Financial Journalist

December 2006

— Alistair Smith, Barclays Capital

As a self-regulated market, foreign exchange has generally avoided any big scandals, yet it is still considered a risky deal, especially with the recent increased volumes of trades. Gerry O’Kane assesses the risks faced by prime brokers and the new solutions available to them.

Risk is an ongoing headache for any party in the chain of a foreign exchange deal. Equities’ dealers might find the forex market something of a nightmare, only having a choice of almost exclusively over-the-counter (OTC) products in an unregulated marketplace that has no central exchange.

Whatever about the theoretical problems, history shows that out of all the markets, the self-regulated foreign exchange environment has managed to tick over without the sorts of high profile scandals that have hit other securities.

However, the FX environment is changing. There are huge increases in volumes, new players, new ways to access markets, greater demands for credit and faster trading and there are worries that risk can only increase.

Each player in the chain is open to risk, although it is generally accepted that it is the FX prime broker that faces it the most since he is providing credit lines.

Risk to both parties

Firstly, there is the relationship between the prime broker and the client. This introduces risk to both parties, even from the stage of choosing a suitable prime broker. Then there is the relationship between the client and their executing broker and the executing broker and the prime broker.

“The obvious first step in limiting risk for the client is in the choice of prime broker,” states Devin Graham, global head of FX prime brokerage at UBS.

“In judging risk you need to look at the institution’s name and reputation, the credit worthiness of the counterparty, the size of the balance sheet, the brokers’ systems, reporting, cross collaterisation of asset classes and the trading system and the ability to communicate electronically,” summarises David Aldrich, head of Bank of New York’s hedge and broker business in Europe.

According to an analysis by Bank of America, the clients are faced with confidentiality and concentration risk and operational risk and market risk.

“Confidentiality is very important for clients – but then that’s why they moved to prime brokers from a single margin account,” says Roger Allen, director of FX prime broking at Dresdner Kleinwort. “There has to be a fair exchange of information with your prime broker but to give them everything is not a great idea but then it’s rarely an issue,” he adds.

As for concentrating risk with a prime broker, the system grew up specifically to move clients from the limitations of a single bank. “It’s essential in the system to trade with multiple parties, no one bank would take on all the risk of a fund and the client needs to adjudge the creditworthiness of the prime broker,” says Mr Aldrich.

The client faces several issues in operational risk: reconciliation of portfolio with the prime broker, trade rejection by the FX prime broker and the monitoring of post execution events.

Utilising technology

But as with so many of the risks facing all the parties in the chain, the use of technology goes a long way to mitigating much of the operational risk faced by all three right through the process.

“It’s important to have a sophisticated system covering trade entry to reconciliation,” explains Mr Allen. “A high level of automation is required through the process and minimising the manual process is important – each time something is re-keyed equals an increase in operational risk which is something you strive to reduce.”

“From the client’s perspective, using prime brokers to effectively provide the infrastructure and integration to track and manage positions limits their risk,” says Mel Gundewardena, global head of fixed income prime brokerage at Deutsche Bank.

As for issues of market risk, such as failing to notify the prime broker of trades in timely fashion, relying on the FX prime broker to properly match trades and highlight discrepancies and derivative issues with multiple brokers, these issues come down to the client’s internal management.

All these failings could happen to a company which did not use a prime broker but the advantage of having one is that these sorts of issues are discussed during initial contract stages and in adjudging levels of creditworthiness. In terms of mitigating risk the prime broker acts as a de facto extra line of defence. Apart from a client gaining market access and a best price advantage by going through a prime broker, its procedures and systems outlined as part of the contract push for business efficiencies too.

It could be argued that the core of any risk lies primarily with the prime broker. They face liquidity, credit, operational and market risks with both executing broker and client.

In reality, the majority of executing broking work they will deal with tends to be within the same institution since prime broking is generally offered free when using the dealing desks. It certainly limits credit and operational risk.

Managing exposure to their highly leveraged clients and establishing appropriate credit terms with them is at the heart of a prime brokers business. “Certainly there’s a clear distinction in the market between funds as an asset class, running alpha rather than hedging – the risk dynamics are completely different,” says Mr Aldrich.

“You must judge the clients suitability based on capital, strategies, personnel and come to a conclusion on what sort of risk positions you want and manage them efficiently,” says Mr Gunewardena. This often relies on real-time processing and managing the clients’ collateral and margin calls efficiently. On top of that he points to technology as limiting the impact risk factors, as with a cross-collateralising system that saves client’s margins and will automatically monitor credit levels at the give-up stage.

And the importance of the use of technology in limiting risk factors through the process cannot be underestimated. “Not every FX product is the same. With a spot trade you know all’s fine very quickly but with a 30-year interest rate swap if the trade does not get accepted it’s more difficult,” warns Alistair Smith, head of global netting products at Barclays Capital. “The communication of some trades is more complicated and small errors can creep in which is why we recognise that it’s important that the derivative transactions go through an electronic process even if it means rekeying at the beginning,” he adds.

Sell-side competitors have different systems for different products and that can make it difficult to ensure standards across the board. It is at this level that a client needs to find just how technically proficient their prime broker really is. “We have a very minimal set of transactions that reach us manually. All are processed electronically through our derivative PB system and fed into downstream booking systems,” explains Mr Smith.

And these sophisticated systems have an increasingly important place in the new developments in FX trading. “As algorithmic trading has expanded, for example, it is necessary to improve intra-day risk analysis and a capability to reconcile these sorts of trades,” says Steven Li, head of prime broking at Barclays Capital.

As for the executing brokers they too face many of these issues. Credit risk is generally the executing brokers prime concern, monitoring its limits within the parameters of the give-up agreement and avoiding trade rejection by the FX prime broker. At this point the prime broker needs to rely on its client to have given clear instructions on both process and procedure to their executing broker – what is permitted (in terms of product and delivery) and what is not.

Credit protection

Much of this will fall within the agreement outlined between the prime broker and client at the beginning. “We want to work with banks and clients within a transparent STP electronic framework, where we feel we can take risk that is well managed through our operational infrastructure,” says Mr Li.

In certain circumstances this may even specify what technology is to be used. But probably most importantly for the executing broker is the fact that the majority of the prime brokers operating in this market are parts of highly rated financial institutions, affording at least some credit protection.

Additionally, worries over give-up agreements seem exaggerated. “The give-up process is much the same regardless of whether it is spot FX, interest rate swaps or credit derivatives. Our system applies the same controls and matching consistently across all asset classes,” says Mr Smith.

“It’s been made even easier with the industry bringing in standard ‘give-up’ agreements,” agrees Mr Gunewardena, referring to the New York Foreign Exchange Committee release of standardised agreements.

It’s an issue which also falls under operational risk since it is considered a manual process and while it is based on a messaging system, many do feed automatically into the prime brokers’ systems. According to Mr Graham, the Harmony messaging system acts as an industry-wide de facto standard. “It makes sense to use one technology, although it is true that deals should be given up as soon as possible – legally within two hours – we aim for real-time because we’ve got a significant investment in the technology,” he says.

In truth, the sector is not facing any risks it has not faced before. As cross-asset management platforms become virtually de rigour, experience in handling derivative products is sliding into the forex office from the experience of the derivative brokers. While the levels of credit risk increase, only reflecting the boost in business volumes and products available, the technical systems to manage them get more efficient.

However, while most players seem happy with the regulatory status quo within the industry there are murmurings of change. There is debate that the regulatory authorities may decide to enforce best execution rules on the FX world and push features like transaction costs analysis on a deal. Both the European MiFID rules and the recent US Regulation National Market System (RegNMS) seem to be trying to do just that.

But as these developments are only rumoured others are worried that they will open another danger. “Getting consensus among industry bodies is important to develop methodologies to keep the forex market orderly and with a defined process,” says Mr Gunewardena. “But the danger lies when institutions with their own ideas try to cut those existing costs work outside the system. By short circuiting the process that has developed could create a systemic risk and effectively increase costs for the whole industry.”foreign exchange, FX, OTC products, risk, prime broker, investment manager, technology, services

FT Mandate December 2006

Electronic communications networks are increasingly used to handle forex deals – but their rise in popularity has been so dramatic that the market remains a mystery to some. Gerry O’Kane talks to the major players and lifts the lid on this technology revolution.

For an industry that likes to dot the ‘i’s and cross the ‘t’s, the fact that no one seems to know how many electronic communications networks (ECNs) handling forex deals are out there is a tribute to their dramatic proliferation.

And the effect of this proliferation over the past few years has been equally dramatic, being attributed to increased turnover in the spot markets and bid/offer spreads sliced wafer-thin.

An ECN brings together multiple market makers, matching buyer and seller together for a small fee and displaying the bids and offers from all market makers and traders on the platform. Orders are matched to the best available price.

eFX, as the techies like to say, has arrived, whether trading takes place over smaller private networks, or networks provided (often under licensing agreements or white-labelling deals) through brokers.

“The biggest change to the traditional FX prime broking landscape, apart from the huge growth in hedge fund strategies, is electronic trading and the growth in networks,” says Stephen Li, head of derivative prime brokerage sales at Barclays Capital.

Volume increases

A study by financial research firm Greenwich Associates found that of foreign exchange traders, 53 per cent traded electronically in 2005, up from 32 per cent only three years
earlier. Currently the average share of total forex trading volume captured by e-trading systems, regardless of size, is about 50 per cent. And it is the UK that tops the league with about 64 per cent of forex volume traded online, compared with 60 per cent traded that way in the US.

“The typical user of e-trading systems executes slightly more than half of its overall FX trading volume electronically, but e-traders tell us that they expect electronic trading to account for a full 57 per cent of their FX volume in 12 months’ time,” says Greenwich Associates consultant Robert Statius-Muller. “These expectations suggest that e-trading volumes will continue to grow for the foreseeable future.”

But Greenwich also warned that growth could be tempered by the fact that eFX platforms would have a harder time attracting new institutional customers.

Even so, size is no discriminator. Greenwich’s research shows that 51 per cent of players who handle more than $10bn per year in the FX market do so electronically.

This electronic market has long been dominated by EBS and Reuters, who in particular cater for interbank trading and who have seen their own trading activity quadruple over the past 18 months. But even these big boys are taking note of the changes in the FX trading environment.

Reuters and Chicago Mercantile Exchange (CME) announced plans in June last year to
create FXMarketSpace, the world’s first centrally-cleared, global foreign exchange marketplace, through a new 50/50 joint venture company. How it will affect the forex trading world is yet to be seen.

The recent acquisition of EBS by ICAP, the world’s largest interdealer broker, shows those in the know do not believe it is a contracting market. But both these deals further blur the clear divisions between regulated markets such as stock exchanges and the unregulated market dominated by OTC FX deals.

Nevertheless, other ECNs are unlikely to go away. There are newer platforms such as multi-dealer firms FXall, Currenenx and State Street’s FXConnect, while Hotspot is a multibank prime credit system. These companies are also experiencing serious growth, with many of them finding success in niche markets that produce enough trade volume to support their business.

“Our revenue growth was 23000 per cent in the past four years and although we’re only seven years old, our monthly volume turnover is hitting $100bn,” reveals Glenn Stevens, managing director of GAIN Capital.

“What we’re able to do is offer the more ‘downmarket’ sector an opportunity to trade – banks can’t service the $500,000 to $5m deals.”

The effects of these new dealing channels has been profound. The affordability of eFX
trading technology allows start-up investor groups to access the markets. It has allowed the smallest sorts of players to access the forex market – the micro hedge funds, the high-net worth individual or the retail speculator.

“The advent of e-commerce has lowered the barrier of entry to the FX market,” observes David Aldrich, head of Bank of New York’s hedge and broker business in Europe.

They have also allowed existing players to adopt strategies they would have found both
difficult and expensive to follow previously and with the cover of anonymity. All benefit from workflow efficiencies and integration into other systems.

Alpha opportunities

Many of these new participants reflect the growing trend of hedge fund and investment managers recognising that the foreign exchange market can produce alpha for their portfolios (although the hedging use of forex remains the dominant strategy).

“To a large extent the increased growth has been because of the recognition of forex as an alternative asset class and an alpha opportunity,” says Mr Stevens.

But for the banks that provide liquidity to the forex market, the emergence of these trading networks has been one of the critical factors in the plummeting bid/offer spreads in the spot market. Both the recognition of alpha opportunities and the price transparency now available across dozens of independent online markets, have pushed spreads dramatically downwards.

This search for alpha has seen technologies active in the equity and fixed income-markets, and algorithmic systems, enter the FX markets. Algorithmic trading is a way of timing entry and exit into a market, exploiting pricing opportunities and pushing up trade volumes.

According to Deutsche Bank, 15-25 per cent of all FX activity is due to algorithmic trading, and these liquidity suppliers have no way to cope with the speed of some of these systems.

Many of them have become unhappy with the growth in these ECNs. Blame has even been heaped upon the opening of EBS Prime to buy-side institutions like hedge funds for starting this trend. While the banks want to regain more control over the market and dream of pushing spreads towards historical highs, the opportunity for influencing dealing patterns remains distant.

“Even between Reuters and EBS, each trading platform is more suited to certain FX players than others for either strategy or product requirements, and while there have been attempts and discussions by certain parties for a central marketplace, the market simply doesn’t want a monopoly,” warns Roger Allen, director of FX prime broking at Dresdner Kleinwort.

He believes that past reactions to players trying to capture parts of the market had shown it was a strategy unlikely to succeed. In his view reactions included direct and outspoken resistance to anyone trying to control the FX marketplace and an organic movement of business. This flow of business also reflected the idea that the FX market is not suited to an overly structured environment.

Indeed GAIN finds its own niche comfortable for avoiding larger deals, but even so there are indications of a certain amount of convergence between some of the ECNs and dominant players such as EBS.

“While a $50m trade would be big for us, EBS is designed to handle such trades,” explains Mr Stevens. “While the smallest trade on it is $1m, its average trade size is about $1.3m, while ours has risen from $250,000 to $700,000 converging towards their levels.”

Whatever the grumbling about falling spreads from the liquidity banks, they still participate on the ECNs. The trading platforms connect in an automated fashion to banks and act as a message hub that can translate the messages of any customer and bank so they can each talk to each other.

“We’re complementary to the banks who find our liquidity useful, and we’re a member of EBS Prime and have access to 10 top banks and remain in the sector because we’re acting like a prime broker,” says Mr Stevens. He views staying ahead of the technology is vital for any ECN’s long-term survival.

“We’re not wanting to re-invent the wheel. We have to keep up with demand for example enabling application program interfaces (APIs) with our system for things like algorithmic or auto-execution trading. We need to be able to provide real-time margining, for example,” says Mr Stevens.

An advantage of these sorts of systems is that they do allow clients to carry out transaction cost analysis, something that organisations with a fiduciary responsibility for best execution need and something that future regulatory changes may require.

One criticism of the way the market is developing is that there are so many ECNs, which, in theory, create market inefficiencies and boost costs to interface with them. But the industry argues these are marginal costs, not linear, and being able to both access the business and see developing trends makes viable whatever extra costs there are.

Additionally, the ease with which clients can get onto this web-based systems attracts both established forex players and the individual speculator. “You sign up in the online environment get a technical demonstration and then await our due diligence activities. After about three days you can start trading,” explains Mr Stevens.

For the ECNs, signing anyone up is good news, since research by Greenwich shows that once a party starts trading electronically, the volume of trades executed that way increases.

As for the future of the sector those involved show boundless optimism. However with so many players in the market few disagree that there will be some consolidation. Acquisitions are likely to be based on both profitability of the companies and also their technical expertise. Buying technology for this sector can be cheaper than developing it – and to stay in the forex business, having enabling technology is crucial.

Electronic communications networks, forex, FX, foreign exchange, trading, growth market, liquidity

FT Mandate December 2006

The future might look rosy for foreign exchange prime brokerage, but those who refuse to provide a broader service through new technology may find themselves left behind. Gerry O’Kane discusses this and other issues facing FX prime brokers in the next few years.

There is little doubt that the industry sees the future of prime brokerage in the foreign exchange market as healthy. Trade volumes may not be growing at the rates of a year ago but they show no signs of declining either.

“In a nutshell, future developments will include many more clients attracted to the prime brokerage model not just for leveraging credit but also to avail themselves of the sort of outsourcing models the prime brokers have,” says Roger Allen, director of FX prime broking at Dresdner Kleinwort.

However, there are likely to be changes as the industry develops and adjusts itself to the ever-increasing demands of existing clients and new entrants.

“I’d expect FX prime brokers will continue to focus on client problems, including efficient pricing or risk management, in order to give them some edge over competitors. They’re pushing to bundle more products” says David Aldrich, head of the Bank of New York’s hedge and broker business in Europe.

At the back end of the process, integration will continue, he believes, making it easier to move data through to custodians and fund administrators.

While technology solutions are seen to be the main driver of change over the immediate future, one area that may get a shake-up are those prime brokers who only specialise in foreign exchange. “I think that FX prime brokerage is a subset of the business and when you’ve got hedge funds only dealing in forex that’s fine but when they want broader market access then capabilities will be important” warns Ted Platt, head of prime brokerage in EMEA at Merrill Lynch.

For these smaller FX-only operations finding the money to invest in the technology required by this broader service demand will not be easy. As a result there is likely to be an increase in white labelling systems and one ECN, GAIN Capital already generates half of its revenues from that business.

But it is unlikely to be an immediate disappearance of the specialist players since it seems that about half the players in forex continue to use non-electronic trading.

“It’s fair to say that technology will move to make the process more automated and reduce the reliance on phone deals and not to be able to go with that growth could cause problems,” says Mr Platt. “I’d never write off a specialist but I do expect broader prime broker players,” he adds.

Elsewhere some expect to see consolidation in the number of ECNs. “There are a wide variety of these systems now and while its likely that both EBS and Reuters will remain the main players, more are likely to come in,” says Mr Allen. “But I’m certain we’ll see a consolidation process in that sector too and it’s starting already.” In June 2006, ICAP, the world’s largest interdealer broker acquired EBS.

“For the future I’d see ECNs offering more tools such as cross-collateral trade to pick up margins and certainly an improvement in real-time servicing,” says Glenn Stevens, managing director of the GAIN Capital Group, an electronic communication network (ECN).

He also notes that as the ECN market develops, players may look for technologies that allow them to disaggregate large trades, something only the more sophisticated FX prime brokers currently offer. This means executing deals in smaller pieces over time concentrating on market impact rather than pure price.

The use of technology to create further operational efficiencies and lower risk will continue to develop, as will an ever-increasing use of electronic trading. The development of more workflow solutions for clients is likely to continue.

As algorithmic trading has left the equities world and moved into forex, some expect more sophisticated models to emerge. The one caveat with it, however, is that it functions better in low-volatility environments, as the forex market-place has been for some time. Should this change there may be a fall-off in some of the volumes coming from the less-sophisticated players, leaving the advantage to those with models that spread risk.

According to Mr Stevens, modelling systems are likely to become more sophisticated. Post trade data-mining is one area tipped for growth. While some of the bigger banks already do this, it is not yet a common but could tighten spreads still further as the systems extrapolate the effects of certain deals in the market.

Already algorithmic trading has highlighted issues of pricing across ECNs, as banks complain that they are being hit by sniping. They argue that some players are putting in bids and offers to EBS and Reuters and then hitting ECNs at the same time for larger amounts. It creates a ‘liquidity mirage’ and hurts the liquidity providers, the big banks, and because the speed of using algorithmic techniques it is hard to respond.

“Sniping does happen but the counterparty banks figure it out after a while and refuse to do business for a time,” says Nick Jones, head of European sales and marketing of FX at Bear Stearns.

The effects of this are two-fold. Firstly few see future bid/ask spreads widening any time soon and secondly, it will push the banks to reassess how they will provide liquidity. The critics of the banks’ complaints on sniping is that it highlights an inefficiency in their pricing methodology and their own systems will have to improve – boosting data mining technologies, for example.

prime broker, foreign exchange, FX, technology, ECNs, Gain Capital

FT Mandate June 2006

The ‘lift-out’ days of old have moved on, since outsourcing providers stood up to being forced into maintaining multiple systems on one platform. Gerry O’Kane charts the modern outsourcing landscape.

It was a gleeful announcement. JPMorgan Hedge Fund Services (JPMorgan HFS) had signed an agreement to take over the middle- and back-office of Henderson Global Investors, along with staff for its 14 hedge funds, representing approximately $2bn (€1.6bn) of assets.

It seemed like the world had changed since outsourcing started with State Street’s 1999 agreement with US fixed-income manager Pimco. “There’s no doubt that outsourcing has been around for a long time, especially in the mature custody sector – you can almost take an off-the-shelf solution,” outlines James Hockley, a specialist in the operations practice at consultancy Investit.

And for JPMorgan, a contract with an asset manager with £67.7bn of assets under management is noteworthy, but it did not have the flag-waving, trumpet-blowing feel of past outsourcing deals.

In part this is because the outsourcing business has changed and its largest players are far more circumspect than in the past. Talk to anyone in the securities servicing business a couple of years ago and trying to get them to speak of anything other than lift-outs was akin to getting Tony Blair to mention socialism.

Doubts raised

Now there are indications that there remains a certain amount of doubt among continental European asset managers that outsourcing is offering solution it purports. Julius Baer Asset Management and Robeco Asset Management are two firms who have been adamant that the big outsourcing route simply does not fit their needs.

And among the industry players there is more talk of component outsourcing.

“The outsourcing market has matured. There may be more lift-outs in the right circumstances but there is a new style of component-based work,” says Richard Warne, head of relationship management for JP Morgan Worldwide Securities Services. “It is possible to break up the services within the middle or back office and consider taking out an element of a service or investment style, rather than the whole thing.”

It is a view with which Mark Kerns, managing director of fund management services in Europe with Bank of New York, agrees. “We might take a lift-out with a view to moving to our environment but the idea of multiple lift-outs is simply not sustainable.”

“What we’re seeing is modular outsourcing continue to grow especially in the area of alternative investments,” he adds.

The deal with Henderson, because it is handling an alternative asset class, now falls under that view of component outsourcing so suggesting that the industry has moved on. The style of outsourcing that dominated the market was the lift-out and even those players no longer hammer the message home.

The thesis of the lift-out operation was win enough outsourcing mandates from well-chosen asset managers and run them on a platform that would give you economies of scale benefiting both asset manager and the securities servicing firm. The system could then be considered a strategic asset and be suitable for many more players, especially the smaller players.

The downside is that such a solution could offer only limited customisation for the
asset manager, but they’ve generally been spoiled by the good life and compromise is not a word often looked up in an asset manager’s dictionary.

As outsourcing projects continued it seemed that providers would furnish any bell or whistle the asset managers desired, including paying them for signing the contract. “Three or four years ago I had providers virtually on their knees with an open cheque book seeking deals,” reveals Luc Leclerq, head of operations at F&C Asset Management.

“The way that most asset managers got into big outsourcing was through lift-out, getting an end-to-end structure for themselves,” points out Mr Hockley. But the asset managers made decisions on the back of a higher cost base and declining revenues and custodians bought their way into the business.

“They were like two blind lovers struggling to find something familiar,” adds Mr Hockley.

But something had to give and 2005 brought something of shock to the asset management industry and their consultants. Those most eager to provide outsourcing grew a backbone when they realised they were being forced down the road of maintaining multiple systems, not one platform.

“There have been something like 30 deals, many seeking to put the same asset managers service onto the custodians’ own platform but you’d struggle to find more than eight that have fully migrated to the lift-out platform,” points out Mr Hockley.

Developing back bone

The custodians wanted to show they wouldn’t be shoved around. While the Bank of New York retained the custody and administration business of Merrill Lynch Investment Managers, it walked away from a full outsourcing deal because of Merrill’s refusal to move to its SmartSource platform. Merrill returned to an in-house system. JPMorgan had already abandoned its five-year struggle to implement an outsourcing deal with Schroders and paid back £20m.

F&C Asset Management and Mellon parted company over outsourcing its back office but maintained other outsourcing deals. According to Mr Leclerq there were issues of service provision at the right price, but those were not the only concerns of fully outsourcing the back office.

“With outsourcing the custody side it’s very simple and there’s competition allowing you to hop from one provider to another without too many problems and the main reason is that there is a structure in place - we’ve a standard gateway called Swift,” argues Mr Leclerq.

This is not the case with the back office. “When I give that away either getting it back or transferring to another service provider is really difficult,” adds Mr Leclerq. “I need to see a win/win situation – my business partner needs to make money too or we all know what happens then…”

And the providers seem to have got the message. “We’ve had our wave of lift-outs as a phenomenon and over the next 18 months State Street will be on a single platform which will be important for the market since with the next wave you can get scale,” says Wade McDonald, head of the asset management and BancAssurance groups with State Street Investor Services in the UK.

As with the Bank of New York and JPMorgan, State Street’s official line is no more lift-outs, but all have the proviso that should the right deal come along with the right staff and technology it might be considered.

Ironically, even Brown Brothers Harriman (BBH) which had been singular in its approach through component outsourcing says it will consider a lift-out but only to acquire a core technology platform.

What all are emphasising is the ability to provide the single solution a new client might be looking for.

Perhaps somewhat paradoxically the provision of single solutions or components, are often as a result of what has been learned through lift-out and the various manouevrings that took them into that market. “With the increase in derivatives there a shortage of resources and a knowledge base and we’ve already seen the big guys buying up hedge fund administrators so they can cover these instruments,” says Mr Hockley.

“There are always factors in this industry driving costs up - new regulations, distribution, new investment strategies especially in the alternative asset space,” points out Mr McDonald. It is in these areas, as well as the more mature outsourcing areas like custody and transfer agency, that he sees much of the component market.

“We’re seeing in the UK that institutional managers are finding that they don’t have efficiencies in certain areas and they are considering component outsourcing,” he adds.

Modular health

“I’d say the modular business will get healthier especially in the light of the growth of the alternatives market,” says Mr Kerns. “Global collateral management services have been a major success for us because of alternative strategies.”

For BBH it must be galling to find all your competitors, once the champions of lift-out, stepping on your patch. “The industry is continuing to change both for what is on offer and what’s in demand,” says Geoffrey Cook, MD, global head of fund administration at BBH. “Infomediary, the cornerstone of our modular outsourcing, has proved itself invaluable because of its scalable nature and looking at today’s landscape having 85 clients shows it has had value.”

“Our view has been that there are multiple ways to do something all with differing requirements and we try to provide suitable components – we’re not saying it’s right but it’s the space we want to play in,” adds Mr Cook.

And it’s the space everyone else now wants too. “We’re going to see an investment-based component approach develop,” observes Mr Warne. In particular, again he mentions alternative asset classes. “Asset managers want to run hedge funds pricing risk analysis or fund of hedge funds and some of these processes they can’t do with their own systems.”

He points out that going short was deliberately made impossible on their systems due to regulation and it is in these areas that securities servicing arms will find new custom.

“It’s a step-change to support new product lines but the ideal of mix and match remains to be seen,” concludes Mr Hockley.

Far more sceptical is Mr Leclerq. “I’m not sure about component outsourcing although the market talks a lot about it – if you have too many components there’s the question of it working at all and if it couldn’t make money as part of a lift-out bundle, how is it economic now?”custody, securities servicing, outsourcing, component outsourcing, asset management,

FT Mandate June 2006

— Mark Kerns,Bank of New York

Fund administration is developing, but in favour of the larger managers who can use the increasingly complex investment style, more regulation and new demands to their advantage, writes Gerry O’Kane.

Fund administration is maturing. Whether it is the service, the pricing or the attitude from either supplier or client, it is frequently described as a ‘maturing sector’. An asset manager talking about outsourcing fund administration to a third party is not the news it once was: within the space of seven days JPMorgan announced a fund administration contract with Charles Schwab, hedge fund administration outsourcing with Henderson Global Investors, while HSBC picked up business with Royal London Asset Management.

In general, fund administration has been accepted as a non-core competency by asset managers.

The business does remain healthy and in the same week as all those deals, Northern Trust announced first quarter results which showed a 28 per cent increase in the value of assets under administration, boosted by its acquisition of Barings Financial Services Group’s fund administration arm.

But while it might be considered a more settled part of the investment world, it is not without pressures and changes, especially on the price of securities processing. “It’s an interesting time with a number of costs coming down and some going up,” observes Geoffrey Cook, global head of fund administration at Brown Brothers Harriman in Luxembourg. It’s a view unquestioned throughout the industry.

“Costs are reducing around clearing and settlement in many markets with the underlying service providers utilising technology in a more efficient way,” agrees Mark Kerns, managing director of fund management services in Europe and Bank of New York.

India would be a most obvious example. Once each share certificate had to be individually stamped by hand each time it was bought and sold. Now an electronic system not only cuts the risk of trade failure (losing share certificates was not unusual as they would travel Delhi streets by rickshaw), but cuts cost too.

While European bourses have not had such dramatic changes in processes, the automation, shortening of trading chains and so on, have lessened costs to both the fund administrator and client. “The efficiencies of local markets and local practice along with the expansion of Swift as a low-cost communications facility, for example, means each market becomes more efficient and administrators can eek out additional savings,” says Wade McDonald, head of asset management and bank assurance with State Street.

Pushing costs up

Agreement is rare in the banking community but no-one dares suggest the cost of handling long-only equity funds has increased. “But there have been substantial phenomena which have not slowed pace in five years that are pushing some costs up – regulatory changes and an evolution in investment style such as derivatives, leading to a growth in non-standard practices which are often people intensive,” warns Mr Cook.

The quest for more yield, whether in the pension fund or with the asset manager, has been unrelenting since the new millennium. To find it, new investment strategies have emerged using alternative products encompassing derivatives and asset classes such as property. “Unlike the long-only equity funds, many of these instruments don’t have uniform downstream processes for settlement. A lot of OTC [over-the-counter] products require manual intervention, don’t have a single price and it’s having the effect of pushing costs up,” outlines Mr McDonald.

BBH points out that for most long-only equity products, straight through processing (STP) levels are well over 90 per cent. “These levels come shooting down when dealing with OTC products,” says Mr Cook.

The impact of this changing face of investment strategy on fund administration outsourcing should not be under-estimated. “Providing this sort of service will put pressure on small administrators in terms of having the skill-set to understand the underlying products and the technical infrastructure,” says Richard Warne, head of relationship management for JP Morgan Worldwide Securities Services.

Like the other big boys of the securities servicing industry, acquisition of firms with experience of hedge fund administration and consequently of alternative investments, has been critical in building the expertise to handle this growing business. Apart from JPMorgan’s acquisition of Paloma, Mr Warne agrees that exploiting alternative investment knowledge from its investment banking arm was vital in the early days and even now it is spending $60m (€46.5m) in boosting the technology to handle this product suite.

While it remains early days for the asset managers and their toe-tipping in the alternative marketplace, the implications are more far-reaching. “It’s not a question of how widespread will derivatives become, for administrators it’ll become an absolute requirement even if only 5 per cent of the asset manager’s portfolio is in alternatives,” says Mr Warne.

As new regulations come to Europe, even traditional long-only equity funds could use derivatives on a small scale.

“At the very least smaller administrators will have to become more focused, they won’t be able to afford to be all things to all people,” says Mr Cook.

Collateral damage

Another implication in the growth of alternative investments is that their use goes hand in glove with using collateral services. For the larger players this requirement is another carrot to lure them to their own fund administration product. Not so the smaller administrator. “There’s been a stronger move to handle collateral efficiently and it’s been a major success for us because of alternative strategies,” agrees Mr Kerns.

Other factors affecting how administrators can operate include fund of funds and pooled assets. Both have further implications on technology infrastructure and the administrators’ understanding of underlying assets. Administrators maintain that funds of funds are straight-forward with long-only equity products, but the issue becomes more difficult when elements within a fund may include derivatives, requiring an assessment of impact on the overall portfolio. It also requires an ability to handle data from numerous transfer agents.

Overall, the larger players in the sector are happy with how the business is developing, if only because the increased complexities of investment style, new regulations and new demands (such as pooled assets) play to their strengths. For the rest of the administration world it looks set to follow custody, either specialise, be bought up or go under.global fund administration, securities servicing, outsourcing, settlement, custody, alternative investment strategies, collateral services

FT Mandate March 2006

The latest research from FT Mandate reveals a more mature securities services industry, with a discerning outlook for deals. Gerry O’Kane examines the winners and the trends of 2005.

It has been all change in the world of securities servicing over the past 12 months. Players have veered away from outsourcing being their seemingly sole preoccupation and some are even touting the hitherto reluctant ‘c’ - word – custody – as being a healthy market in which to be.

“Anybody who discounts the value of custody which creates the platform into which you can sell other services is crazy,” says Tim Keaney, head of the Bank of New York (BNY) in Europe. He estimates that basic custody in Europe added $500bn (€420bn) to the bank’s assets under custody over the past year.

Now the talk is of selling new services to existing clients, an expansion of business in continental Europe and the increasing growth in alternative fund administration. There even seems to be an agreement that the industry as a whole, clients and suppliers, has matured.

“Clients are becoming more realistic,” points out Nadine Chakar, chief executive of ABN Amro Mellon. “Everyone wanted that landmark deal and promised the stars and moon but now people are taking a sceptical look at what’s on offer and are more realistic.”

“There’s a more mature understanding among clients as to what is custody and administration,” agrees Penny Biggs, head of corporate and institutional services and global sales at Northern Trust. “In the past when margins needed to be clipped, they focused on services like custody.”

The industry itself seems to have taken a step back to consider deal implications. F&C Asset Management walked away from a potential new outsourcing contract with Mellon because it was no longer attractive and while State Street flaunted its renewal of outsourcing to Scottish Widows Investment Partnership (Swip), there was little competition for the contract.

The Bank of New York retained the custody and administration business of Merrill Lynch Investment Managers but walked away from a full outsourcing deal because of Merrill’s refusal to move to its SmartSource platform.

For the first time since FT Mandate has been casting its eye over the performance of players in the custody market, JP Morgan has moved to the top of the pile with $11,200bn under custody. It leap-frogged both the Bank of New York and State Street to pole position, in spite of both banks boosting their assets over the year by $1200bn and $600bn, respectively.

“Firstly we must say that it’s not our aim to be the biggest in the business but it’s a consequence of our success with clients,” says Richard Warne, head of relationship management for Europe, the Middle East and Africa at JP Morgan Worldwide Securities Services. More modestly, he also points out that most of the firm’s clients had a good 2005, helping to boost asset figures.

Pinning the group down on what accounts for its sudden emergence as leader is more difficult. It did witness the exit of some well-known personnel in the past year and has been seen as taking a more focused approach to the business by creating the Worldwide Securities Services arm.

However, the bank has done more than simply create a new department, it is also pulling in newly created business arms to provide a full service such as provision of fund administration services to private equity firms. It had already been performing these services for its own various private equity businesses worth over $11bn under management.

Like others in the sector, JPMorgan is taking a closer interest in servicing the buy-side of the industry. “An area of keen focus for us is the recently launched Alternative Investment Services Group,” explains Mr Warne. This is founded on the acquisition of the middle and back office operations of hedge fund Paloma Partners Management, which has been in the hedge fund business for 25 years and its JP Morgan’s existing Tranaut hedge fund administration unit.

“Servicing alternative assets is an absolute trend in the industry, especially in Europe with asset managers and pension funds seeking alpha while having an eye on asset liability matching,” says Mr Warne. And there is little doubt it ought to have the expertise having spent $60m on new technologies.

Certainly, having a close eye on the alternatives market has been the continuing trend throughout 2005 and a bigger headache for all those involved in securities servicing.

“The year 2005 was a slightly different one for us,” explains Ms Biggs. “We knew we had to do something pretty significant in the alternative asset group.”

Northern Trust bought Barings financial services group from ING and has been busily integrating the entity into its own custody unit. From Northern Trust’s point of view the acquisition gives the bank an easily exportable solution in the alternative investment fund administration world and it intends to concentrate initially on Europe.

Similarly, BNP Paribas Securities Services (BNPPSS) says it intends to beef up its handling of alternative assets. “Because of the French usage of over-the-counter (OTC) products we’ve brought in people with dedicated experience in leveraging the market,” says Margaret Harwood-Jones, head of client segment, institutional investors at BNPPSS. “We’re also looking at a range of instruments for reporting and will offer independent valuation services.”

However, things have not all gone BNPPSS’s way. It remains in sixth place in the FT Mandate table, but dropped nearly $400bn in assets.

Even so, it is one custodian to have profited from buy-side business. Its outsourcing mandate with Aberdeen Asset Management was renewed in 2004 and now includes Edinburgh Fund Managers. It also won parts of Deutsche Asset Management and it is leveraging all these contracts for alternative investment expertise.

One contract it must have been bitterly disappointed to lose out on was the outsourced business of Axa Investment Managers in France, which was secured by State Street.

Muted but successful

“It was a great year for us,” says Alisdair Reid, head of the asset owner group EMEA with State Street, pointing to the Axa deal, retaining the Swip business and winning an outsourcing contract from ABN Amro Asset Management in the Netherlands.

But apart from these hefty contracts, business at State Street could be considered muted and reflected in its third place standing in our table. The disappearance of the well-respected Jeff Conway back to the US at the end of 2005 would have had little effect and the bank seemed to concentrate more on sorting out loose ties. “We’ve just marked the end of our major integration efforts bringing legacy clients to the State Street platform,” says Mr Reid. This includes the Deutsche business of which it retained 88 per cent.

He also said that tough decisions, especially in outsourcing, had to be made in 2005. “We have to deliver value to shareholders and had to walk away from deals because they weren’t financially viable.” He warns that any company thinking about gaining market entry to the business by cost cutting would now be playing a very dangerous game.

Like Mr Keaney, he sees growing business based on good relationships as vital for the company and straight-forward custodial services are the base for that. “There is an increasing demand for bundling – companies are finding they don’t have the time or resources for certain elements and come looking for extra services,” explains Mr Reid.

“Bundling is a continuing trend,” agrees Mr Keaney. Transition management has been one area where Bank of New York has built business with 25 per cent of its clients now using that service. “It’s been a matter of making an effort in education.” All the players seem to have picked up business in transition management or securities lending, as part of this trend.

He also identifies the middle-market players as those most likely to take standardised products and services. “We’re keen on the $5bn-$50bn-sized firms who are most likely to go that route,” he says.

Nadine Chakar, who has long argued the benefits of buying components based on strong relationships with clients, says this sector is benefiting from price transparency and adds that ABN Amro Mellon is aiming to be the Dell of the asset management
servicing industry, providing whatever bells and whistles are required. “Rightly there is an expectation [from clients] that their provider can take off-the-shelf products and customise them to achieve a solution to their unique requirements,” she says.

“There’s a greater requirement for price transparency and asking ‘Am I getting the best execution on FX?’ and they’re smart enough to know they can’t get everything for nothing,” summarises Ms Biggs.

The view that the ‘black-box’ solution is no longer good enough is supported by Mr Reid. “You have to be able to customise, whatever the statement of recommended practice.”

But there are warnings. Ms Biggs says that component business is developing but it must be built from a position of holding the custody mandate. “We’ve had to be quite discriminatory about that,” she says. And Mr Keaney adds that there are very few operational one-off components in the market: “About 99 per cent are bundled.”

Although it is refreshing to hear so many securities services providers cite good relationships and basic custody as being the stepping stones to other service provision, it would be foolish to think that beady financial eyes were not on the look-out for new forms of business.

Nevertheless maintaining their technology and meeting the new challenges of the alternative investment market and coping with the differing regulations abundant in Europe is taking some effort. State Street boasts that 20-25 per cent of its operating budget goes on information technology. On top of that is staffing, finding the expertise and knowledge.

The Bank of New York had a tough year with many of its senior staff being poached. “It’s a knowledge worker business, experience is the key,” accepts Mr Keaney. He admits it has been a bit of a struggle to keep staff, exacerbated by a planned move of staff from London to Manchester. However, he adds that BNY has brought in people from the US and has led the way in hiring from the big consultancy firms.

Mr Warne at JP Morgan agrees that keeping staff is crucial but made easier if you’re a global organisation offering a full career structure. “It’s a challenge to the smaller players in the market,” he says.

And all these pressures are both creating more difficulties while opening new markets, especially in continental Europe. (State Street aims to boost revenues outside the US from 38 per cent to 50 per cent, mainly in Europe.)

One new area of business is pooled funds with a number of multi-national companies sponsoring pension schemes in Europe attempting to pool their pensions, such as Unilever and IBM.

There are certain tax advantages to some pooling vehicles. “Multi-nationals can invest their pension assets through funds set up in Dublin or Luxembourg and these fonds communs de placements or common contractual funds do not have to pay withholding tax on investments,” explains Mr Reid.

And everyone is talking the talk about capability but in reality there have been few deals.

In the more mundane world of outsourcing and securities services, continental Europe has differed from the UK and US in its approach. There has been a slower take-up of outsourcing because of a model in which all operations are done in-house from custody to asset management. But banks are being pressured to change and the global custodians are looking expectantly on.

“In Italy and France local guys are approaching a decision on whether to remain local or go global or partner – the underlying clients are international themselves and are outgrowing their custodian,” says Mr Keaney.

Merger moves on up

Société Générale, which moved from eleventh to ninth and boosted its assets under custody by a 42 per cent to $2000bn in the FT Mandate survey, acquired the custody arm of Italy’s UniCredit Group for $690m including custody, clearing and settlement, depository bank, fund administration and transfer agency for clients in Italy, Luxembourg and Dublin.

BNP Paribas has also announced its intention to buy Banca Nazionale del Lavoro in Italy, including its fund management business and private bank. In addition to expected benefits in retail and corporate banking, there is the theory that Italy’s pension market was due for a shake-up and a developing asset management industry would boost
custody returns. Already Italy spends one of the highest levels on pensions in Europe.

In Germany, BNPPSS took over the Invesco Depotbank operations starting with fiduciary and custody and moving towards full administration outsourcing. Ms Harwood-Jones says that winning this sort of business depends both on technological capability and experience. Even the announcement of State Street winning the Axa deal in France had the benefit of acting as a catalyst on the rest of the European market, in her opinion.

Others have been more proactive in gaining European business. Northern Trust,which fell one place to eighth in the survey, managed to crack the lucrative Nordic market. It was selected by Swedish insurance company Folksam as sole global custodian for all its $17bn investment portfolio through a new agreement with Swedish trustee Svenska Handelsbanken. “This is a sophisticated market, the institutions have been globalising and we’re hoping to pick up some of that business,” admits Ms Biggs.

Everyone expects some form of continued consolidation. Mergers in the industry were few and far between in 2005 and the closest came with the announcement that Royal Bank of Canada and Dexia would form a 50/50 joint venture to create RBC Dexia Investor Services. The only surprise was that both parties committed all their securities servicing arms to the business.

The deal also kicked RBC from 12th place in the league table to ninth with assets under custody totaling $1993bn.

Hedge fund administrators, technology providers and domestic European providers have just seen the start of a predatory environment which leaves them at the lower end of the food chain. No-one, however, will name a big cat that might be too old in the tooth.

securities services, servicing, custody, asset management, alternative fund administration,outsourcing

By Gerry O’Kane

“Mr Museveni is it true that you are demanding the position of Chairman of the Military Council from Okello and want to become president?” asked a journalist. Museveni smiled his ‘knowing’ smile, tilted his balding head to the side and peered through the Vis-News camera spotlight. “What’s wrong with that?” he answered.

Thirteen days later he had signed the ill-fated peace agreement with the Okello Government in Nairobi and after another 43 days Yoweri Museveni was sworn in as Uganda’s President. His National Resistance Army had won routing Okello’s rag-tag UNLA and the ruthless Anyana, the ex-Amin men.

Born in 1944 or 1945, he’s not sure himself, Museveni spent most of his life involved in a war against someone.

Magical powers
Now he has cultivated the image of the image of the sincere idealist, the “intellectual whp picked up a gun” as he once said. But this Ankole tribesman, born in a place called Ntugamu some 40 miles from Mbarara, is much more than an idealist intellectual who believes in nationalism, pan-Africanism and development. He is politically shrewd. His intuition when in government allowed as many political escapes as he had from death — which led many to say he had magical powers.

Nowhere was his political keeness more obvious than during the protracted peace talks in Nairobi. His high-profile and well-organised press conference contrasted with Lt. General Tito Okello’s absence and the Military Council’s poor press relations.

In the final weeks of the talks he was calling for the prosecution of all those involved in war attrocities, pointing out that most of the Military Council had been in government during Obote’s bloody reign.

Everyone somehow forgot that Museveni had fought with Tito Okello and Oyite Ojok (who was later Obote’s Chief of Defence Forces) in 1979 to overthrow Idi Amin. Museveni maintains that his group and Obote’s were separate. No-one mentioned that he had been in government when President Lule had been forced to resign or that he had worked with Paul Muwanga (later Obote’s Vice President) and Tito Okello in overthrowing President Binaisa.

Yoweri Museveni studied at the University of Dar es Salaam in Tanzania, where he embroiled himself in African liberation politics. There, he did publicity work for the Mozambique Frelimo movement who were then fighting the Portuguese. He also visited Fretimo liberated areas, learning guerrilla warfare.

On graduating in 1970 he joined President Obote’s office as an Assistant Secretary for Research. With the coup that put Amin in power, he fled to Mozambique where he set about training an army. In 1972 he joined with Obote for their first and unsuccessful invasion. By 1979 Museveni’s Fronsa (the Front for National Salvation) had about 9,000 soldiers and once again he agreed to join with Obote’s UPC (Uganda People’s Congress) forces and fight Amin. This time they succeeded and Yusufu Lule, seen as “neutral” by Obote and Museveni, became President.

Although Museveni became a senior member of the Military Commission and Minister for Defence in the new government, Obote had remained in Tanzania. It turned out his “corner” was being looked after by Paulo Muwaanga, the Minister for Internal Affairs. Pressure from Muwaanga and Binaisa (for different reasons) forced Lule to resign, making Binaisa President. But Museveni’s position hadn’t changed, in fact at first it seemed to strengthen. He acted as Head of State when Binaisa was abroad.

It didn’t last, however, and with UPC members whispering that Museveni was after the President’s “sweet chair”, Museveni was demoted to Minister for Regional Co-operation. Down with him fell Muwaanga to Minister for Labour and pressure increased on General Oyite Ojok, a Lango like Obote.

These were powerful enemies to make and within a short time Binaisa was overthrown by Muwaanga, Ojok and Okello, allowing Obote to return to Uganda. It was rumoured that Museveni had helped Muwaanga to get rid of Binaisa. What is certain is that he remained for the 1980 elections.

Muwaanga had unsubtly fixed the elections to allow the U PC to gain most seats and return Obote to the presidency. Museveni and his Uganda Patriotic Movement only gained one seat and Museveni lost in his own constituency. He claimed it had been gerrymandered but sources close to the Democratic Party, who also lost to the UPC, said it had been one of the few that wasn’t.

With Obote back in power Museveni returned to the bush in 1981 and began a war of guerrilla attrition. His non-smoking, non-drinking, Protestant work ethic moulded a formidable group of guerillas in a short time, although some believe that much of the early National Resistance Army was made up of planned remnants of Fronsa,

Grass roots support
His gifted military ability, gained from Frelimo and the textbooks of Mao and Clausewitz, brought one victory after another. His belief in a people’s war rather than a coup, gave him loyal grass-roots support, they agreed with his public sentiment that the aim of the NRA was “dignity for the African people”.

It is perhaps this aim that gives the best insight into Museveni. He waged a war to produce a government that “respects the people” and the NRA’s strictly disciplined soldiers showed that respect. But Museveni also knew that to gain power and develop Uganda, he needed some strange bedfellows. Some observers believe that he was backed by millionaire entrepreneur Tiny Rowlands, while much of his weaponry is said to come from Libya, once Amin’s staunch ally.

Similarly, in redeveloping Uganda’s abused and neglected economy, he accepts that Marxism isn’t the answer and advocates a mixed economy. Already he has said that Uganda counts upon the goodwill of the international community to assist it.

Interview with Yoweri Museveni, Uganda, African politics, peace talks

BUSINESS EQUIPMENT DIGEST, 1984

Seattle-based Microsoft is one of the largest software houses in the world with a $100 million turnover. Its close connections with IBM are unique in the computer industry and has given Bill Gates, the founder of Microsoft, an opportunity to draw some conclusions about them. Gerry O’Kane talks to Bill Gates, Chairman of Microsoft.

SITTING tapping feet, hands clasped under arms while swinging backwards and forwards, does not sound like a description of a successful man. Yet Bill Gates is.

Gates is the Chairman of Microsoft, one of the world’s largest software houses, most noted for providing IBM with the operating system for its personal computer. Only 29 years old, his company in the 1984 fiscal year, turned in net revenues amounting to $100 million, a 50 per cent increase on 1983’s total.

It started in 1974 when he and Paul Allen produced the first BASIC Interpreter for a microcomputer which was used by Apple, Commodore and Pet in the new and growing market. Basic remains the standard language for eight-bit machines like the BBC Micro.

It was six years later that he and his partner made the next technological and business leap. It went hand in hand with probably the most important development in the world of personal and minicomputers which came about with IBM’s move into the PC market.

IBM approached Gates in July 1980 but only with tentative marketing discussions about a ‘new personal computer’. One of their prime concerns was finishing development in about one year. So they decided to use software already existing and industry standard parts, like the Intel chip. Since Microsoft was already the most successful and popular designers of high-level languages, it was an obvious choice.

As the relationship between the two firms became more stable, IBM settled on producing a 16-bit machine using the 8086 chip partly, having been advised to go in this direction by Gates. They also decided to incorporate disk drives. Here was a problem because they needed an operating system up and running in a year. ‘We said “you’d better go and see Digital Research”,’ explained Gates.

However CPM wasn’t going to be available for IBM. Apart from refusing to supply Microsoft with the source code to help machine design, Gary Kildall, the company’s president, spent several hours flying above the desert while IBM executives sweated below in 105 degrees awaiting a meeting and some sort of agreement. Enough was enough, particularly for IBM and shirts open and ties loosened, they returned to Microsoft.

‘We had heard of a guy in Seattle who had designed his own 8086 operating system. He was called Tim Patterson, so we bought it and modified it,’ said Gates. At this time, as it remains, the IBM contract was based on royalties. In actual fact IBM does not own a source code for any PC machine and each time a new DOS is developed it means a new contract.

Gates seems to have a mixed attitude to working with IBM. ‘They are the most honest and straightforward company we deal with,’ he said. Nevertheless he did admit that dealing with a large company could be frustrating and only personal contacts could help clarify IBM’s often ‘mysterious’ policies. Comparing ACT to IBM as business partners, he felt more relaxed with ACT, ‘I mean, the legal niceties are less critical.’

The fruits of success also included Apple. In 1980/81 one of Microsoft’s rare excursions into hardware provided the Softcard that allows CPM compatible software to be run on an Apple using a Z80 processor. Gates pointed out that they still sell 3,000 boards per month.

Since then there were rumours that the firm had been involved with Apple’s failed Lisa computer since they were the first to produce ‘Windows’ after Lisa’s decline. (Windows allows users to look at unrelated packages simultaneously and like Lisa uses graphic representations of a packages functions — icons.)

Gates denies this. ‘Look most technology, about 95 per cent, comes from Xerox, well now most of them work for me.’ Charles Simoyne, for example, was an early experimenter on Windows.

The latest involvement with Apple has been very close. Steve Jobs, the chairman and founder of Apple and Bill Gates first began discussions on the project that had been conceived at Apple in July 1981. By January 1982 work had begun at Microsoft code-named Sand. By 1984 they had designed Word, Microsoft File, Clipart, Multiplan and Basic for the Mac.

One of the most interesting aspects of this powerful software house has been its approach to the market. Gates admits the future, in terms of projects, has already been planned with IBM but he likes to believe that his company is not dependent upon them. In a report about the 1984 fiscal year net revenues, it said ‘Significantly, no single customer accounted for more than ten per cent of the total revenue.’

Gates accepts this as a deliberate policy, ‘We are creating a long-term company which is a leader in software … we have proven we succeed in many different areas.’ This stance must mean there is no emphasis on one market and with the recent move into providing MSX, a new standard for home computers, this seems to be true. Undoubtedly with a justified mistrust of large corporations and the fickle attitudes of the consumer, breadth of base is the safest policy. ‘It is an important indication of a company’s strength that not all the revenue comes from one company,’ he added.

Interview with Bill Gates, Microsoft