Financial Standard Best Practice Series Patrick Liddy Date 28 th - PowerPoint PPT Presentation

Financial Standard Best Practice Series Patrick Liddy Date 28 th June 2011

The material that follows is a presentation of general background information about IE Group’s activities current at the date of the presentation 28th June 2011. It is information given in summary form and does not purport to be complete. It is not intended to be relied upon as advice to investors or potential investors and does not take into account the investment objectives, financial situation or needs of any particular investor. These should be considered, with or without professional advice when deciding if an investment is appropriate.

Agenda Leakages in FX and cash does it really matter? • What is the total cost to a fund? • Different methods of execution • Benchmarking • How it can improve • Conclusion •

Does it really matter? Many funds receiving 3 percent below the OCR • Common balances of $100 – 250 mill • Foreign exchange generally turned over four times • US funds suing custodians •

Does it really matter? What is the total hidden cost to members? • Estimates from Mercers and Russell • Needs to be measured • Increase in return and decrease in risk •

Does it really matter? The SEC, Europe’s MiFID and APRA all have regulatory • requirements around “best execution” of FX deals Cooper report on costs • “Best execution” is also a standard clause in IMA’s • Total counter party exposure • 6

Does it really matter? For an international portfolio, the currency trades can be every bit as • important as the equity trades Managers tend to focus on getting the equity trade execution right • and the FX execution gets forgotten Implementation leakage due to inefficient FX execution is a very • real cost 7

The different methods of execution 1. Third Party Panel Fund negotiates rates with a third party panel of FX brokers • and cash providers Creates pricing tension and allows full visibility of rate prior to • execution of cash and FX Requires FX and cash agreements to be in place • Easy to implement • 2. Custodian – Direct Fund negotiates rates with custodian • Allows visibility of rate but no pricing tension • Still granting a monopoly • 8

The different methods 3. Custodian – Indirect FX and cash instructions are appended to equity deals • No visibility of rate prior to execution • No pricing tension and subject to internal vagaries • “Standing instructions” • Pure monopoly • 4. Direct Market Access Managers trade on electronic trading platforms • Delivers good results but managers need to be of sufficient • size and sophistication 9

Analysis Methodologies 1. Time of Execution Compares the execution rate to the midpoint of the • bid and offer rates available in the market at the time of the deal This is the most accurate method but needs time stamp data – • not easy to get 2. Average rate method Compares the execution rate against the average of the rates • available in the market over the execution window Simple and effective but requires reasonable volume • of trades Some limitations, but identifies trends • 10

Analysis Methodologies 3. Accounting and tax reports diagnostics Compares the cash rates applicable across the • entire portfolio This is the most accurate method and shows total cash • utilisation and all interest rates Not restricted to “cash accounts” • 4. Cash portfolio rate method Compares only the cash rates applied to ‘cash funds’ • Simple and effective but does not include all cash • 11

Information Manager Methods Average FX ‘cost’ Manager 1 Third Party Panel 1 bp Manager 2 Custodian direct 5.7 bps Manager 3 Custodian indirect 22.6 bps Manager 4 Custodian indirect 26.3 bps Manager 5 Third Party Panel 1 bp Overall average accounting 15.5 bps for volume Russell “Market” Average 9.9 bps

‘Typical’ cash diagnostic data on a fund Super fund cash and cash rates Fund Number Fund Fund Manager Rate Amount xxxxxx Super Fund 1 1.95 14,016,927 xxxxxx Super Fund 1 1.95 18,315,451.11 xxxxxx Super Fund 1 1.95 12,397,428.98 xxxxxx Super Fund 1 0.5 15,900,058.28 xxxxxx Super Fund 1 1.95 12,283,336.04 xxxxxx Super Fund 1 4.5 347,211.79 xxxxxx Super Fund 1 4.5 6,159,156.72 xxxxxx Super Fund 1 1.95 791,828.07 xxxxxx Super Fund 1 1.95 998,326.29 xxxxxx Super Fund 1 1.95 314,156.29 xxxxxx Super Fund 1 1.95 15,574,933.22 xxxxxx Super Fund 1 4.65 10,247,020.56 xxxxxx Super Fund 1 1.95 2,405,789.78 xxxxxx Super Fund 1 1.95 4,166,695.45 xxxxxx Super Fund 1 1.95 922,584.21 xxxxxx Super Fund 1 1.95 1,632,933.18 xxxxxx Super Fund 1 1.95 11,745,275.24 xxxxxx Super Fund 1 1.95 1,043,369.55 xxxxxx Super Fund 1 1.95 883,926.06 xxxxxx Super Fund 1 1.95 3,166,721.79 xxxxxx Super Fund 1 1.95 389,511.60 xxxxxx Super Fund 1 4.5 6,099,316.84 xxxxxx Super Fund 1 0.15 27,259,576.63 xxxxxx Super Fund 1 1.95 260,284.01 xxxxxx Super Fund 1 1.95 10,601,566.32 xxxxxx Super Fund 1 1.95 15,491,988.55 xxxxxx Super Fund 1 1.95 2,299,399.11 Total cash Total 195,714,773 Source: IEG research

Information Many not measuring – • o Counterparty $1.6 billion o Daily rates o No control o Monopoly exploitation o FX turned over 4 times

What to do - measure Undertake regular FX execution audits • Where possible utilise a third party broker and cash panel model • Do not use “standing instructions” • Include FX execution framework as part of due diligence process and • enshrine it in the mandate Include FX execution analysis in Quarterly reporting requirements • 15

What to do - measure Daily monitoring of all ‘operational’ cash • Do not leave a monopoly • Look at total counter party exposure • Include ‘operational’ analysis in Quarterly • reporting requirements 16

Advantages Reducing counterparty exposure • Increasing return • Every dollar saved goes to investors • Easy to implement • Gives a complete picture •

MiFID requires that firms executing orders, or who place orders with other entities for execution when providing the service of portfolio management, or who transmit orders to other entities for execution when providing the service of reception and transmission of orders, must have arrangements in place to take all reasonable steps to obtain the 'best possible result' for their clients. The best possible result should be determined with regard to the following execution factors: price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of an order. As part of these arrangements, the firm must have a policy. When establishing its policy, a firm should determine the relative importance of the execution factors, or at least establish the process by which it determines the relative importance of these factors, so that it can deliver the best possible result to its clients. For retail clients, MiFID provides that price and the costs related to execution will be the most important factors. Ordinarily, we would expect price to merit a high relative importance in obtaining the best possible result for professional clients as well. Appropriate information about the firm's policy should be provided to clients.