both buy andsell side clients now demand higher pro-tection from co-mingling of assets andmisuse of assets and thus individual segre-gation is requested, which Eurex Clearingintroduced in August 2011. Separately,at the time of writing this editorial we received the much anticipated news thatEurex Clearing has received authoriza-tion as a Qualified Central Counter Party(QCCP) under EMIR. Well done to the team!

Lastly, Simon Marks, Brussels Corre-spondent at MNI, looks at the new ruleadopted by the European Commissionon 24 March aimed at stamping out banksecrecy and tax evasion. This rule hadbeen in the pipeline for five years butfaced opposition from Luxembourg andAustria with fears their banking systemswould be at a competitive disadvantagewith tax havens like Switzerland, until itwas recently revised.

I hope you enjoy this edition of Institutional Insights. As always, I welcome any questions or commentsyou may have regarding the content of the magazine so please do get intouch with any thoughts: [email protected]

Catherine, on behalf of the team

Catherine Alexander

Vice President,Buy Side Relations, Eurex Group

http://www.eurexgroup.com/group-en/newsroom/hedge-fund-lions-den/




Thought leadershipKathryn Kaminski and Valeri Sokolovski

Short selling in ETFs Perhaps even more interesting, ETFs alsoprovide a new avenue for taking shortpositions. Unlike individual stocks or securities, ETFs can be easily sold shortand they have never been subject to the “uptick” rule. Short selling accountsfor a non-negligible proportion of the ETF trading volume. For example,the average short interest for U.S. common stock is typically less than 2 percent, while short interest in ETFsis typically around 10 percent. Unlikecommon stock, it is not unusual thatshort interest percentages of shares outstanding are over 100 percent.1

ETF short sales are often made to reduce,offset, hedge, or manage risk. Highly liquid ETFs, such as the Spider (tickerSPY) or the Cubes (ticker QQQ) whichtracks the NASDAQ 100, are in direct competition with index futures.

For the specific case of shorting ETFs,there are several unique features whichmay provide some incentive for their use in short selling. In most cases, man-agement fees drag performance. For thecase of shorting ETFs, management fees

Kathryn M. Kaminski, PhD

Deputy Managing Director,Institute for Financial Research (SIFR),Affiliated Faculty, Stockholm School of Economics

Valeri Sokolovski

PhD candidate in finance,Stockholm School of Economics

The short on shorting ETFs:The art of create to lend

Similar to stocks, Exchange Traded Funds(ETFs) or even more broadly ExchangeTraded Products (ETPs) are portfolios of securities which are traded on an ex-change. Since their introduction in 1993,the ETF market has ballooned to a size of over USD 5 trillion. Currently, close to40 percent of all U.S. trading volume is in ETFs. The oldest and largest ETF, the SPDR S&P 500 ETF (also known asthe “Spider”), has a colossal market sizeof USD 150 billion making it the most liquid and actively traded security in theworld. Although ETF growth has beenstrong in the U.S., the European ETFmarket is not far behind. Interest andgrowth in the European ETF market hasexploded with roughly USD 400 billioninvested. Despite its humble origins almost 20 years ago, ETFs have becomea formidable asset class. Today’s ETFmarket offers both breadth of optionsand depth in volumes to such a pointthat futures contracts are even offeredon individual ETFs. The ability to sellshort, a wide array of investment options,and the overall ease of use of ETFs is fuelling demand. Outside the largerhighly liquid ETFs, more specialized andesoteric ETFs are emerging to fill this increasing demand.

1 A short interest percentage above 100 indicates that the average share the fund has outstanding has been lent and re-lent several times with a round-robin effect.


2 For example, there have been cases where a hedge fund may short sell an ETF and establish a long position in all but one or possibly several hard to borrow securities. This net portfolio allows the fund to short only the difficult to short securities.


Figure 1 presents a diagram for the“create-to-lend” process. In standardshort selling transactions, a short sellerapproaches a prime broker to borrow a security to short sell. The prime brokersources this security from a lender (suchas an institutional investor) in exchangefor collateral and a fee. The fee is passedonto the short seller. In the case of an ETF, the process is similar except thatthe actual ETF is somewhat more difficultto borrow (for example due to low insti-tutional ownership). Instead, the primebroker can borrow the underlying securi-ties and pass them onto the ETF provider.The ETF provider can create new ETFshares which can subsequently be givento the short seller.

On a daily basis, the number of ETF shares can change through the “creation-redemption mechanism”. By simply deliv-ering a physical bundle of securitieswhich corresponds to the underlying ETFportfolio to their broker, new ETF sharescan be created. Similarly, by deliveringETF shares to a broker, ETF shares can be redeemed for an underlying portfolioof securities. Creation and redemptionorders are at a minimum of 50,000 units.They must be placed at the end of trading day and they carry a small fixedcost per creation or redemption irre-spective of the size of the transaction.The creation and redemption mechanismboth increases liquidity and ensures thatan ETF never deviates too far from its net asset value (NAV). Gastineau (2004)aptly states “the theoretical maximumsize of the typical ETF, given this in-kindcreation process, can be measured in

provide a tail wind. In addition, the shortselling of ETFs provides a more cost effec-tive avenue than short selling a group ofindividual stocks. The individual short sellof each security as a group can be morecostly and time consuming.2 Althoughsomewhat counterintuitive, the numberof shares outstanding for an ETF can be increased at a moment’s notice. This makes short sellers of ETFs largelyimmune to supply constraints. Market Makers in ETFs can easily create addi-tional shares exclusively for the purposeof lending them to short sellers. This process is often called a “create-to-lend”.

Figure 1: A schematic for the “create-to-lend” process

Since their introduction in 1993, the ETF market has ballooned to a size of over USD 5 trillion. Currently,close to 40 percent of all U.S. trading volume is in ETFs.

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Demonstrating create-to-lend: a casestudy of the U.S. financial ban of 2008On 18 September 2008, the U.S. Securitiesand Exchange Commission (SEC) tempo-rarily banned short sales in 797 financialstocks. This ban was enacted on 18 Sep-tember and subsequently lifted on 8 Oc-tober. ETFs were, however, exempt fromthis particular ban. Karmaziene and Sokolovski (2014) show that a substantialportion of shorting volume moved to the most liquid SPY (Spider) ETF duringthe ban on short selling in financials. For this particular period, liquidity was a serious issue even for ETFs. As a result,short selling in financial ETFs was sub-stantially more difficult.3 For the periodbefore, during and after the short sellingban, Figure 2 plots the value and shareof stocks on loan for the SPY. Immedi-ately after the ban announcement, shortinterest in the SPY began increasing. At one point, close to USD 5 billion newshort sale positions were created using theSpider ETF. For the period before, during,and after the short selling ban, Figure 3plots the total market capitalization andtotal number of shares for ETFs. Drivenby rapid share creation, market capitali-zation of the SPY grew during the ban –arguably to fill the corresponding rise in short selling demand. Combining theeffects in both Figure 2 and Figure 3,

3 The size and depth of financial ETFs most likely made short selling more difficult.

hundreds of billions or even trillions ofdollars of market value”. This mechanismallows for ETF shares to be created for the sole purpose of facilitating shortselling. “Create-to-lend” is a unique feature of exchange traded funds.

Despite this, the “create-to-lend”processremains somewhat misunderstood. Putinto more simple terms, if a prime brokeris faced with a request to borrow ETFshares which are not readily available,the broker can dip into the pool of under-lying securities and create new ETF shares. These shares are created andsubsequently lent out to a short seller.Since ETF providers are often active participants in the securities lending markets, the availability of the underlyingsecurities to borrow is seldom an issue.The creation-and-redemption processmakes it possible to create shares for the sole purpose of short selling or create-to-lend. In a recent academic study, Karmaziene and Sokolovski (2014) uncover evidence of this behaviour during the 2008 shorting ban for U.S. financial securities.

Short selling accounts for a non-negligible proportion of the ETF trading volume. For example, the average short interest for U.S. common stock is typically less than 2 percent, while short interest in ETFs is typicallyaround 10 percent.



this demonstrates how shares were essen-tially created for the sole purpose of shortselling. This case study demonstrateshow the create-to-lend mechanism inETFs facilitated the short selling duringthe U.S. financial ban. This was obviouslyneither anticipated nor welcomed by the regulators.

The short on shorting ETFsDespite the extreme example in Karmaziene and Sokolovski (2014),it demonstrates how the create-to-lendprocess works and that it worked even in a rather difficult moment for short selling. Outside the world of derivatives,short selling in ETFs provides a new avenue for investors to short sell with relative ease.

The ETF market has grown substantiallyover the last 20 years. Product offerings,market depth, and liquidity continue toexpand in ETF markets to fill the increasein demand for this type of product. Although many investors use ETFs for investment, short sell interest is non-negligible. The unique creation-and-redemption mechanism provides newavenues for using ETFs for short selling.

References BlackRock. ETF Landscape. IndustryHighlights. 2013.

Gastineau, G. L., Is Selling ETFs Short a Financial Extreme Sport?, in Frank J.Fabozzi, ed., Short selling: strategies,risks, and rewards, John Wiley& Sons,2004, chapter 4, pp. 37–57.

Karmaziene, E. and Sokolovski V. L., Exchange Traded Funds and the 2008Short-Sale Ban, Swedish House of Finance, working paper, 2014.

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Figure 2: Value and short interest for the S&P500 SPY ETF from August to October 2008

Figure 3: Market capitalization and shares outstanding for the S&P500 SPY ETF for August to October 2008

•Hedging portfolio valueSale of futures /buying of puts or collars to protect portfolio value• Transition management /tactical assetallocationSale of equity index and simultaneouspurchase of fixed income futures to assist in the reallocation of funds fromequities to bonds or vice versa• Portfolio beta /duration adjustmentPurchase/sale of fixed income futuresto adjust portfolio beta/duration• Alpha durationSale of fixed income futures againstpurchase of bonds to isolate or negatemarket risk• Portfolio yield enhancementSale out-of-the-money options to benefit from limited market moves/range bound market conditions

Eurex Exchange’s Euro-Bund, Bobl, Schatz Futures enjoy consistently highopen interest. Therefore, they rankamong the most liquid fixed income derivatives in the world and attract a broad range of market participants.

Eurex Exchange’s Euro-Buxl® Futurescontract is particularly attractive to fundmanagers undertaking liability-driven


Trading insightRenaud Huck


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Euro-Bund Futures: volume & open interest (in millions)

Renaud Huck

Head of Buy Side Relations,Eurex Group

Eurex Exchange’s German fixed incomefutures and options are the benchmarkfor the European yield curve and serve asthe standard reference when comparing,evaluating and hedging interest rates in Europe. These form the core of our interest rate product suite and providethe market with instruments for triple A-rated Eurozone debt.

Trading opportunities Investors are able to use these products to create the following trading opportunities:

• Cash equitizationReinvestment of coupon income andinvestment of new flows or funds generated via asset sales by purchasingfixed income futures

the advantages offered by a listed deriva-tive product – particularly cost-efficientstraight-through processing.

For the Eurex Block Trade facility, the transactions are subject to minimumBlock Trade thresholds.

To facilitate basis trading, the Exchangefor Physicals (EFP) and Exchange forSwaps (EFS) facilities allow for simulta-neous purchase (sale) of futures alongwith a sale (purchase) of the underlyingbond, vanilla swap or another futurescontracts. Such transactions are not sub-ject to a minimum number of contracts.

Mitigating risks through CCP clearing With Eurex Clearing, Europe’s leadingClearing House for securities and deriva-tives transactions, as the central counter-party to all trades, you benefit from miti-gated counterparty risk. Eurex Clearingprovides effective CCP, risk mitigationand collateral management services thusimproving operational efficiency as wellas market safety overall.



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strategies. The 30-year product allowsthem to effectively manage risk by alle-viating duration mismatches between assets and liabilities whilst maintainingtheir asset allocation strategies.

Trade Entry services With the aim of complementing the OTCinterest rates derivatives market, Europeanfixed income derivatives listed at EurexExchange can also be traded outside theorder book, and subsequently booked to Eurex Clearing via the Eurex TradeEntry facilities.

Much of Eurex’s fixed income optionsvolume is generated through the EurexTrade Entry offering. This means that,when it comes to position keeping andthe clearing and settlement of trans-actions, investors benefit from all of



Clearing insightRenaud Huck

Segregation and portability have becomeincreasingly important because of client(buy side) demand and regulation.

After the Lehman and MF Global defaults,the demand for segregation increased as clients have faced issues around un-certainty of porting, double funding, mutualization of client and ClearingMember risks from co-mingling of assetsand potential misuse of client collateral.

EMIR article 39 requires CCPs and Clearing Members to offer at a minimumomnibus and individual segregation models.

ESMA finally provided clarity that indivi-dual client segregation requires the segregation and portability of the actualclient assets. Models which merely segregate the value of collateral due tothe accounts of clients, “do not meet the requirement to offer individual client segregation” (ESMA Q&A, 5 August 2013).

Individual models are intended to securethe positions and the collateral assets at all times in the event of default of a Clearing Member or other clients ofthe Clearing Member.

Some local investment laws require asset managers to segregate assets at the fund level to prevent co-mingling

of positions and assets between the clearing broker, other clients and funds of the same fund company.

Both buy side and sell side clients are requesting protection from additionalrisks including transit and liquidation risk.

Elementary Clearing Model (ECM) The ECM enables Clearing Members todistinguish the positions and assets (collateral) held for the account of theirclients (omnibus client segregation) fromtheir own collateral and positions.

Historically, the ECM was Eurex Clearing’sdefault net omnibus model for listed derivatives. This model offers an EMIR-compliant solution that will come at noextra operational complexity to ClearingMembers.

What are the attributes?

• Undisclosed client positions can be segregated into one or more positionsaccounts, i.e. net omnibus segregation.• Disclosed clients can be registered underthe ECM. Registered Non-ClearingMembers (NCM) and Registered Cus-tomers (RC) have their own positionaccounts (and can execute listed deriva-tive and OTC transactions), which aremaintained on a gross-position keepingbasis and initial margined on a net basis per account. This set-up effectivelyallows gross margining for NCMs and RCs, with a single commingled collateral pool.

Renaud Huck



Institutional Insights December 2013

• 4 percent capital charge (subject tofinal rules).• Porting is possible where all clients (undisclosed and NCMs/RCs) agree toport to a single replacement CM.• Inherent in this clearing model are fellow customer, liquidation, replace-ment and transit risks.

Where are the positions?Separate positions accounts are main-tained to segregate proprietary (P/M Account), client (A Account) and NCM/RC positions.

Individual segregation Individual Clearing Model (ICM) providesfull physical segregation of client’s assets and positions and allows portingon Clearing Member (CM) default.

Eurex Clearing introduced the ICM in August 2011. The ICM provides CMs with:• Full physical segregation of actual assets• Very likely porting• Efficient pass through or direct delivery& withdrawal of the client’s collateralto the CCP and• Compatibility with industry standardand bespoke CM documentation

What are the attributes?

• 2 percent capital charge (subject tofinal rules)• Segregation and porting of client’sactual collateral• Direct delivery of securities to separatephysical accounts at the CSD or tagged• Porting window can be extended to 5 days under our interim participationconcept.

• The ICM will have a higher degree ofoperational complexity because CMswill individually segregate clients at the CCP level (therefore offering thegreatest level of protection envisagedunder EMIR).• Eurex Clearing will not charge addi-tional fees based upon segregationmodel chosen.

ICM ensures maximum portabilitythrough individual position and collateralaccounts, as well as it offers alternatives in a default situation and facilitates the handling of segregated clients afterclose-out netting.

There are three options an NCM/RC canchoose from:

1. To receive a final pay out of the cashsettlement amount, the liquidationprocess begins.

2. Immediate re-establishment undernew relationship (with a back-up CM)

3. To become an Interim Participant andbenefit from a 5-day window to havethe positions and collateral ported to a new CM.

Thanks to Eurex Clearing’s ICM, the highest level of collateral protection andposition portability is given to the buyside community in the case market con-ditions were to become challenging andit is specifically, in these conditions thatbuy side clients will need a reliable OTCclearing model which will help them to protect and port their positions andcollateral.



In this issue, Renaud Huck talks to Andrew McCaffery, Global Head of Alternatives at Aberdeen Asset Manage-ment PLC, about the impact of EMIRand other regulations on his companyand the industry as a whole.

Huck: Andrew, can you tell us a bitabout yourself?

McCaffery: Yes, of course. I am currentlythe Global Head of Alternatives at Aber-deen Asset Management. At Aberdeenwe have moved all of our alternativestrategies and illiquid asset investmentinto one division. Our goal is to deliverour capability in all these areas througha combination of direct and indirect allocations, which includes hedge fundstrategies, private equity, real estate andinfrastructure investments, and access to other niche strategies, to our clients. We are looking to be a “trusted adviser”in this process and work with investors,whether as a manager or adviser capacity,to deliver effective solutions to meettheir objectives and needs. Fortunatelywe work closely with our Investment Solutions colleagues to incorporate tradi-tional and non-traditional investmentideas into a range of client portfolios aswell as those managed purely in alter-native strategies and assets. My back-ground is not entirely an asset manage-ment one, I started my career in thebond markets in the early to mid-1980s.

Through that period I worked primarilyfor investment banks and finished thatpart of my career as Managing Directorat UBS where I was responsible for the interest rate derivative business inEurope, but also ran the global hedgefund coverage that we provided as a firm across the breadth of investmentbanking services. When I left I looked atvarious ideas, and I decided upon a roleas CEO for a fund of hedge funds busi-ness. Since then I have been involved in the asset management side of the financial industry, with Aberdeen AssetManagement today, and prior to my role with BlueCrest Capital Managementfor just under three years.

Huck: You are the head of one of the biggest asset management firms,how would you define the profile of Aberdeen Asset Management?

McCaffery: I am just responsible for a small part of it! We are very fortunatein that one of the great things aboutAberdeen has been its continuity andstability through its first thirty years,driven by the fact that we’ve had a verystrong senior management team. OurCEO, Martin Gilbert, is known as a verycharismatic and successful industry

In conversationRenaud Huck and Andrew McCaffery

Renaud Huck


Andrew McCaffery

Global Head of Alternatives,Aberdeen Asset Management PLC

figure, and it is important to bear inmind that he, and other key members of the management team, are still withthe firm today having been here at the beginning and still managing the larger business today. Others such as the Head of Equities, Hugh Young, andAnne Richards, our CIO, bring a greatdeal of value in their investment and

business skills. It is also reflected in the continuity they also bring to the firmoverall, along with the overall manage-ment team, to support and develop the company’s culture.

One of the key things for us is definingour profile and who we are as a firm. As you may be aware we went through,and are continuing, a high profile brand-ing campaign last year to present our-selves as “simply asset management”and the principle of asset managementbeing all we do. We are not affiliated to any other organization; we are inde-pendent with a sole focus on asset management and providing a range ofinvestment capability and asset manage-ment services to our clients. The cultureof the firm is, in my opinion, a very important part of the firm. We are long-term oriented in thinking, very focusedon our own fundamental research andour proprietary due diligence processes –whether an equity that we are buying or

a hedge fund manager we are allocatingto – and it is important to understandthe management of the company, haveconfidence in their approach and devel-op a strong, professional relationship. In the specific case of hedge funds wemust have confidence in their ability torepeat their process, and to demonstratethe ability to make money for us.

Huck: What are your aims for AberdeenAsset Management and how would you like Aberdeen Asset Managementto be regarded in the 21st century?

McCaffery: First and foremost, none ofus know exactly what the future holds.One of the skills of Aberdeen has beenthe ability to adapt and build out busi-nesses through time into a very strongplatform, which can generate organicgrowth and integrate acquisitions effec-tively. The performance of the companyin recent years shows our ability to generate investor confidence and in-creased asset inflows. The deal to acquireScottish Widows Investment Partnership(SWIP) at the beginning of April reflectsour ambition and our strength to recog-nize opportunities to become a moresuccessful asset manager. Obviously,given my personal bias, I would love tosee Aberdeen recognized as a broader,more diversified asset management busi-ness and to be seen as a premier alter-native investment provider within that.The SWIP acquisition is a very positivemove in that direction for the firm over-all and within the Alternatives Division.



“One of the key things for us is defining our profile and who we are as a firm.”

This will take the building blocks ofclients perceiving us as a global, full service investment manager with a well-resourced and clear structure to deliverthe capability we have and that any investors can utilize. One of the keythings Aberdeen has built is the strongculture that can sustain this. Anotheraspect will be our ability to manage andadapt as regulation changes significantly,as this will continue to influence howwe manage our business and how weinteract with clients. Also, the nature ofhow investors approach their investmentneeds will develop further, in terms ofhow capital will flow as a whole, whetheracross asset classes and/or differing alter-native strategies, the demands aroundmanaging their portfolios will continueto evolve.

Aberdeen would like to think that throughthe 21st century we will continue toevolve with our clients, and hopefullyeighty plus years from today the companywill continue to demonstrate the abilityto respond and deliver for our clients –and that the highest quality service andtop rated performance.

Huck: One word is on everyone’s lips –EMIR. How does it impact you?

McCaffery: As an asset managementfirm that transacts in the exchange-tradedand OTC derivatives markets and has

a large European presence, then it hashad a significant impact. We have hadto commit the necessary resources to understand and comply with the initialreporting requirements, and the longer-term record keeping needs demanded. I think that every firm has found certainchallenges with this, but it is now inplace and we are aware of our obligationsto meet the regulations in the financialmarkets that we invest and trade in onbehalf of our clients’ portfolios. It is onething capturing and reporting informationand data, but it is also important to understand why these regulations havebeen created. The after effects of the“Global Financial Crisis” (GFC) has produced some natural consequencesand the way regulators have respondedin this example is by seeking muchgreater transparency in some markets as a start. The burden on the businesscan be notable, with increased resourcesrequired, but it is part of the environ-ment we now have to contend with.However, it is something we have to incorporate as an issue for all partici-pants, and key for us is to ensure thatour clients are confident, comfortableand continue to receive positive resultsfrom us, whatever the reporting require-ments and other demands end up on the regulatory front.

Huck: What is your reaction when yousee regulation whether it be MiFID,AIFMD, EMIR, DFA piling up in front of you?

McCaffery: I think that the key reactionis to appreciate that this is part of a process which is still flowing out from



“We are not affiliated to any other organization; we are independent with a sole focus on asset management and providing a range of investment capability and asset management services to our clients.”

a very large shock to the system, i.e. the systemic shock waves from the GFC.This was a very large shock to regulators,as well as to the marketplace, and theyhave had to adapt as a consequence.The evolution of the regulations is con-tinuing at a considerable pace. However,key for us is the opportunity to have a dialogue with regulators, across various

jurisdictions, and participate in discussionplus understand what the regulator islooking to achieve, and assist the regu-lators by giving measured and usefulinput throughout the process. In this waywe are not only being a “good citizen”but we are developing an understanding of the regulators goals and can provideconstructive perspective back on theirpotential impact, intended and unin-tended. The harsh reality is that all usersof financial markets, and especially managers of investors assets, will havean increased cost burden in a variety of ways but we need to adapt quickly,deploy the necessary resources to overcome initial difficulties and create

efficient environments to ensure ourclients can continue to work with a highdegree of confidence.

Huck: Moving on towards the experienceyou had with The Hedge Fund LionsDen (HFLD). What did you take fromsuch an initiative?

McCaffery: First and foremost, it was veryenjoyable! Enjoyable because it was greatto have the opportunity to be involvedin something that I think is making a large step forward for promoting newand emerging hedge fund managers.Eurex and Hedge Funds Review shouldbe commended for bringing to light newmanagers and promoting both educationand a constructive profile for the industry,plus the challenges emerging managersface in the industry today. The evolution-ary nature of the hedge fund industry is important to maintain and develop,as it has felt threatened in recent times.However, part of this is a maturing ofmany businesses still labelled“hedge fundmanagers”. They are, or are becoming,asset management firms with a platformand multiple products and funds to offer.Barriers to entry have increased for new managers, partly as a result of theincreased regulation, but also the addi-tional costs of starting with “institutionalstyle” infrastructure to attempt to attractinstitutional investor flows. Putting thefocus back onto the value and quality ofsome of these people was, in my opinion,a very important aspect that was high-lighted in HFLD.With Lord Fink impartingknowledge from his extensive experience,Luke Ellis giving thoughtful and valuable



“Barriers to entry have increased for new managers,partly as a result of the increased regulation, but alsothe additional costs of starting with “institutionalstyle” infrastructure to attempt to attract institutionalinvestor flows.”



insights throughout, and hopefully myinput also adding some value to the process, there was an opportunity forpeople to hear and see aspects of adviceand discussion that could prove veryuseful for them. Overall, it is importantto take away that the challenges are significant but a clear business strategyand investment approach, a stablestructure and the ability to produce good returns, will entice investors!

Huck: The series was showcasing emerging portfolio managers; do youthink that it is an area of strong development for the asset manage-ment industry?

McCaffery: I hope so. However, it hasbeen a challenging environment and the alternatives, for example where a talented trader joins a larger “plat-form” firm, have become more attrac-tive. Stepping back, it is not just about a trading capability though, it is alsoabout being an entrepreneurial businessventure and the appeal and excitementattached to this element.

It will be important to see growing capital made available again to new and talented managers, and there aresome signs of hope I will come on to.However, as I have stated, the process to move out “on your own”, and thebarriers attached, have become moreonerous. Also, investor activity, beingmainly institutional in nature and oftenconsultant led, has produced very largeand concentrated flows into a limitednumber of managers, with little “trickledown” effects to note today.

Being more constructive for the future,last year many hedge fund portfolios,e.g. several FoHF products, have notableoutperformance versus the headline broadhedge fund indexes of single managerperformance. This raises the likelihoodof value being found outside the largermanagers and gives some hope that capital could flow again throughout theuniverse rather than just to the very largest firms. The jury is out, but thereare some signs of life. Overall though, I am excited to see that we have somenew managers, with excellent new funds,that are not just on large platforms. I hope ideas like HFLD, and improvingrecognition of small/new manager performance coming through, will givethe emerging manager category moreprofile and will provide the momentumfor reinvigorating this entrepreneurialand dynamic sector again.

Huck: What type of strategy do youthink investors are looking for?

McCaffery: There has not been one strategy in particular, but there havebeen trends in hedge fund strategy selection and broader investor needsprompting renewed activity in someareas. Following on from a very strongdeveloped equity market environment in 2013, which prompted greater flowsinto long-biased equity strategies, long/short equity strategies and kept capital



moving into “activist” event-driven exposure, we are now seeing subtlechanges. First, with dispersion at a stockand sector level that have been attractive,there has been a move into more con-servative managers, with an emphasis onless equity “beta” and more on the activemanagement of short as well as longstock exposures. We have also seen moreflows towards Europe, as sentiment hasimproved, with some allocations fromother strategies but also from U.S.-orientated exposure, and other developedand developing equity market exposure.Overall, anything with a degree of “beta”has done well but with this kicker and sodispersion, so some hedge fund managersreally stood up. This is looking back atmarkets, however looking ahead, thechallenge will be the degree to whichthat dispersion is maintained so the stockpicking, the idiosyncratic performanceand the opportunities around that con-tinue in quite the same vein. I think forthe moment they can continue, so thosemanagers who demonstrate the abilityto manage their portfolio risk selectivelyand efficiently will do well. However, it is something to monitor closely, alongwith overall beta risk levels, as marketsmay see greater tests of the positive expectations that had been built intomarkets. What will also be interesting at some point through this year is thedegree to which global macro and longvolatility-biased strategies, show signs of stabilising, and even picking up. Basically, putting some protection, andtrue convexity, into the portfolio may finally be worthwhile and reasonablywell-priced from here.

In collating these thoughts, I would sug-gest we are slightly wary about increasingthose exposures that would give highermarket beta-style risk. When we add inthe conversations we are having withmany investors it is interesting to see“diversification” being brought up, butversus bond risk as much as equities, which is an interesting challenge for several hedge fund strategies to considerand build a portfolio around. The othertopic is general “protection”, someagainst markets seeing losses and someagainst longer-term concerns around deflation or inflation. Again, severalhedge fund strategies, such as those that are long volatility-biased, couldprove interesting.

Huck: What type of strategy is Aberdeen Asset Management interestedin for 2014?

McCaffery: Well, I would highlight a move towards fundamental conserva-tive style long/short managers, so againtaking advantage of that dispersion Imentioned earlier but avoiding the lighterlevels of direct market risk. We havealso maintained exposure to mortgage-backed relative value and credit, struc-tured credit especially where possible,with fixed income relative value featuringhighly. We think discretionary globalmacro, where managers are very nimbleand manage capacity very conservatively,



About the intervieweeAndrew McCaffery is the Global Head of Alternatives, responsible for all alternatives globally, including hedge funds, private equity, infrastructure and property multi manager. Andrew joined Aberdeen in 2011 from BlueCrestCapital Management, where he was a founder member of the Alignment Investors division. Andrew joined the investment industry in 1983, and hasheld senior roles in fixed income, capitalmarkets and asset management prior to joining Aberdeen.

and deploy an opportunistic trading-orientated approach, can be successfulwith the increasing opportunities appearing across various markets.

However, as per my broader commentsbefore, as we enter the second quarter,we are starting to get a little bit morecautious. Whether activist event-driven,more aggressive equity long/short oreven mortgage-backed linked exposure,we are looking to book good relativegains and tone down some of our riskprofile where we can. We are very warythat if markets not only started to stall,with global liquidity declining (read Fed

actions) and uncertainty over asset pricing increasing as position risk hasbeen built to considerable levels again,but saw more concerted losses, then the environment could deteriorate quitequickly as market-based liquidity, e.g.dealing spreads took a toll on tradingactivity and risk management. For now,becoming more concerned about therisks to some managers in more marketsensitive strategies, but not completelyavoiding risk, just taking down and building a little more protection forportfolios where we can.



Austria due to fears their banking systemswould be put at a competitive disadvant-age when compared to tax havens suchas Switzerland.

But both Luxembourg and Austria agreedto adopting the new rules at a summit inBrussels mid of March after receiving as-surances from the European Commissionthat Switzerland and other tax havens

Market insightSimon Marks

Simon Marks

Brussels Correspondent,MNI

Europe adopts new rules tocombat bank secrecy

The European Commission adopted newrules in March aimed at stamping outbank secrecy and tax evasion more thanfive years after it originally made the pro-posal to member states.

The proposal, which obliges all 28 mem-bers of the European Union to share information on interest payments so theycan properly tax their citizens, has foryears been opposed by Luxembourg and

respected,” Semeta said referring to the concerns raised by Austria and Luxembourg.

“I believe they were particularly encour-aged by the report that I gave to financeministers on the progress we are makingin negotiations for stronger tax reviewswith our closest neighbours. Switzerlandand the four other countries (Liechten-stein, Monaco, Andorra and San Marino)now accept that an automatic exchangeof information must be at the core of relations with the EU in taxation.”

Semeta said talks would continue withthese countries on bank secrecy with the aim of reaching solid conclusions before the end of the year.

EU officials say that billions of euros intaxes are lost every year in the Eurozonedue to funds and individuals placingmoney in offshore jurisdictions after exploiting loopholes in the EU’s originaldirective on savings taxation. In 2009,member states reported EUR 2.3 billionin interest payments, though the actualamount paid is believed to bemuch higher.

“It is in general very difficult to saysomething about the size of the marketsand how they have developed. And it’svery difficult to say how much of this is due to the savings directive,” said an EU source, who spoke to reporterson the condition of anonymity.



are now on the same page when ex-changing information on the amount ofinterest paid to account holders.

“After 6 years of hard discussions, the EUsavings tax directive was formally adoptedby member states this morning,” said Algirdas Semeta, the EU’s commissionerfor taxation and customs, at a press con-ference in Brussels. “Loopholes exploitedby evaders will be closed.”

The EU’s decision to adopt the new rulescomes as the Organization for EconomicCo-operation and Development is puttingthe final touches to global standards on the free flow of banking information.G20 countries are expected to endorsethe OECD’s rules on global standardswhen finance ministers and central bankdeputies meet in September.

The Commission decided to revise therules after identifying a widespread useof offshore jurisdictions as investment locations, a situation that led to billionsof euros in lost revenues for countries at a time when the sovereign debt crisisrisked crippling regional economies.

The new rules now cover new types ofsavings income, and products that generate interest or equivalent income.This includes life insurance contracts, as well as a broader coverage of invest-ment funds.

“I know that this file is of enormous national significance for them and I am glad that they are now reassuredthat their interests are protected and

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It remains to be seen how successfulcountries will be in abiding by the newrules, though there are talks underway inBrussels to implement harsher penaltieson those that do not disclose the correctinformation.

“I don’t think at this stage I would specu-late on other types of measures thatcould be envisaged, though I recognizethe European Council has made referenceto this in the provisions. But I think it isclear that we are definitely not at thisstage today,” the EU source said regardingpunishments for non-compliance.

Since the end of the 1990s, the OECDhas encouraged tax havens to exchangeinformation with other countries on

the basis of bilateral tax treaties, but until2008 most tax havens declined to signsuch treaties.

Though some countries such as Switzer-land and France have since signed treatiesto exchange information, tax evadershave easily responded by transferringtheir funds to havens that have no treatywith their home country.

Member states must implement the revised rules by January 2017.

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