Regulatory Corner & J.P. Morgan in the News

Regulatory Corner

Regulatory reform for the financial services industry generated national and international debate in 2009 and it is certain that more regulation – and more broad-based dialogue – is coming in 2010.

Regulators restricted short-selling in response to market volatility and in an effort to stem falling equity prices. During the ban on short selling in the United States, bid/ask spreads on relevant securities widened and liquidity disappeared as transaction costs increased and volume declined. Generally intended to be temporary in nature, the restrictions have in most cases been relaxed or lifted completely during the course of the year.

During 2010 we expect to see broad regulatory changes as authorities seek to prevent any future financial crisis. Although financial markets for the most part made a robust recovery during 2009, many of the underlying concerns harboured by regulators and legislators in relation to market stability and systemic risk still remain to be addressed.  The scope of the regulatory reforms is therefore far-reaching and truly global and encompasses most established financial markets, industry segments and products on sale to both institutional and retail sectors.

In 2010, new securities lending regulations may focus on tighter settlement requirements, increased disclosure of short positions and, perhaps, requirements to have borrowed or located shares prior to a short sale. Outright short selling bans are unlikely although many regulators will reserve the right to take swift action again in this area should market conditions warrant it. The proposed legislative changes for next year contained in the U.K. government’s Financial Services Bill published in November illustrate the expected regulatory trends. Broad in scope, the Bill seeks to deliver wide-reaching reforms designed to strengthen financial regulation, support better corporate governance and empower consumers. It also provides the U.K.’s Financial Services Authority (FSA) with full statutory authority to prohibit or require the disclosure of short selling, something that was not in place in 2008.

In what is perceived as a positive development by the securities lending industry, the FSA has publicized its intention to work toward agreement on disclosure requirements at an international level rather than introducing a separate domestic regime. This is important because the Committee of European Securities Regulators (CESR) is currently preparing its advice to the European Commission on the disclosure of short positions. CESR’s advice is expected in the first quarter of 2010. The United States, Japan and Australia are also reviewing proposed regulatory changes. For more information, please contact your securities lending relationship manager.

J.P. Morgan in the News

J.P. Morgan secured top ratings in the International Securities Finance Beneficial Owners Survey, ranking first amongst custodian agent lenders. This year’s survey was particularly important as the financial markets, and specifically the securities lending industry, were impacted by a variety of historic and unprecedented events during the last 12-18 months. J.P. Morgan had its best showing since the survey’s inception and J.P. Morgan’s results demonstrated a high degree of consistency with a top three ranking in 27 of 28 survey categories. Categories included: overall, overall by type of lending agent, regions, respondent type and services. This year’s results were a testament to our program’s approach, philosophy and attributes. Our focus on customized separate accounts, improved reporting and providing premier client service resonated with our client base. The J.P. Morgan team would like to thank our clients for their support and feedback. For the full results, please visit www.jpmorgan.com/securitieslending.

In November, J.P. Morgan announced that the firm will provide global custody and securities lending capabilities to Jackson National's variable insurance funds. The investment options in this mandate total approximately. The review and appointment of J.P. Morgan was coordinated by Jackson National Asset Management, LLC (JNAM) and approved by the Board of Trustees/Managers for the Funds. JNAM and Jackson Fund Services’ assets under administration exceed $49 billion as of September 30, 2009. Key to winning the mandate was proving J.P.  Morgan could support Jackson’s growth agenda by providing trusted and transparent global custody and securities lending. Our ability to provide Jackson control over cash collateral reinvestments was particularly important.  For more information about the mandate, please visit www.jpmorgan.com/securitieslending.

J.P. Morgan announced expansions to the Securities Lending management team. Judy Polzer took on the role of Securities Lending Product Executive in January. Judy will lead the Securities Lending product team in managing all aspects of product development, management, program management and credit, risk and regulatory affairs. Anne Sylvester also joined as Western Hemisphere Head of Client Management and Technical Sales for Financing and Markets Products, reporting to Paul Wilson. Anne will have specific responsibilities for managing all aspects of Securities Lending Client Management and Technical Sales.

Special Commentary: A Focus on Hedge Funds

Across the hedge fund industry, 2009 provided a welcome relief following the doldrums of 2008. A median drop of 7% in the composite index in 2008 was followed by a welcome gain of 12-18% in 2009. In terms of strategy winners and losers, emerging markets equity, convertible bond arbitrage and distressed proved standout successes. CTAs (managed futures), who were the big winners in 2008 with their reliance on trend following have, in general, performed weakly. Strategies with an Asia bias, particularly China and India, have shined with certain hedge funds providing returns into three digits! The Hennessee Hedge Fund Index gained 24.6% in 2009, one of the strongest performances in ten years. Merger arbitrage, often a strong performing strategy, had a modest return of approximately 9% for the year as financing availability was weak in the first half of the year and deal flow weak throughout the year.

Leverage was down across all strategies and portfolio managers viewed 2009 as a return to core principles, with a focus on value investing. We had a lot of discussions with clients on transparency and legal frameworks - principally UCITS 3 - both with an eye on market watchdogs and investor base. A significant number of funds had developed a long bias by the middle of the year and this intensified the requirement to gain greater transparency around asset protection.

It was a hard year for launches, with only a handful raising target AUM and investors looking at the larger managers, some of whom opened to inflows for the first time in many years. As a consequence, we are starting to see inflows from investors once more and as a combination of strong performance and money being invested again, we expect AUM in the hedge fund industry to approach 2007 levels again by the end of 2010. There is a general belief that increases in allocation from pension funds into the hedge fund arena will fuel this trend, particularly as the opportunity to invest in high profile funds that have traditionally been "closed" are temporarily open once more.

As we go into 2010, we see China's move to allow stock index futures and short selling for the first time as a major drive to open up their markets and allow Asia to continue to have focus for the year ahead.