The Australian Way, August 2010

On a glorious limestone hillside in Turkey’s Cappadocia, Andrew Rogers is supervising a team of 50 local carvers hewing the steps of an amphitheatre out of the earth. Beneath them, workers with a crane are hoisting a pillar of rock the height of a four-storey building off the back of a groaning truck. These are the final stages of a vast artistic endeavour four and a half years in the making, and you can see it all from the amphitheatre’s steps: 10 stone-wall and basalt sculptures extending two and a half kilometres down the valley, so big you can see them from space.

This is Time and Space, a collection of geoglyphs, or land art, and it is creativity on an epic scale. The installation in Cappadocia is big – 10,500 tons of stone, seven kilometres of rock walls – but not unique, for this is the 12^th location in which Melbourne-based Rogers has worked: 40 sculptures built by 5,500 pairs of hands on five continents, from Iceland to Slovakia, Bolivia to the Gobi Desert, Chile to Geelong. In sum, it is easily the largest contemporary artistic installation in the world.

See this article is it ran here: qa0810_Landscape.indd

When you are an artist on this sort of canvas, the vision is just the start: it’s an exercise in logistics, engineering, staff management and architecture. It requires a character that is not just creative but driven, patient and stubborn. “I’ve basically found out you can build anywhere, in the most difficult situations of terrain and labour, as long as people want it,” Rogers explains as we bounce around the site in a van. “You just have to be very tenacious and driven. Fortunately I’m both of those things.”

The road to this vast undertaking in Cappadocia really began in Israel more than a decade ago, when Rogers was teaching in an architecture faculty there. On a trip to a desert area in the south his colleagues told him they wanted to create something to attract tourism, and he suggested a giant sculpture. A year later, he walked back into the desert to create the first of four artworks there.

“In those days I wasn’t trained as an artist,” he says. “I was trained as an economist.” He had no idea of techniques that might make life easier. “I didn’t realise you could use surveyors. So we used to stand there in 40 degree heat for four weeks at a time and triangulate everything, making points in sand to lay out the sculpture.” Today, the same process takes three to five days.

Next he found himself doing the same thing in the Atacama desert in Chile, the world’s driest, having been inspired by the Nazca lines in Peru. “I thought, what a great idea, why don’t we draw some things across the whole of the earth instead of just one place? That’s the idea behind the whole project. A connected series of drawings on the earth.”

As for Cappadocia, Rogers first visited the region 27 years ago; like anyone who comes here, he was struck by its odd, spiky beauty. He always wanted to come back, and everything about the place suited his purposes. “Each time I decide there should be something of special significance that is inherent to the topography. Here, it’s amazing: the limestone formations that have been caused by nature are quite remarkable and unique. And it is impregnated with thousands of years of history.”

Like any colossal journey it started with a single step – or a phone call, to a sister of a friend in the local travel industry in 2006. “I asked who I could talk to and it went from there.” Then negotiations began. “Getting the permits is always the hardest part,” he says.  How do people feel when approached for something so unusual? “Most of them have never thought about it. It’s like Kleenex tissues: until they were invented nobody thought they needed them. But everybody is interested in preserving their history and heritage and fostering memories for the next generation.”

“You’ve got to find the person that’s interested, or the municipal authority or the elders who believe in the project,” he adds. In Cappadocia this required the support of two successive mayors to chase and approve permits, as well as numerous Turkish and western business leaders to provide funding. People like this need to be free-spirited sorts themselves. “He thinks what I do is quite normal,” says Rogers, impressed, of a local backer, “which is unlike a lot of people.”

For the art itself, Rogers tends to use a mixture of images based around central themes. “We perceive our existence in space and time,” he says. “In this world where technology is constantly advancing, human nature is not; it is often the values of the past that are most relevant today.” This theme, inherent to his work, comes through in many of his sculptures: A Day on Earth features 22 words such as memory, compassion and heritage carved in English and Turkish on basalt columns. Others take forms basic to life and culture – a grinding wheel, a palm tree, a horse – or reflect local myth, such as a Griffin and a double-bodied lion.

Common to every installation he has completed around the world is The Rhythm of Life, which started out as a bronze sculpture 17 years ago and whose original now resides in the National Gallery in Canberra. Rogers describes that original as “a dynamic structure in space, a series of points connected which make a line. It’s like life: all the connected influences we all have, friends, family, activities. It’s an optimistic symbol about life and regeneration.”

Then there’s construction, which began in 2007. Material is key to Rogers. “Stone has been intrinsic to civilisation forever,” he says. “It’s great to touch and feel rock and stone; it brings you back to the fundamentals about the earth, about what’s important.” The stone must be local and where possible nothing foreign is brought onto the site. “In Nepal we used mud with granite. In Chile, bird droppings with clay. Wherever we find a local technique that’s successful and stood the test of time, we use it.”

He has also always insisted on indigenous labour – a rule breached only once, when constructing in the Gobi desert in China, when the authorities decided the best way of getting things done was to give him an army to do the building. (“They don’t normally build sculptures and I don’t normally command an army,” he says.) In Cappadocia, almost a thousand local people were involved. Do they understand what they are working on? “They understand after they’ve worked on it. When they start, it’s a totally abstract concept.”

Relatively speaking, Turkey has been an extremely smooth project; the greatest controversy came with his insistence on paying men and women labours equally, which caused a minor revolt among some of the men. “They’re all challenging for different reasons,” he says. “In Bolivia we worked at 4300 metres, gasping for oxygen all the time. In some of the deserts we’ve been working in 45 degrees. Then you have people issues: too many workers wanting to work in India, and stopping fights between 300 people.”

There’s still a certain rustic approach to producing the art: Rogers judges levels by eye, then marks the pattern each metre with a peg in the ground. But with the workforce engaged, the building is in some sense the easiest part. Unbelievably, the Rhythm of Life sculpture in Cappadocia – whose walls, at the highest point, are two and a half metres high and hundreds of metres in length – was built in just 10 days, by a team of 380 stonemasons. The stones were simply picked up from the ground around the valley, passed hand to hand along lines of people; there’s no cement, no mortar, yet the dry stone walls are pristine three years after their completion.

So why build big? Does it change the meaning of a sculpture to make it writ large? “It doesn’t add anything to its meaning, but scale always adds another dimension,” Rogers says. “It’s more confronting for people. It’s taking the ruins out of being just a material into the realms of speculation.”

‘Visibility from space’ isn’t a casual claim either: Rogers commissions satellites to photograph the sculptures from 280 miles (450km) up. To help with visibility, he coats them, although the material varies with what is local; from place to place it has included cactus juice and bird droppings.

Even as Rogers opened his installation in Turkey on May 29, he was active elsewhere; the next step is Kenya. “It’s all set to go,” he says. “We have 1,000 Masai warriors who will come and camp around the site and build the structure.” It will bring its own challenges and quirks. “They don’t use stone for anything so it will be very interesting. It’s a totally abstract idea for them: they only use thatch.” The structures – which elders have requested include a lion’s paw and traditional markings from a shield, as well as the Rhythms of Life motif – will be made on a volcanic lava plain from deposits around the edges. “It’s going to be fascinating.”

As an installation on a sixth continent, this completes the objectives he originally had for his project. But one senses that it won’t stop here. “I have lots of invitations and if they are interesting places and interesting people I wouldn’t say no. It’s about getting an idea.”

SIDEBAR: Cappadocia

Cappadocia is perfect travel: stunning scenery; history; towns with accommodation and restaurants set up well for tourism without yet being ruinous; and a focus for unusual activities like hot-air ballooning.

The area is filled with curious limestone conical towers that have become known as fairy chimneys, and over the centuries many of them have become homes – or, more recently, hotels. Some have been used to carve churches out of the rock, magnificently painted inside. People have lived here for at least 4,000 years since the Hittites settled the region, followed by the Persians, Romans, Christians, Seljuk and Ottomans.

It is also one of the world’s best places to go hot-air ballooning, blessed with a rare combination of favourable wind and flying conditions and extraordinary topography to see from the air. Skilled pilots can not only navigate the balloons over the region’s most beautiful valleys but descend deep into them, just metres from the rock formations. Other balloons – there may be as many as 40 in the air – add to the extraordinary sight.

In Göreme, Cappadocia’s main travellers’ centre, is the World Heritage-listed Open-Air Museum, a clutch of rock-hewn churches and monasteries. Pay the extra TL8 (A$6) to enter the Karanlık Kilise, or Dark Church, painted inside with vividly colourful biblical scenes.

Elsewhere you can see underground cities, as many as eight levels deep, excavated in the sixth and seventh centuries to give an escape route for Christians fearing Persian and Arabic armies. 10,000 people lived in one of them, Derinkuyu, staying there for months, their air shafts disguised as wells.

More than anything, Cappadocia is a place to walk around, enjoy the scenery, eat well in excellent and friendly restaurants, and sit back with a glass of wine to watch the sunset from a hotel terrace. For many people it is the highlight of a trip to Turkey.

It is January 23 1960, and Don Walsh and Jacques Piccard are on top of a wonky submersible called the Trieste, pitching on 12-foot Pacific Ocean waves having just made history. Over the previous nine hours they have piloted their craft, called a bathyscaph, more than seven miles to the floor of Challenger Deep in the Mariana Trench – the deepest place in the world’s oceans. And now, waiting to be picked up by their support ships, they are already wondering who will follow them. “We thought that in a year or so there’d be more people out here with better machines, to explore these deep trenches,” Walsh says. “We certainly hoped so.”

Not so. Fifty years on, nobody has ever gone back; and since the death of scientist Jacques Piccard in 2006, Walsh – recalling the tale to Discovery Channel Magazine at his ranch in Dora, Oregon – is now the only man alive to have gone so deep. You might think of him as the Hillary of the ocean, except it’s even more pioneering than that: where hundreds have followed Hillary and Tenzing to the top of the world, none have ever followed Walsh and Piccard to the bottom.

This is the version filed. To see the article is it ran in Discovery, click here Trieste (3)

The journey really started for Walsh in 1958 when, as a submarine lieutenant, he volunteered to work on a program leased by the US Navy from a family of Swiss scientists called the Piccards. They had a submersible called the Trieste, an ungainly contraption comprising a thick-walled spherical cabin for crew suspended beneath a thin metal float filled with gasoline. “It looked like an explosion in a boiler factory,” Walsh thought on first sighting it. “I thought to myself: I will never get into that thing.”

The Trieste’s premise was simple: vent the ballast tanks to sink; slow or stop the descent by releasing solid weights filled with small steel pellets; and then, because the gasoline in the float is lighter than the water around it, return to the surface. The sphere itself, which would have to protect the crew from pressure 1,100 times greater than at the surface, was made of three rings, five to seven inches thick and glued together with epoxy at the joints. Walsh recalls the Admiral who ran the Navy’s Bureau of Ships coming to see the Trieste and asking how it was fastened together. Walsh told him about the glue. “Lieutenant Walsh, the Navy does not glue its ships together,” he replied.

But a glue-held submersible was in the spirit of the time, the Space Race era in which vast natural challenges were tackled with simple ingenuity. When the Trieste came back from one of its many test dives near Guam with failed glue joints caused by the differences in sea temperatures during the dive, Walsh says the team’s machinist fixed the problem with “a forklift truck and a large timber battering ram to put the pieces into alignment,” holding them together with a series of bands. “It was a remarkable piece of shade tree engineering and it saved the project,” Walsh says. Set against that, though, was a growing reluctance on the part of the Navy to court publicity, something he had to tackle when seeking approval for the record dive from Admiral Arleigh Burke. “The navy in its exuberance had claimed we were going to put the first earth orbiting satellite up. And they’d fire these rockets out of Cape Canaveral and they’d splash into the bay or they’d have to destruct them because they were heading for Kansas City. It was very embarrassing.” Consequently Walsh was told to garner no publicity: it would be promoted only after it was successful. “You tell [lieutenant Larry] Schumacher [who would be topside on Walsh’s dive], if he doesn’t come back up with Walsh, I’m going to have his balls,” Burke told Walsh.

After a series of tests in San Diego and later Guam, the stage was set. So on January 19 Walsh and most of his team set off in a corvette to the dive site and set about trying to find the deepest point by dropping dynamite into the ocean and timing the echoes. “We didn’t know exactly where the deepest place was: there were no maps or charts,” he says. “We didn’t care about exact depth measurement, only that 14 seconds was deeper than 12 seconds.”

At the same time a navy tug pulled the bathyscaphe towards the dive site at five knots. It arrived on dive day, January 23, in “a pretty good sea state, six or seven on the Beaufort scale.” For a craft like the Trieste, that was a challenge, but Walsh said they never considered aborting; “If we’d towed it back in, our masters in San Diego would have said: that’s it.” In fact, they did exactly that, but fortunately by the time the message reached them the Trieste had already dived. “The chief scientist put it in his pocket, walked around for a while, then sent a message back to San Diego saying ‘Trieste passing 20,000 feet’.”

Walsh and Piccard were together in the snug sphere for nine hours. “It was close. Jacques was two metres in altitude, and we had all our kit – equipment, instruments, cameras and stuff. We kind of coiled up inside it.” It got cold, too. “But, shit, it’s no more crowded than sitting back in peasant class on a trans-Pacific flight for 14 hours. You want to know about discomfort, just fly from here to Singapore.”

The Trieste began descending at 8.30 am and hit its first obstacle when it started bouncing along on the top of a thermocline at about 300 feet under. Eventually Piccard and Walsh valved off enough gasoline to break through and began sinking in earnest. It took five hours to get down.

It was dull in the main, but enlivened considerably at 31,000 feet. “We heard and felt a giant bang.” All instruments looked fine – so, despite being in a craft untested at this depth, deeper than any man had gone before, and having heard an explosion, they carried on. “We didn’t think it was OK to carry on,” retorts Walsh when challenged on this. “We knew it was OK to carry on because our readings were normal.” A pragmatist, he claims never to have been scared because the testing had been so rigorous.

The Trieste sank further and further, deeper than they had expected, until finally the loom of the lights was visible reflecting from the floor. Piccard ditched more shot to slow the descent and they made an easy landing; the gauge (wrongly, it would later turn out) read 37,800 feet. But this was to be no “giant-leap-for-mankind” moment. “We shook hands, congratulated each other and called topside on the underwater telephone, a voice modulated sonar. We told Larry Schumacher we had reached the bottom, 6,000 fathoms, and it was good.” What did he reply? “He just acknowledged. You kept your messages pretty simple.”

There, seven miles down, it became clear what the bang was: a crack across the window in the entrance hatch. Bad as that sounds, it wasn’t dangerous on the floor, since the entrance tube was always flooded during a dive, meaning the window was not a pressure boundary. It did, though, create a chance of being trapped at the surface. “If we couldn’t get out we’d be stuck in there for a few days feasting on Hershey bars.”

There is a sense of anticlimax about the bottom. No photos, since the landing had stirred up a cloud of sediment which didn’t disperse; and only 20 minutes on the bottom since they needed to surface in daylight. “It was like being in a bowl of milk. We didn’t get any pictures.” The highlight, instead, was Piccard sighting a foot-long flatfish, “like a sole or halibut”, which confounded scientists given the intense pressure on the ocean floor.

The journey back to the surface was smooth. “There was a sense of achievement. And some celebration: we worked like hell for almost a year to get to this place.” There was little carnival, though, 200 miles out at sea. “After dinner I was ready to have a nap.”

A period of celebrity followed, with a meeting with President Eisenhower; Walsh says he is “genetically not programmed for celebrity stuff” but appreciated the opportunity it gave to lobby for more support for this type of exploration. But it didn’t pay off: not long after the dive the Navy decided it was not safe to dive below 20,000 feet, so the Trieste became, and remains, a unique event.

For his part, Walsh says the motivation was not a record per se. “I was never driven to go deeper and deeper,” he says. “There was a singular goal out there and that was the deepest place in the ocean. Getting there required a systematic testing of the vehicle. Things broke, we fixed them.”

Nevertheless, down to earth though he is, there’s no escaping the frontier significance of the time. “The number of people that had piloted manned submersibles in the world you could count on one hand: it’s the days of Glenn Curtiss and the Wright Brothers when there were only two airplanes.” It’s just that perhaps when you go down instead of up, less people notice the significance of what you’ve done. “I’m writing an unauthorised autobiography,” he dead-pans. “The Right Stuff, The Wrong Direction.”

BOX 1: THE OTHER DON WALSH.

So what happened next after the Trieste program? “Well,” says Walsh, “a lot of people think I died.”

Such is the penalty for creating an historic event with so much of your life still to go. In fact, Walsh did plenty: he commanded a submarine, the Bashaw; served in both the Korean and Vietnam wars (“I think two per customer is sufficient for a lifetime”); gained three graduate degrees; worked in the Pentagon as an advisor on submarines; became the founding director of the Institute for Marine and Coastal Studies at the University of Southern California with the rank of dean (“universities are more rank-conscious than the military”); and built a successful consultancy, International Marine Inc, that continues to run from Oregon today.

But it’s the continuing exploration that sets the pulse racing, and Walsh has done plenty.

In 1971 Walsh first visited the Antarctic with the navy, as part of Project Deep Freeze, which involved inhabiting and running Antarctic stations on behalf of scientists. His efforts were so well appreciated that he has an Antarctic ridge, the Walsh Spur, named after him. “I really enjoyed it but I never thought I’d get back,” he says.

The opportunity to do so came when small expedition cruises began to grow in popularity, taking tourists to the Arctic and Antarctic; Walsh was approached to serve as an on board lecturer in the mid 90s and has now notched up 27 trips to Antarctica, 26 to the Arctic and five to the North Pole itself. Walsh (and his wife, Joan) were part of a non-stop circumnavigation of Antarctica on a Russian icebreaker in the 2002-3 season, only the 11^th time the trip has been done.

He’s also dived in the Russian Mir submersibles on the Titanic, Bismarck and the North Atlantic Ridge, something born out of many years of cooperation with Russian submariners who were once very much the enemy. “On a North pole trip on a Russian icebreaker most of the engineering staff on this nuclear powered icebreaker had come from the Soviet sub service,” he recalls. “We would sit in the bowels of the ship and drink lots of vodka and talk about our adventures; they showed me periscope photos of the US aircraft carrier Kitty Hawk they had taken from their Soviet sub.” On one trip conversation turned to the fact that nobody had ever been to the real North Pole – under the sea, 14,500 feet beneath the ice cap. A plan was hatched with Mike McDowell, the Australian founder of Quark Expeditions, to do so using the Mir submersibles and a Russian mother ship.

“We needed three things,” he recalls. “We had to get money, the front end one-time cost of about $3 million; we needed to sell tickets to about 20 tourists to come along and make a dive after the explorers had gone; and the third was to get the charters of a nuclear icebreaker and a mother ship for the submersibles.”

For years, though, only two of the three would ever come together, and the Titanic and Bismarck dives came along as commercial operations for tourists and aficionados like Titanic director Jim Cameron in the meantime. “All these were placeholders, bookmarks; the real goal was the North Pole.” And then, in 2007, came bad news: the Russian government had decided it would be an all-Russian expedition. “They came in and took all our planning and hijacked the whole thing.”

This clearly annoys Walsh but life is not so bad, living on his ranch deep in rural Oregon, surrounded by books in an office designed by his wife and apparently made up almost entirely by shelves. “Joan says that end to end they make 1,006 feet – the exact length of the Bismarck,” he says (among the many achievements of Walsh’s life is finding a wife who not only tolerates his adventures but knows to the foot how long the Bismarck is).

It’s an odd place, one might think, for a specialist in undiscovered ocean depths. “Simple,” he says. “I have bonded with my fellow man as much as I care to in this lifetime. My nearest neighbour is a mile away, I have a half mile salmon river on the far side of that pasture, and if more than half a dozen cars go by the front of the house during the day my wife complains about the heavy traffic.” Even the experimental biplane he built is up for sale in nearby Bandon. “I haven’t flown it for a while,” says the 78-year old. “I’m just too damn busy.”

“Now that I’m 78, it’s probably time to act my age,” he says. His immediate schedule – a host of engagements around Europe – doesn’t sound much like slowing down. “But in the polar regions you’re working out of the zodiac boats, helping passengers who’ve never been to these places before,” he says. “You don’t want this geriatric old fart stumbling around tripping over penguins.”

He and his wife talk about “a ritual burning of the parka, out in the yard,” to symbolise this end to the adventuring. It hasn’t yet happened. “But there’s got to be a last trip.”

BOX 2: WHY HAVEN’T WE GONE BACK?

In 50 years, the only other visitors to Challenger Deep have been remote-controlled submersibles: the Kaiko in 1995 and the Nereus in 2009.

Why have no humans gone back? Partly, it’s about money. “Science is primarily interested in data per dollar and since the 1990s ROVs [remotely operated vehicles] have proven themselves useful at trench depths,” says Peter Batson of Deep Ocean Expeditions.

“The exploratory desire is always balanced by difficulty, cost and safety,” says Captain Doug Marble in the Office of Naval Research – the division responsible for the Trieste dive 50 years ago. “Oceanographers have been able to probe the Challenger Deep by other means, such as acoustics, without going there in person.” In addition, the equation about human safety has changed since 1960. “I would guess that the intense, large scale activities of World War II and the atomic bomb prompted the realization that geophysics was ill understood for the needs of the time. Risks were undertaken [by humans] which today would be ceded to remote and autonomous systems for the initial steps.”

Then there’s engineering. Batson says: “The deepest trenches are about 11 kilometres deep, but cover only 2% of the ocean floor. So if you can build a manned submersible that can go six kilometers down, you’ve got access to 98% of the world’s sea floor.” This has influenced the design specifications of later manned submersibles, such as Japan’s Shinkai 6500, which can go to 6.5 kilometres. “Trieste’s deep-diving abilities came at a cost – it was huge compared to modern submersibles and was logistically difficult to operate,” Batson says. Instead it will be endeavour that takes us back: hence the most likely man to repeat Walsh’s feat is currently Jim Cameron.

Walsh is, if not bitter, then disappointed by the way things have gone and one senses a certain antagonism both about the US’s failure to keep pace with manned submersible technology, and with disproportionate spending on space exploration. Asked about the context of the 60s, when the space race was developing in earnest and Joe Kittinger was setting a high dive leap from a hot air balloon at the edge of space that still stands today, he prefers to highlight the achievements of submariners at the time: the Nautilus going across the Arctic Ocean under the ice cap by way of the North Pole; the Triton circumnavigating the world totally submerged. “When I met President Eisenhower I realized that he had only given personal decorations to three military persons in eight years,” Walsh says: himself, Bill Anderson of the Nautilus and Ned Beach of the Triton. “They were all submariners.”

“There is a lack of investment in studying the ocean compared to space,” says Walsh. “But we live here on this manned spacecraft called Planet Earth. Few of us are going into space. It’s entertaining, and certainly the son et lumiere of a space launch is formidable. What we do, one minute it’s there, the next minute it’s a cloud of bubbles. It’s not very exciting. But it’s very important.”

Australian Financial Review, February 2 2010

When Anwar Ibrahim walks into the Kuala Lumpur High Court today, he will at least know what to expect.

Anwar, Malaysia’s one-time deputy prime minister and now the de facto leader of the first credible opposition in Malaysia’s independent history, is facing the third incarceration of his life. The first was a 22-month detention when a student leader in the 1970s; the second a six-year stint in 1998 for sodomy (overturned in 2004) and corruption, during the administration of his one-time mentor, Mahathir Mohamed. Now, he faces another sodomy charge, and the potential of 20 years in jail. Locally the press are calling it Sodomy II, like a sequel. “They use the same script,” he tells the AFR in an interview in his Kuala Lumpur offices. “I’ll leave it to the lawyers. I don’t have any trust in the system.”

That’s no surprise. Anwar’s trial represents an enormously significant moment for Malaysia, because it could make or break the opposition movement at a time of intense racial tension on a scale the country hasn’t seen since the race riots of the 1960s. Malaysia, though a sometimes uneasy patchwork of a Muslim Malay majority and significant Chinese and Indian minorities, has for decades been amongst the most moderate and peaceful of Muslim nations. Yet in recent months it has become a place where churches are firebombed over the right for Christians to use the word Allah, and where cows’ heads are kicked around outside Hindu temples.

Some feel these forces have been inflamed by the country’s UMNO party, the leader of the ruling Barisan Nasional coalition, seeking to secure its hold on the Malay vote; Anwar calls it “desperate measures to frustrate this peaceful transition.” But at the same time Anwar’s own rise, with his multi-racial coalition securing one third of the votes and five out of 13 states in landmark elections in 2008, has become something of a catalyst for this expression of tension. “Yes, of course that is true,” he says. “You can see the press, controlled by UMNO, blaming me for causing this, for giving courage to non-Malays to express themselves. But I think the contrary: we are giving that right of expression to all. There is a new generation of Malays who are asserting themselves with greater confidence.”

Another jail term for Anwar could do one of two things. It could wreck his coalition, which despite its outstanding 2008 performance has widely been viewed as fragile: it unites a party formed by Anwar’s wife, Wan Azizah Ismail (who is still officially its president), during Anwar’s 1998 jail term, with a sometimes hard-line Islamic party and another whose key constituency is overseas Chinese. Lacking a charismatic leader to glue it together, the alliance could fail well before the next elections, due in 2013, although Anwar insists detailed contingency plans are in place among the three parties. “There is already an agreement what to do in the event – the unlikely event – I am convicted, yet again. The coalition will stay with or without Anwar.”

Alternatively, another conviction could unite opposition behind a cause and give it renewed momentum. It is also not likely to go down well overseas, where doubts over Anwar’s earlier conviction are already widespread; public figures who have already voiced their concern for him range from Al Gore to US Supreme Court Justice Sandra Day O’Connor and, right up to his death, former Indonesian president Abdurrahman Wahid.

The uncertainty is not helping Malaysia, where foreign direct investment numbers are flagging even after accounting for recession: from M$62.8 billion in 2008 to M$12.6 billion in the first nine months of 2009. “Foreign investors are asking me about Anwar and the firebombings all the time,” says one foreign banker in Kuala Lumpur who deals with major foreign investors. “If Anwar ends up back in the slammer it’s going to have major negative consequences on Malaysia. Whether or not it will mean riots on the streets I don’t know, but it will certainly harm the government.”

Anwar is an appropriate figurehead for his country’s painful change. It’s easy to forget it now, but he was once the chosen one to succeed Mahathir: he was deputy leader and finance minister through the Asian financial crisis and was trusted so implicitly he was made acting prime minister for two months in 1997 when Mahathir took a holiday. But he wanted reform in governance and institutions, and when he started linking Mahathir with improper contracts and bailouts for family members and cronies, his time in the sun came quickly and brutally to an end. His 1998 trial raised concerns worldwide; Amnesty International considered him a prisoner of conscience, and the injuries incurred in jail cause him back pain to this day.

Because Anwar’s corruption conviction was never overturned, he was banned from politics until April 2008, and took to teaching in the US. Malaysia’s then prime minister, Abdullah Badawi, timed the 2008 elections to be just one month before Anwar’s ban expired, fearing his popular voice, but it didn’t work: Anwar simply canvassed for his wife’s party, and when his ban expired she surrendered her seat and he won it in a by-election. For a time his momentum seemed unstoppable: by September 2008 he was claiming to have secured 30 parliamentary defections that would give his coalition a majority. He demanded a vote of no confidence.

But then things stalled. First, he couldn’t force that vote, and he says he couldn’t expect his converts to declare openly until the moment of truth on the parliament floor – consequently, there’s no proof that he ever had the numbers at all. “In any democratic country we would have taken over by now, because we had the numbers, but there’s no way to go about it,” he says. “In this climate of fear and repression you can’t expect people to declare openly now except for the critical moment when the motion is tabled.” By this he is referring to the string of opposition figures, including a number of state leaders, who have been comprehensively investigated by federal institutions since the election.

Momentum was further derailed when in June 2008 a new sodomy charge, from a young aide called Saiful Bukhari Azlan, appeared with a convenience of timing that many have found deeply troubling: the taint of sodomy, illegal in this Muslim country, is considered a death knell to an aspiring politician. Whether people believe the charge or not, defending it has been time-consuming and helped to take the wind out of the challenge’s sails. And many events in the build-up to the case – the team of commandos sent to arrest him when he was on his way to the police station to make a statement, the dispute over whether the prosecution should have to let the defence see evidence prior to the trial, confirmation that Saiful visited current prime minister Najib Razak’s residence days before filing his police report – seem to bode badly for him.

But while Anwar is under pressure in the court, it’s the incumbent government, and in particular the UMNO party at its heart, that is struggling, and not just with those election results. Even in a country with a largely compliant mainstream press (but a vibrant alternative media), the government and the country’s other key institutions have found themselves mired in scandal: the death of opposition political aide Teo Beng Hock, who fell from a 14^th floor window during questioning by the Malaysian Anti-Corruption Commission (MACC). There’s the murder of the Mongolian model Altantuya Shaariibuu, the mistress of Najib’s foreign policy advisor, who prosecutors claim was killed by government commandos in 2006 and whose body was destroyed by C4 explosives. There have been scandals over contracts for French submarines, jet engines that have gone missing, and a dispute over the legitimacy of a state government in Perak.

And most recently, a court case regarding the use of word Allah by non-Muslims has flared up. In December the High Court, in dealing with a long-standing dispute between the government and the Catholic Herald newspaper, ruled that the government had no power to prohibit the use of the word Allah or to make it the exclusive preserve of Muslims. Numerous acts of arson on Christian churches have followed the ruling, while the original debate has become a somewhat farcical exercise in semantics, with the government – which, incidentally, is in the middle of a major public relations tilt called One Malaysia aimed at promoting racial and religious unity – ruling that Christians in East Malaysia can use the word Allah when speaking Malay, but that those in West Malaysia cannot.

Many of Kuala Lumpur’s business community are increasingly alarmed. “You see Najib on one hand talking about One Malaysia and a multi-racial tolerant country, and on the other you see the complete opposite of that driven by the establishment,” says a banker, who like all commercial figures in this article wished not to be named for fear of damaging relationships with government. “This may sound over the top but I would describe Malaysia as almost anarchy at the moment, because all the institutions of government believe that their job in life is to restore BN back to its previous power. The judiciary believes its job is to prosecute the opposition. The police: that their mission is to prosecute the opposition. MACC, the same. The guys in power are stoking racial unrest because they believe it’s one way of supporting the Malay vote.”

Anwar – who took some strident positions on Islam himself in his youth – has sought to preach a less radical middle ground. “I have asked the world’s most renowned authorities on Islam and nobody, not one, disputes the fact that Allah can be used by anyone,” he says. “It’s been a non-issue for 1,400 years among the Muslims.” Even PAS, the Islamic party in Anwar’s coalition, normally known as the voice of those with a more traditional and inflexible view of Islam, has publicly said they have no problem with Christians using the word: the fact that the purely Islamic party is now on more moderate ground than the government has cemented a feeling that the government has been playing the race card to try to win back disgruntled Malay voters.

The government has not been blind to change and has taken some reformist measures itself. The most significant concern the New Economic Policy, the measures enacted in the 1960s – by Najib’s father – in support of the local Bumiputra (“sons of the soil”, or Malay) population. It guaranteed them, among other things, a certain proportion of civil service jobs, and a minimum share of any stock market float. While understandable in the context of its time, many, Malays included, have come to see it as a crutch that has become a hindrance, damaging competitiveness and breeding complacency. Late last year Najib began some modest repeals.

So does Anwar believe change can be effected peacefully in Malaysia? “Well for the first phase, the five states [in the March 2008 elections], it did,” Anwar says. And despite doubts about his coalition’s durability, he argues its very cross-faith existence is enormously positive. “It means that in Malaysia, if political leaders don’t continue to incite hatred and use the race card in politics, we can survive,” he says. “The problem is UMNO: they have become an obsolete party of the past.”

But Anwar is not a Mandela and will never quite be embraced in that way. For a start, there is the fact that, having started out a somewhat radical student and youth leader, he switched allegiances to Mahathir in the 1980s and made his name soaring through the ranks of the party he now dismisses as “the last refuge of scoundrels”. He argues that when he joined Mahathir in 1981 he did so because the leader was talking about reform, and that through much of the 1980s they were effective; it was when a more authoritarian style came into effect that he objected, at great personal cost. “But can I absolve myself from the entire policy, decisions, excesses? No I cannot. I have made that very clear to the people.” Did he ever engage in the money politics commonplace in UMNO at that time? “When I announced my candidature (as deputy leader) 80% of the UMNO cabinet members, all chief ministers, were with me. So I didn’t need to go beyond that. The culture on the ground, you have big fees, but nothing compared with this cash being paid [in UMNO now].”

Additionally, some accuse him of opportunism in his career, and of inconsistency: a chameleon quality (he uses the word himself), saying what the audience of the moment want to hear, which raises questions about how he would fare in office when there can be only one decision for all audiences. Some say he is disorganised too, and unable to give his closest staff a clear mandate. “He is a great politician inasmuch as his oratory skills are fantastic, and he can definitely speak to a crowd,” says one observer. “But he can’t administer and he can’t organise.” Another stresses that “what happened in the election was a vote against government, not a vote in favour of the opposition.” On top of that mainstream media is unlikely to take his side, though the advent of Twitter, Facebook and blogs have helped dramatically, and it is noticeable how much stronger his support in well-connected and tech-savvy urban areas is than in rural Malaysia.

Listening to him in English, fluent but understated and sometimes a little unclear, one wonders how the chameleon projects to the heartland.

The answer comes later that night at a rally in a community hall in the Kuala Lumpur suburb of Cheras. Here, in the local Malay language of Bahasa, the delivery is utterly different, voice playing the ranges from aggression to a whisper, arms expressively aloft, the audience by turns brought to laughter, indignation and applause.

For sure, this is a home team crowd, but it’s largely a Malay Muslim crowd, supposedly the very core of UMNO’s appeal, and they are packed 50 deep outside the hall exits, arms folded, listening intently. Some have brought their children, drooping flopped on shoulders; it is 11.45pm on a Thursday night.

He will do the same on alternate nights leading up the trial, campaigning steadily when an election could still be years away. Over noodles with his chief ministers and supporters, well past midnight, he tells the AFR about the forthcoming weekend rallies where he expects crowds far greater than the 1,000 or so who turned up tonight.

It’s no surprise he looks tired. Earlier the AFR had thanked him for his time, remarking how busy he must be. “Not busy,” he says. “Under siege.”

 Click below for a PDF of the story as it ran

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Euromoney, September 2009

IF MACQUARIE GROUP is at a crossroads, it probably already owns it. The financial services group, best known outside Australia for its infrastructure investments from Sydney Airport to the M6 motorway in the UK, has had a difficult year and has seen one part of its model – the satellite fund – run into trouble. It has faced belligerent hedge funds intent on bringing down the stock, and indeed the bank; it has taken billions of dollars of impairment charges on its listed funds; and it has faced a certain local Schadenfreude in a country that shows little warmth for tall poppies. But as imitators have gone bankrupt it has stayed profitable throughout and is already tweaking, evolving and reinventing, just as it has ever since it started out in 1969.

“In the time I’ve been covering the stock it’s gone from market-making equity options to gold bullion trading, to R&D tax financing to cross-border structured financing to listed infrastructure,” says Brian Johnson, one of Australia’s most highly rated banking analysts, who recently moved from JPMorgan to CLSA. “The model just continues to evolve.”

It has been common in the past 18 months to talk about the Macquarie model, and to ask if that model is broken. Typically, when people use this term, they are referring to an approach that Macquarie pioneered: buy infrastructure assets, put them into funds, gear them and then list them, with the parent drawing base and performance fees for the management of the funds.

This has unquestionably been big business for Macquarie – it has 14 listed real estate or infrastructure funds or fund managers listed in Sydney, Singapore, Tokyo, New York and Seoul, with A$11 billion ($9.1 billion) equity under management between them even after market declines, but the bank has lately been at pains to point out that in terms of the overall business it’s not that big a deal. In the year to March 31, specialized funds accounted for just 13% of Macquarie’s A$7.6 billion in operating income – ranking just fourth as a source of revenue behind such areas as lending and leasing, commodities and FX, and cash equities. That is partly a consequence of declining values and performance but this business’s contribution has never been higher than 20%. 

“That includes all the income from specialist funds, M&A fees, advisory fees, underwriting fees – everything to do with those funds,” says Nicholas Moore, chief executive. So is Macquarie misunderstood? “Well it’s certainly an important point to make,” Moore says. “Because our [funds] business is so strong people will naturally recognize that. They might not recognize the other 87% of the group.” And even that overstates the contribution, he says. “Of that 13% we estimate the listed portion is less than 5%. The group is more than 95% non-listed funds.”

It’s natural, though, that this has captured the most attention, and Macquarie was much more vocal about this point of differentiation when the model was working well. People get attached to infrastructure because they can see it, be it the motorway they drive on to get to work or the airport they fly out of. Once you start exposing retail share investors to these assets, that visibility increases dramatically – particularly when things are not going well. And, lately, they haven’t been.

Things were fine in an era of cheap debt and a ready acceptance of leverage, and investors in many satellite funds have done very well out of them over the years. However, the approach fell drastically out of favour as sentiment towards indebtedness changed. Some listed funds, such as Singapore-listed Macquarie International Infrastructure Fund, are trading at around one-third of their listing price. At a group level, the full-year result to March 2009 included A$2.54 billion of provisions, one-off costs and equity losses, some of it from one-time hits such as the group’s exit from Italian mortgages and for modest ABS or CLO exposures, but mainly for the funds, real estate and resources equity investments, and co-investments in infrastructure such as Japan Airports and Spirit Finance.

In the event, these impairments weren’t even enough to put the bank into the red: its A$871 million profit for the 2009 financial year was down 52% on 2008 but still mocks the multi-billion dollar losses of many banks in Europe and the US. But the era of those listed funds is over, at least for now.

The final straw from the retail investor perspective was Brisconnections, set up by a Macquarie-led consortium to design, build, operate and finance an A$4.9 billion airport toll road in Brisbane. BrisConnections was floated in July 2008 using an installment model: investors were to pay A$1 up front, with two more A$1 payments to come in subsequent installments, to make a A$1.2 billion flotation, which Macquarie also underwrote (with Deutsche). By November it had reached the lowest possible price on the Australian Securities Exchange, one tenth of an Australian cent, with investors still on the hook for two installments each 1,000 times higher than the trading value of the stock. (See Euromoney June 2009, page xx for more on this; most investors have since taken up a Macquarie offer to give up their shares for nothing in exchange for being excused payment of the next two installments.) Moore points out the road will still be built on schedule, but clearly the brand damage to Macquarie and listed infrastructure was severe. Broadly, many feel that Macquarie’s involvement in listed funds as both a manager and as the recipient of fees from that fund based in part on scale and transactions is a conflict of interest. Moore responds: “It’s pretty clear the governance structures are designed to ensure that’s not the case.”

Asked if that model is gone for good, Moore speaks of “the frustration we feel and our investors feel” that the good assets in the funds are not reflected by the listed markets. He adds: “Needless to say, whether it’s Macquarie or anybody else, there’s no capital going into listed funds to buy infrastructure assets today because they’re just not valued by the listed market. Will that turn around? Sure… but where we sit today, plainly there is frustration.”

And so a shift is under way: Macquarie is stepping away from listed funds (see box) and moving more and more into unlisted. The net effect is that Macquarie is going to remain every bit as active in infrastructure as it always has been, and indeed already the equity under management in the unlisted funds (including real estate), at A$41 billion, is almost four times the amount in listed vehicles.

And it’s growing fast. In August Macquarie signed a deal to put $50 million into a $530 million infrastructure fund with Vnesheconombank, Russia’s state development bank, to capitalize on Russian government promotion of private sector activity. This followed the April launch of a $1.04 billion Indian infrastructure fund with State Bank of India, in which Macquarie committed $150 million. Next up will be a joint venture with China Everbright to raise $1.5 billion for investment in North Asia infrastructure projects.

Clearly Macquarie still has to make these vehicles work but doing it this way has a lot to recommend it. Stock market investors, particularly retail ones, tend to be skittish, and also want a dividend yield, which in the good times was generated by re-gearing the assets in the funds but is impracticable now. “In the unlisted model, you’ve still got governments selling assets, but you’ve got wholesale pension funds that want to buy long-duration assets to match their liabilities,” says Johnson. “They don’t need the illusion of a distribution of the capital value. They are more worried about the long-term value of the asset. To me the unlisted model looks a lot more sustainable.”

Chief financial officer Greg Ward says: “I like unlisted funds. Retail is hard, you’re dealing with exchanges and mass investor communications – it’s quite a process. In unlisted you can sit around a table with the investment committee… you put it all together and it’s done.” Moore depicts the decision between listed and unlisted models as “a market driven issue – it’s not a call we’re making, we’re just reflecting what’s happening in the broader marketplace”.

A big question with this shift is what happens to the fee structures, which have long been a keystone of the bank’s investment banking division. There have been years in which as much as half of Macquarie’s overall M&A transaction count has featured a party with a Macquarie link. Ward says the fees are “about the same” in the listed and unlisted models, although clearly the bank will lose its underwriting fees on the flotations that will no longer occur. Johnson feels that this area is “where the jury is still out” but thinks the fees will end up being similar, just pushed further back in the fund’s process. Macquarie should hope so, as the investment banking arm is the one part of the business that was still declining in the first quarter of the 2010 financial year compared with the fourth of 2009.

But, if Macquarie is not just funds and infrastructure, what is it? Crucial to understanding Macquarie is a comprehension of its style of business. Allan Moss, Moore’s predecessor as chief executive, used to talk of the “loose-tight” approach to risk management; within certain parameters, if someone comes up with a good idea, they are pretty much given the keys to go and make it work. Moore too talks about “this entrepreneurial nature, making sure the initiative and the enterprise is really owned at the grass roots. These are the people who are going to see the opportunities and are going out into the marketplace, so we are going to create an environment that is supportive of them.”

The consequence of this is a business that can appear bitty, with siloed businesses apparently running in isolation from one another. “My two biggest competitors in the industry when I was there were other parts of Macquarie,” recalls a former employee. But it is extraordinarily wide-ranging in both a business and a geographical sense. Some 40% of its 2009 operating income came from businesses that did not exist five years ago, and a look at developments in the securities business, one of five key divisions within the bank’s structure, over that period illustrates how it happens. There was the Asian cash equities business, the old Baring franchise bought from ING Asia in 2004; the launch of a cash equities business in India; a joint venture with First South Securities in South Africa; the acquisition of Orion Securities in Canada in 2007; greenfield businesses in Europe and the US, the establishment of a European structured equity finance team, and a synthetic products business. Other divisions, including treasury and commodities, corporate and asset finance, banking and financial services, and funds, look the same: incremental shifts into tightly defined new areas, almost franchises.

If we accept that Macquarie is through the worst, where next? Following its A$1.2 billion share capital raising in May, it has A$4.3 billion above minimum regulatory requirements. Although that has clearly been highly useful as a buffer and a source of security for investors, it will soon become a drain on return on equity (which, incidentally, has an unusual side effect at Macquarie since the calculation of its bonus pool is directly linked to ROE). “The drag of capital will become a big issue over the next 12 months,” says Deutsche bank analyst James Freeman, “and they are going to want to use it sooner rather than later.”

This ties in to a nagging fear that, in demonstrating its stability, Macquarie might have neutered some of the outside-the-box entrepreneurship that made its name. “When I look at Nicholas going from Macquarie Capital [the investment banking and specialist funds arm, which Moore built] to CEO, he goes from being the entrepreneur to being the risk rationer and that must be hard for him,” says a person who has worked with him. And Moore’s unavoidable change of focus, a function of promotion and market environment, is perhaps emblematic of a necessary group-wide shift in attitude from brassiness to caution. The use of that surplus cash will say a lot about the group’s confidence and boldness as the financial crisis eases. (Five days after the interview as Euromoney went to press, Macquarie announced a US$428 million acquisition of Delaware Investments, a US money manager, in the largest foreign acquisition the group has yet announced. Perhaps rumours of lost gumption were premature.)

When will it be deployed? “That’s the sort of dilemma or debate we have internally,” says Ward, who thinks that the 2011 financial year – which starts for Macquarie in April 2010 – is the time when “there will be a bit more attention to the traditional metrics of return on equity” and therefore banks will be expected to put excess capital to work.

Macquarie historically has never gone anywhere near its regulatory capital minimums – at March 31, before the share capital raising, its tier 1 figure was 11.4% compared with a 7% minimum – so not all of that excess capital is deployable, although Ward says “if the minimum held was a billion over or a billion and a half I think that would be more than ample.” On that methodology about A$3 billion is available to be put to work.

Asked where it might go and when, Moore’s detailed response covers every area of the business and pretty much the world, from US debt capital markets to Australian and global fund management, corporate and asset finance lending, leasing, and domestic retail banking, but what’s lacking from it is any sense of a visionary or transforming acquisition or a major deployment of funds. “We’ve always had a relatively small and expensive balance sheet and we’ve always been very cautious in the use of it,” says Moore, stressing the bank’s role as a provider of services more than a lender of capital. “We don’t see the role of the organization to be taking the last basis point of use out of the balance sheet.”

If one were to identify the acquisition that comes closest to transformative in the past five years, it would probably be the ING Asia brokerage business, which brought more than 400 people into the fold – yet that deal’s cost was so low that it has never been disclosed, meaning it didn’t even meet the Australian Securities Exchange’s definition of a material transaction. This can seem at odds with the bank’s recent history of landmark bids for, for example, the London Stock Exchange and Qantas, but those (neither of them successful) were mooted investments in which Macquarie would actually not have put much of its own capital on the line. Macquarie does get linked with specific businesses – such as Fox-Pitt Kelton and ING’s Asian wealth management arm – but it is never likely to turn up buying an entire continent of Lehman staff like Nomura, for example. Moore says that the deployment of capital is typically for organic growth rather than big deals.

At times this can be a difficult business to get a sense of direction from. “What’s the model going to be?” asks Freeman. “It seems a collection of businesses trying to make money but with no overarching strategy. I’d characterize it as being in limbo: surplus liquidity awaiting a defined strategy.”

Still, there is a common theme to the modest acquisitions of the past 12 months: energy. In May it bought Tristone Capital Global, an energy advisory and capital markets business based in Canada, for C$116 million ($106 million); this followed, in February, the purchase of Constellation Energy’s downstream natural gas trading operations in Houston, and the earlier development of a gas trading business called Macquarie Cook Energy. Between them, the three have quietly made Macquarie one of the leading players in North America’s wholesale natural gas market.

Johnson in particular thinks this is the next big step for Macquarie. “I can see the next wave of the business model beyond the unlisted funds, which is oil and gas,” he says. “That’s certainly the space Macquarie is moving into. The evolution continues.”

BOX: GETTING OUT

Macquarie’s departures from its listed funds are happening in a variety of ways. One key deal came when Macquarie sold its Macquarie Communications Infrastructure Group – which contains the communications assets Broadcast Australia, Arqiva and Airwave – to the Canada Pension Plan Investment Board for A$3 a share shortly after fund itself was trading at 83 cents. Moore sees this as vindication of his view that the underlying assets in the funds are far better than the listed markets think they are. Other trusts have been selling assets to raise cash or retire debt, notably the Macquarie Countrywide Reit and Macquarie Infrastructure Group (which sold a 25% stake in the Westlink M7 motorway in February), while Macquarie’s 26% stake in the Singapore-listed Macquarie Prime Reit was sold outright to YTL. A co-investment vehicle called Macquarie Capital Alliance Group was taken private in August 2008, and others may follow.

Increasingly, though, Macquarie is keeping its stakes in the funds but backing out of their management completely. This has been put to shareholders in two trusts – Macquarie Leisure, which owns theme parks; and Macquarie Airports, which with a A$4.1 billion ($3.4 billion) market capitalization is one of the biggest funds (and the most visible, since it owns most of Sydney Airport). Macquarie Infrastructure Group, the other heavyweight listed fund, is also believed to be considering going it alone without the parent  – and may also be split into two vehicles.

The airport deal is controversial as Macquarie is surrendering its management rights at a cost: stock worth A$345 million at the time of the deal. The mechanics of calculating that figure – what’s the right to management worth? – are unclear and some shareholders plan to vote against the proposal, with Perpetual Investments believed to be among the big managers grumbling about the circumstances of Macquarie’s exit. Some think there should be no payment at all “It remains difficult for us to shake the feeling MAP has overpaid to sever the relationship,” wrote JPMorgan analyst Kirsty Mackay-Fisher in a note entitled: “MAP lays one last golden egg before flying the coop.”

While it’s not strictly fair to say Macquarie is cutting trusts adrift – if the deal goes through its stake in Macquarie Airports will actually increase – there is clearly a reputational issue if Macquarie trusts, granted independence from the mother ship, then get into trouble. That, surely, would make the listed model difficult to return to should Macquarie ever feel the need. CFO Greg Ward says he has never felt any of the satellite funds have had problems with gearing.

BOX

How close did Macquarie get to the edge?

As Lehman went under and Merrill Lynch lost its independence last year, attention turned to investment banks across the world. What of the pretender from the Southern Hemisphere?

At first glance there were plenty of reasons to wonder about Macquarie. There were widespread questions about leverage in the funds model, the strain impairments in those funds might cause on the parent, and the fact that two Australian groups that imitated that model, Babcock & Brown and Allco, both went bankrupt. The market clearly had its doubts – the stock fell from more than A$80 to A$15.50 in a little over a year from early 2008 to March 2009. But perhaps more ominously, credit default swaps blew out alarmingly: to 1,800 basis points on its subordinated debt in October, compared with a 200bp to 400bp range over the previous six months.

Logically there shouldn’t have been any cause for alarm, because of Macquarie’s capital position. Greg Ward, chief financial officer, says that Macquarie had been selling off lower-yielding assets such as margin lending and Italian mortgages through early 2008, realizing about A$15 billion ($12.5 billion), “basically to have in place the funding should we not be able to issue for an extended period of time”. Ward says that by the time of Lehman’s collapse Macquarie held a cash balance A$7.4 billion greater than all its short-term wholesale debt, enabling it to repay its commercial paper in full, while maturing longer term debt typically stands at A$3 billion to A$4 billion a year, so was well covered. “We’re not funding short and lending long like a traditional bank, we’ve been match funding,” says Ward. “That’s one of the reasons we didn’t have a problem – plus of course we didn’t have the principal positions [of Lehman] because we’re client driven, not a punting shop.” Additionally, it had built up the retail deposits in the bank, an area little remarked upon but by March worth A$18.8 billion, or 25% of the funding base.

Although some in the market say that Australia’s government guarantee on bank debt issuance was put in place because of mounting concerns about Macquarie and Suncorp, Ward is adamant “we’ve never needed the guarantee. The whole industry needed the guarantee but Macquarie back in March 2008 was unlike any other bank because of this match-funded balance sheet. If we had done no more borrowing in the last year, no more debt issuance, we’d still have more cash now than we had a year ago.”

But can fear bring down solid institutions? If counterparties had believed what those CDS spreads were implying they would have stopped doing business with Macquarie altogether. “We didn’t do any issuance at anything like what the CDS was suggesting,” Ward says. “Our major counterparties could see this was not real. The default risk when you’ve got more cash than borrowings is not real. But no one wanted to believe that at that point of time. It was: Lehman’s has gone, Bear’s has gone, in this market Babcock and Allco have gone, why aren’t you next?”

CDS, Ward says, are “obviously not a regulated market”. He recalls: “there would be three brokers or something that would seem to quote the whole market – they would talk about volumes per day of $2 million to $5 million and the thing would move 50 basis points on nothing.”

Some groups were working hard to hit Macquarie’s share price and CDS spreads with false rumours, a practice that prompted a stern and unusual statement from the Australian Securities & Investments Commission (which banned short-selling for eight months up to May). Around this time analysts and fund managers began to distance themselves from what was happening. Charlie Aitken, from Southern Cross Equities, previously a vocal critic of the Macquarie model, wrote to his clients in September: “I do not want to be even a peripheral part of a sinister campaign of Chinese whispers and manipulation to bring down a great Australian institution. It’s just not right.” Stephen Mayne, a renowned gadfly and shareholder activist usually tough on Macquarie, ran the letter in his widely read Mayne Report blog. A curious change of tone was taking place: Macquarie, often portrayed in the vigorous domestic press as a cold-hearted millionaires factory willing to go to any lengths for the last buck, was emerging from a “serves-them-right” attitude in press and population as concern grew about market manipulation.

For his part, did Moore ever perceive a threat to Macquarie’s sustainability as an independent entity? “No,” he says. “There was certainly a threat to our profitability… but there has never been a challenge to the underlying strength of the balance sheet.” He adds: “Worst case, if the world had actually stopped, we would have just run down the assets as they matured and run down the liabilities as they matured. Plainly, profitability would have been painful, but certainly it wouldn’t have impacted on the survivability or the existence of the organization.”

Institutional Investor, September 2009

Sean Chen took on the chairman role at Taiwan’s Financial Supervisory Commission in December, becoming the agency’s sixth head since its creation in 2005. It has been a difficult period to preside over for the former chairman of Sino-Pac Financial Holding, but he can at least take comfort in the fact that Taiwan, and particularly its banking sector, has weathered the global storm well so far.

“In Chinese we say you can find fortune in misfortune,” says Chen, speaking to Institutional Investor in Taipei. “Our major export market, the US, is the country which suffered most from the financial turmoil, But we are also blessed because for the past 10 years we have been shifting our export markets to mainland China – now the largest export market for Taiwanese manufacturers.”

Since Taiwanese banks have been major providers of credit and services to the manufacturers who are exposed to China’s continuing boom, Taiwan’s banking sector continues to look very healthy. Non-performing loans are just 1.6% – much lower than the US, where the level is around 2.5% – and provisions stand at 69.8%. The capital adequacy ratio for Taiwan’s banking sector as a whole is between 11 and 12%, well above the statutory minimum of 8% and again higher than the norm in the US. “Our banking industry, even after the financial turmoil, remains relatively healthy compared to other areas,” Chen says.

But will it stay that way? Apart from that fact that NPL levels look bafflingly low, there are clear headwinds to come (see main story for NPLs and the D-RAM sector). “Personally I’m not so optimistic: I would not say the worst time is behind our back, because this world is too small for us to prosper or suffer alone,” says Chen.

Bankers are also alarmed by the prospects of a law capping interest rates on credit cards. Chen is quick to point out that the US has a similar law that has already passed the House of Representatives, and argues that the mooted Taiwanese law – which would have a floating cap moving with changes in the central bank base rate – is more flexible than the US approach which proposes an outright cap. (“That’s incredible. The US is a free economy!”) He also points out that although the Taiwanese law has passed a first reading of its legislature, in Taiwan any such amendment must go through three readings, and that major discussion will take place first, including the banking industry and consumer protection associations. Nevertheless, he says: “After the financial turmoil in Taiwan as other countries, the administrative and legislative branches are paying more attention to the interests of the consumer,” and he puts the credit card amendments within that context.

Chen is part of the team negotiating the eagerly awaited memorandum of understanding with China (see main story). “There is a French word, rapprochement, building a bridge; it’s a very good word to describe the present situation,” he says. “We have to mend the relationship between Taiwan and China. Any financial institutions which intend to conduct cross-border activities need a blessing from the home and host regulators. But how can they do that? Those regulators have to sit down and talk to each other.” Taiwan has previously signed MOUs with 35 counterparties in other countries; mainland China has more than 50, so there’s no lack of experience in negotiation. “The problem is, for the last eight years, not only the regulators but the governments on both sides of the strait don’t want to sit down and talk.”

Now that they are, things have improved. “We all agree it will be very healthy for the financial institutions on both sides of the strait to set up a financial presence in each other’s territory,” he says. The MOU provides for an agreement for the two regulators to jointly supervise institutions which intend to conduct cross-border activities, and three are under negotiation: for banking, insurance, and securities businesses. “There will be obstacles, but those obstacles will be removed and the MOU can be signed,” he says. “The most difficult question to answer is when.”

Pressed for detail, he says: “Well, frankly speaking, there’s nothing new in the MOU. A very basic MOU should include, first, the intention of cooperation; second, the intention to exchange necessary information; third, how to protect those information exchanges between the regulators; and fourth, the intention for further cooperation. It’s very simple.”

Interestingly, Chen says one reason progress is slow is that for both sides, despite the common language, this is the first time to structure an MOU in Chinese. “There’s a problem,” he says. “After separation, from 1949, the Chinese language changed a bit on both sides of the Chinese strait. So sometimes it takes a lot of time to find a terminology which is acceptable by both sides.”

When the MOU is signed, “it doesn’t mean Taiwanese institutions will be granted a license in China automatically, because they have to prove their institutions have been managed under prudential principles,” he says. But it paves the way.

It is strongly noticeable how Chen’s attitude towards banking consolidation differs markedly from that of his predecessors, who sought actively to encourage consolidation, even to precipitate it. “You should come back to basics and let market forces operate,” he says. “If a financial institution can operate by its own, it can be a niche player and we should allow it to operate in that way.

“We should not give it any guidance that it should be acquired by another institution. That’s not fair.”  That said, “I would expect to see further consolidation – but not in the instant future.”

Institutional Investor, June 2009

Earlier this year Institutional Investor was invited to Kuala Lumpur to meet with Dr Zeti Akhtar Aziz, governor of Bank Negara Malaysia, on the 50th anniversary of the institution’s foundation.

Aside from her standing in Malaysia, she is also one of the world’s most important figures in Islamic finance, and one of the most senior women in the Islamic world.

Institutional Investor: How do you balance deregulation with keeping sufficient control of the financial system?
Zeti: The supervisory and regulatory framework has been strengthened, our communication has intensified and surveillance has become more significant. The information we obtain is very forward-looking. We do not just look at the financial position of financial institutions: we stress test them, and look, for example, if commodity or property prices dropped, how would they fare under those more extreme circumstances?

We have consolidated from a fragmented banking system to having larger players, and even though we do still have medium-sized financial institutions that focus on specialised areas, they are not similar to what we had before the [Asian financial] crisis where there were very small institutions who were vulnerable, who couldn’t take advantage of economies of scale, or do the massive investment needed in new technology. Additionally, we have instituted best practices in risk management and corporate governance, and this is key. And there are a few incentives that we give: if they are better managed in terms of their risk management, they are given greater flexibility in their product development, and so on.

II: Will you impose restrictions on the sorts of assets banks can hold?
No, because we have moved away from that, but we do strengthen the regulations on the role of the board. The board and their risk management committee have to sign off that they are aware of the risks associated with any products they enter in to, so there is accountability.

II: You have presided over the removal of a number of capital controls. Is Malaysia better served in a global financial crisis by these removals – particularly those around the currency?
We have removed all the controls except one, which is the non-internationalisation of the currency. I think, at this point particularly, it is quite important that we keep that in place: it reduces the vulnerability of our currency being attacked by speculative activity financed from offshore sources. It is fine to have flows of funds that have come into the country, and those can flow in and out freely. But to give speculators access to ringgit financing, to sell the currency down, which is what was happening during the crisis, that renders us vulnerable.

We see an important precondition of removing that particular control is to develop our own domestic foreign exchange market. Once we have a vibrant market, with all the hedging instruments and so on that will develop, and the talent in our own financial system, we would see the potential to remove that restriction.

II: Do you need other tools to intervene, and in what circumstances would you use them?
Right now we have moved to a flexible exchange rate regime. We were on a fixed rate for about seven years: during that time we built the preconditions to move to a flexible regime, such as participating in the open market with market based instruments, strengthening the banking sector, and developing the bond market into one of the largest in southeast Asia, where the private debt securities market is now larger than the government securities market. When we were ready to move it was a successful transition, and very orderly. We do not stand in the way of an appreciation in the currency. We have a very good understanding for the potential for reversals, and we highlight this to the market so there won’t be any overreaction if the reversals take place, but so far it’s been well within our expectations.

]]> http://www.chriswrightmedia.com/zeti/feed/ 0 http://www.chriswrightmedia.com/euromoney-oct08-gail-kelly-westpac/ http://www.chriswrightmedia.com/euromoney-oct08-gail-kelly-westpac/#comments Wed, 01 Oct 2008 13:07:27 +0000 Chris Wright http://www.chriswrightmedia.com/?p=321 Euromoney magazine, October 2008

There are big entrances, and then there’s Gail Kelly. In February, she started work as chief executive of Westpac, one of the so-called Big Four banks that dominate Australia’s financial landscape. Just three months later, she struck a transformational $18 billion deal for Westpac to acquire another bank – and not just any bank, but the one she’d just left, St George. The merger will create the largest bank by market capitalisation in the Southern Hemisphere.

Clearly, Kelly likes to hit the ground running. But there are several other things that make it interesting and unusual to find her in the CEO’s corner office of Westpac’s inspirational new HQ on Sydney’s Kent Street, overlooking the old Darling Harbour wharfs. Most obviously, there’s the fact that she’s a woman: the only female chief executive of an Australian blue chip company, and arguably the only truly significant female corporate executive in the country since the departure of long-standing Qantas chair Margaret Jackson. One assumes she’s also the only mother of triplets (four children overall) to be a major bank CEO anywhere in the world.

Then there’s the fact that, despite 11 years working in Australia, her accent today is not Sydney but southern Africa: she was born in Pretoria, South Africa, in 1956, only arriving in Australia to take up a position with the Commonwealth Bank in 1997. Her banking career began not with an Aussie big four but with South Africa’s Nedcor Bank; she only became an Australian citizen in September 2001.

This mercurial rise in a foreign country has been characterised by a deep belief in the power of a brand. (It’s fitting that her first job in Australia, at the Commonwealth Bank, was as general manager of strategic marketing, and she left that bank as head of the customer service division.) Kelly doesn’t talk numbers much, or ratios, or big business: it’s about people, customers, advocacy and brands, and on this vision her Westpac tenure will stand or fall. Indeed, one could argue that Kelly is in some measure a brand herself, and there has rarely been a merger of such importance that has seemed so crucially connected to one individual.

To understand what appealed to Westpac in appointing her to replace David Morgan, it’s instructive to look at just what she did to St George during her time there. When she became CEO and managing director in 2002, St George was certainly not in trouble or badly run, but it was a little-remarked second-tier player. It was considered a likely takeover target for one of the big four lenders, with substantial shareholder National Australia Bank considered the most likely candidate when she arrived.

Instead, St George grew considerably on every measure under Kelly’s tenure: assets, profitability, market valuation and prestige. Assets more than doubled, to over A$100 billion, between her arrival and departure, and profits more than doubled too, to over A$1 billion, with return on equity climbing from 16.6% to 23.2% at a time when the cost to income ratio declined. St George boasted double digit earnings per share growth in every year under Kelly’s watch. Business banking and wealth management enjoyed especial improvement.

In particular, Kelly worked hard to position St George as a community-based bank – its roots were as a building society – with customer satisfaction levels higher than its bigger peers. (The research group Roy Morgan put customer satisfaction at over 80% by the time of her departure.) But, while appearing local, it also became a viable national alternative to the big guys, capitalising on the increasingly noxious individual sentiment towards the big four and suggesting a more personal and reliable experience was available elsewhere. A popular advert during Kelly’s time used to depict someone at a barbecue being asked what he does for a living. When he says he’s a banker, there’s a horrible silence and everything stops. When he says the bank is St George, everyone is relieved and carries on again.

So when Westpac decided on Kelly last August, she had made St George more or less impregnable to takeover. The irony is that, by the time she turned up for work at Westpac six months later, the global credit market had changed so dramatically that it was back in play – by now to her benefit.

It’s unlikely that, back in August, with the Australian stock markets still enjoying a multi-year bull run and the banks in their best ever condition, Westpac’s board settled on Kelly in the hope or belief that she could effect the takeover. Instead, they probably hoped for two things.

One was to continue the excellent work done at Westpac by David Morgan, a 17-year veteran of the bank who spent nine of them as CEO. It is hard now to recall just what a mess Westpac used to be: the A$1.6 billion loss it logged in 1992 was at the time the worst ever recorded by any Australian corporation, and it required widespread redundancies and a dip into company superannuation (as pensions are called in Australia) to keep the place viable. The acrimony of the AGMs around that time remain the stuff of legend.

Morgan brought to the top job a certain Friends-Romans-Countrymen bombast, a master of the rhetorical flourish at press conferences, but in fact he was broadly conservative in his approach, and the fact that Westpac has come out of sub-prime and the credit crunch in better shape than any other major Australian bank so far is to Morgan’s credit. Impaired assets represented just 0.25% of total committed exposure in the third quarter and that result disclosed no new troubled assets, unlike any of the other three major banks.

Under Morgan’s watch the bank undertook a number of important acquisitions and grew dramatically in wealth management, which has been the holy grail of Australian banking in the decade to date. In August, in a market update, Kelly was able to predict 6-8% cash earnings growth for the 2008 financial year and revenue growth of 8-9%, an enviable situation for any bank CEO in this environment and a particularly good one to inherit now. “They are certainly in a far more solid state than any of the other banks in Australia,” says Peter Vann, a portfolio manager at Constellation Asset Management in Sydney.

The other aspiration in appointing Kelly was no doubt to make Westpac loved again. All Australian banks have tried to reinvent themselves in a more cuddly image in recent years – the Commonwealth Bank in particular has spent a fortune on rebranding itself – but it would be hard to say any have really succeeded. More than anything, Kelly offers the prospect of truly getting through to the customer again.

“I’m someone who is a big believer in the power of brands, the power of distribution,” she tells Euromoney. “That’s where banks need to focus a whole lot more, and to strengthen and empower their touch points with the customers. It’s driven by a vision of transforming the way customers experience financial services within Australia; it’s driven by a vision of seeking to earn all of our customers’ business, to really deepen relationships with customers in a very fundamental way.”

This is a characteristic Kelly response: in half an hour of discussion she uses the word “vision” 12 times and “brand” 15. Another keyword is advocacy. “Within Australia, customers have traditionally not had a high regard for banks, and particularly major banks,” she says. “I have a vision of turning that round and having customers who become advocates for the brand and suite of products we have within Westpac, who are delighted by the support and advice that they receive from their bank. They feel their bank is actually working with them, and is a partner with them and has a deep relationship with them and is seeking to help them actually fulfil their life goals.”

This might seem like hot air if she hadn’t already made it work once. An engaging people person – she is certainly the only bank executive to compliment Euromoney’s correspondent on his tie in the last 15 years – the zest of her delivery can occasionally invite cynicism. “There’s a lot of polish, and you have to get past that to see what’s behind it,” says Vann. But he, like many others, has done so only to find that there’s substance behind the appearance, and he is very positive on the merger.

The big question, though, is whether Kelly’s success at St George can be replicated on the bigger stage of a big four bank – and in particular whether St George can keep its appeal when subsumed into that bank. In some measure, St George thrived on its underdog, alternative, community status: that, surely, can’t be reproduced in a bank of Westpac’s scale?

Kelly thinks she can pull this off because of the way the merger will be conducted. Unusually, there will be almost no evidence of a merger at the front end. She has pledged that even if a Westpac and St George branch happen to sit next to each other, neither will be closed; they’ll continue as they were in order to ensure continuity of experience for the customer. “We’re not going to be positioning ourselves to the St George customer as the big Westpac with the little St George subsidiary,” she says. “St George is an alternative, it’s a fighting brand, a people focused-brand, a community-focused brand. We want to retain that. We might even build that distinctiveness even further.”

This is a big claim, particularly coming from Westpac. In 1997 it acquired Bank of Melbourne, keeping the rights to the name and logo and pledging at the time to retain the brand; instead, the name has long since disappeared completely. Kelly brings this up herself. “There’s a level of not surprising cynicism you have in a marketplace, questioning that Westpac’s said this before,” she says. “There’s that kind of commentary that you can’t really be serious that you’ll keep two branches even if they are alongside each other. But I believe in the power of brands and I believe they do stand for different things.”

Besides, she can claim that St George has managed to keep a differentiated brand within its group, with Bank SA, a South Australian enterprise. “Most Bank SA customers wouldn’t have any idea that the bank is actually owned by St George,” she says. “They see it as Bank SA. That’s who they deal with.” And this is the theory of the Westpac-St George merger: that the synergies behind the scenes, in IT and other back office areas, will remove the need to merge the front end too.

But one could argue that Kelly wants to have her cake and eat it here. The merger documents call for a 20-25% saving of the St George cost base in the next two to three years, without a single branch closure. Achieving this ambitious double-act is predicated on an eye-catching projection: that the merger will cause no more than 5% customer attrition.

Challenged on this, Kelly is convinced she’s right. “My hope, the plan, is less than five per cent,” she says. “My hope is actually none at all.” That is not how bank mergers typically go (although Westpac likes to refer to the Royal Bank of Scotland/NatWest merger in 2000, which apparently did have a less than 5% attrition rate), but then bank mergers rarely look like this. “We are setting it up from day one to say everything you experience in your current relationship with St George will be maintained, plus more.” Besides, she says, the cost numbers are not aggressive. “Traditional mergers could get anywhere up to 40% of the target’s cost base. 20 to 25 is actually quite a modest target relative to traditional targets.” If she gets the reduction she wants that will already equate to about A$340 million, not just through IT but things like combining the human resources, risk, finance and marketing functions for the group. A significant advantage, and especially relevant with the state of today’s credit markets, is that St George’s single-A credit rating would be replaced by Westpac’s AA, giving it cheaper funding in the capital markets.

What’s striking about this merger is how much its success is perceived to be reliant on one individual. It’s not over the line yet: although St George and Westpac signed a merger planning agreement on May 13, and a merger implementation agreement on May 16, it is only this month [OCTOBER] that a scheme booklet containing full details of the proposed deal is arriving on the doorsteps of St George shareholders, who will then vote in early November.

Whether they vote in the affirmative is seen as having a great deal to do with the trust that Kelly built up among that constituency when she was St George CEO. “She is very level headed and friendly, and goes out of her way to accommodate shareholders and find out what they think,” Peter Morgan, founder of 452 Capital, one of Australia’s most powerful boutique fund managers, told the author when Kelly was still at St George. “She has produced that results that have effectively saved the company from being gobbled up, without resorting to silly acquisitions.”

Kelly describes her unusual status in this deal as “a unique set of circumstances,” and its timing as “just a confluence of events. Every single major bank, and Westpac absolutely amongst them, has had files on St George. St George has been an attractive acquisition opportunity for Westpac for a long period of time and I’ve no doubt that that’s the case with other major banks as well.” A year or so ago, valuations made such a pitch a big stretch for any of the big four, but things have changed. “I was appointed to Westpac in August last year, and it was a very different environment at that point…. I kicked off in February, and one goes into the files again and dusts them off and says: do any of these opportunities that we’ve looked at in the past now make more sense because of what’s happening globally?”

The deal itself was struck on scrip, with an offer of 1.31 Westpac shares for every St George share. The pros and cons of this arrangement for St George shareholders have drifted and wobbled with market gyrations since May. Initial calculations were based on the Westpac closing price on May 9, at which point if both companies’ interim dividends were counted out, it represented a 28.5% premium for St George shareholders. By early September, though, that premium had almost completely eroded: although Westpac, after losing almost a quarter of its value between May and July, was by the time of writing almost back to the same level as at the time of the bid, St George has moved up over 25%, almost exactly the same as the initial premium.

Investors will therefore have to make a call on whether Kelly’s charisma and track record are enough to make them go with the deal despite the diminished financial appeal.

Analysts by and large seem to think it a no-brainer. “We expect even the most stalwart bears on bank M&A will see the merits of the deal as it becomes increasing obvious the financial and operational outcomes of this merger will be unlike any other bank deal in the last two decades,” wrote Macquarie analyst Tom Quarmby in August. Deutsche’s Ross Brown is less impressed, writing: “We find that whilst banks almost without exception deliver on their cost saving targets, often it is achieved at the expense of organic productivity improvements, as resources are diverted to integrating the acquired bank.” Consequently he doubts the revenue synergies will come through as quickly as Westpac predicts.

Shareholder opinion is always difficult to gauge, but if anything the clinching factor is likely to be St George’s uncertain funding outlook in the continuing credit crunch (although a A$1.05 billion mortgage-backed capital raising in early September, which took care of 40% of the bank’s funding needs for fiscal 2009, suggests it is doing fine so far). Lacking the depositor bases of the big four, St George relied on wholesale credit markets to fund its outstanding loan growth in the earlier years of this decade, and it’s going to be much more costly to use those markets for funding for the foreseeable future. JP Morgan’s banking analyst Brian Johnson has noted how St George has “significantly shortened the duration of its debt funding profile over the course of 2008,” perhaps in the expectation that when it needs to raise longer term funds to take the shorter debt out, it will be as higher-rated Westpac. If the deal didn’t go through, Johnson said, “the new term debt requirement for [St George] may prove problematic for a single-A rated bank.”

If shareholders do go with Kelly, then on November 24 the shares of a new banking heavyweight will begin trading. “The mandate I came in on, the explicit mandate from the board, is to drive a customer service agenda,” she says. “To take a major bank and drive that agenda, to have customers who are advocates for their bank and delighted by their bank, that’s a huge challenge. And I’m up for that challenge.”

BOX

What sort of bank will the merged Westpac and St George be?

It will have 10 million customers, which is roughly half of Australia’s entire population. Crucially, it will have Westpac’s AA rating, rather than St George’s A. At the time of the merger announcement the merged bank was envisaged as having a combined market capitalisation of A$66 billion, although a significant improvement in the St George share price since then had increased that figure at the time of writing.

The combined bank will be Australia’s leading home lender, with a 25% market share; the leading overall lender, and the leading credit card provider. It will also be the largest wealth platform provider with A$108 billion of funds under administration. It will have 1200 branches and 2700 ATMs, A$408 billion in loans and $299 billion of deposits, based on March 31 figures. According to data from the Australian Prudential Regulatory Authority, also from March, the combined bank won’t be a leader in every field though: in corporate lending it will still lag National Australia Bank and ANZ, while it will trail Commonwealth Bank of Australia in household deposits.

Looking at the bank capital, Westpac had a pro-forma tier one ratio of 7.7% in the first half of 2008, with a recent investor presentation suggesting the post-merger capital position should be “at a similar level”.

The group will have a range of brands. Apart from the Westpac and St George banking names, there will also be a South Australian group, BankSA, that was part of St George; and RAMS, a home lending brand purchased by Westpac in January this year.

Both institutions have significant wealth management businesses: in Westpac’s case BT (which was itself formed from a three-way merger involving elements of BT, Westpac and Rothschild businesses), and in St George’s case Asgard. These, in turn, involve a host of other entities: St George’s product manufacturing division, called Advance; its distribution and advice network, called Securitor; and a financial planning arm under Westpac called Magnitude. The administration platforms Asgard and BT Wrap are two of the biggest in Australia, serving the more than A$1 trillion Australian investment management industry; it is perhaps little surprise that this was the one area the ACCC asked for more information on in giving a tentative thumbs up to the deal in late July.

One of the few visible areas of combination will be on the institutional side, where the business will be combined under the Westpac name with common infrastructure.

At a management level it will look rather more like Westpac than St George, notwithstanding the fact that it will be run by someone who has been CEO of both. St George, whose shareholders will own 28.1% of the combined group, will put three of its directors onto the Westpac board, including St George chairman John Curtis who becomes the new deputy chairman.

Westpac reckons the deal will be cash earnings per share accretive for St George shareholders from the first full year of the merger, and for Westpac from the third. Merger documents allow for $700 million in integration and transition costs over two years, but ultimately expect pre-tax savings equivalent to 20-25% of the St George cost base by 2011. As discussed in the main piece, the assumption for revenue attrition – from customers walking off because they don’t like the merger – is just 5% or less.

Picture two countries. One has an infant mortality rate of almost one in 10, a male life expectancy of 47, and 40% of the population in poverty. The other has $3 billion in a burgeoning sovereign wealth fund fuelled by oil and natural gas reserves, a figure that will reach $20 billion before long even in the worst case scenario. The curiosity of East Timor is that it is both of these places at the same time.

There is surely no country in the world where the sovereign wealth fund is so utterly key to the future of the country, the very sustainability of its people’s existence. The world’s newest nation, a sovereign state since just 2002, its oil and gas fields in the Timor Sea really are its only shot. Consider this: the government estimates $1.39 billion in revenues for 2008 – all but $27 million of it from oil and gas. Coffee, the second-ranked contributor, accounts for $8 million, 170 times less.

All of which makes the story of the Petroleum Fund, founded in 2005, so remarkable. The Peterson  Institute for International Economics, a Washington DC-based independent research group, ranks it the third best run sovereign wealth fund in the world based on structure, governance, transparency and accountability, behind only New Zealand and Norway. (The Abu Dhabi Investment Authority ranks 32^nd on the same list.)

It gets this accolade for its peerless transparency and its commitment to build for the future rather than to spend today: a bid to make sure there’s something left for the country when the oil runs out. On its website one can find up to date reports detailing everything it holds, how much it manages, even thoughtful responses to public queries about things like bond valuations – a far cry from some of its Middle East contemporaries. Its mandate states that in any one year it can only withdraw what it calls estimated sustainable income, which in practice means 3% of the likely near-term assets of the fund, on the grounds that a 3% reduction should be easily replenished by prudent investment. This display of discipline tends to win it applause from overseas commentators, but is a source of considerable friction from people on the ground wondering why they don’t have enough roads and hospitals while oil revenues sit in long-term investments.

It’s a discipline that comes from having watched others fail. “Where poor countries like Timor-Leste have quickly attained vast amounts of money very quickly, while their human resources and infrastructure still needs to be developed, the outcome is usually a failure,” says Alfredo Pires, Secretary of State for Natural Resources. “I don’t think I could name a single good example in the world. The challenge is for us to be the first ones to avoid the oil curse.”

As of June, the fund had $3 billion under management, a product of revenues from the Bayu-Undan oil and gas field being exploited by a team led by ConocoPhillips. East Timor gets 90% of the taxes and royalties from this field, with Australia taking the other 10.

This field ought to be good until 2023, and has proven reserves of around 4 trillion cubic feet of natural gas and about 500 million barrels of condensate. Pires estimates it ought to bring about $10 billion to East Timor over its life.

Then there’s the Greater Sunrise field, with almost twice as much natural gas and about 300 million barrels of condensate besides. It would take a book to describe the painstaking negotiations between Australia and Timor over the development of this field and the maritime boundaries affecting other, still-to-be-found fields (indeed, one has been written: Shakedown by Paul Cleary, who advised the Timorese on the deal) but the outcome was a 50/50 split with the Aussies on royalties and taxes. Still to be decided, and an increasingly fractious issue, is how it will be developed: although the field is closer to Timor than to Australia, there is a trench more than 2000 metres deep on the Timorese side, a geological curiosity that has been at the heart of decades of dispute about maritime law. One side wants the pipeline to go to Darwin, the other to Timor, while the site operator, Woodside Petroleum, is believed to be leaning increasingly to another option altogether, with a floating LNG plant. Development won’t start until they decide. But whatever the outcome, Timor’s revenues from this ought to generate at least $10 billion.

That’s before anything else is considered. For any funds within an area called the Joint Petroleum Development Area, Timor will take 90%. There are proven fields, albeit small, within Timorese waters. And nobody has really started looking onshore yet. So, although unpredictable oil and gas prices don’t help with projections, the worst case is really that this fund is going to enjoy $20 billion of revenues, and it is common to hear people talking about $50 billion, and sometimes even twice that.

That creates all sorts of whacky statistics: since the national population is barely a million, Timor could end up with a theoretically higher per capita GDP than Australia (although since it has the world’s highest fertility rate of more than seven children per woman, that imbalance is unlikely to stay in place for long). But suffice to say the management of the fund is of vast responsibility and importance. It is, as David Edwards, vice president in worldwide securities services at the fund’s custodian JP Morgan says, “basically all they’ve got.”

So far, the methods used to invest this wealth have been deliberately passive. The Petroleum Fund law insists that 90% of funds must go into US treasuries, bank bills, term deposits or other similar securities; the law dictates a minimum rating of AA-, or that the securities be guaranteed by a sovereign of that rating or higher. The law allows 10% to go into other assets, provided they are issued abroad, are liquid and transparent and are traded in a financial market of a high regulatory standard; in practice, though, the whole lot has stayed in the safe treasuries, and indeed no investment has yet been made in anything rated less than AAA.

The fund’s mandate requires it to track the Merrill Lynch 0-5 year government bond index; its duration must be within 0.2 years of the index, and it is only allowed to drift within 25 basis points of the index’s return, which so far it has managed, lagging it modestly. “The idea was to start with something simple and safe,” says Venancio Alves Maria, executive director of the Petroleum Fund. “At the time we Timorese didn’t have any expertise at all in the fund management area.”

It’s an approach that has served them rather well in a year when sovereign funds from Abu Dhabi to Singapore have found themselves billions of dollars out of the money on investments in American investment banks. But there are signs that the relentless caution may be about to give way to a slightly more daring approach.

The first signs of this change in approach have come with the fund’s first appointments of external western experts. Last August, Mercer was engaged as asset consultant. Then, in June this year, JP Morgan was appointed as the custodian for the fund. JP Morgan is also an advisor to Norway’s sovereign wealth fund, which is a clear model for Timor’s (Torres Trovik from Norges Bank is a member of Timor’s five-person Investment Advisory Board). JP Morgan’s role will cover settlement, administration, accounting, and in future will include performance measurement, mandate compliance monitoring and fund performance services. It’s the clearest sign yet that external managers will be appointed in due course. “This is an early step to accommodate the government’s intention to diversify the fund,” Maria says.

Edwards at JP Morgan in Sydney has high hopes for the fund. “When we initially received the [tender request], the first concern was going to be the stability of the country, how they were looking to structure themselves and invest. We did a lot of due diligence on the individuals, the structure of the fund, the Acts that they passed and made sure we had absolute comfort in what they were trying to do. We do.”

It was, he recalls, quite a moment to step out of a car in Dili for the signing ceremony and face a phalanx of photographers: “my first experience of such overwhelming interest in a contract signing for a custody deal.”

 JP Morgan is believed to have offered a low fee for the work in order to secure this potentially lucrative client. “The value of the reserves, the price of oil and the value they will add through their investment means this is going to be a significant client for us in Asia, perhaps one of the largest,” he says. “On the fee side, for every client that we want to have a relationship with, we will price that very aggressively.”

He too expects a change in investment approach. “They’re at US$3 billion and growing at $180 million a month, and they understand that diversity of assets is going to be very important to them,” he says.

Then there’s the new finance minister. The Petroleum Fund is run by the Banking and Payments Authority of Timor-Leste, which is in every practical sense the country’s central bank and is intended to become it, although it doesn’t have that formal title yet (and doesn’t issue banknotes, since Timor uses the US dollar as its currency). But it conducts the fund’s management on behalf of the Minister of Planning and Finance, and last year, with a change in government, the person in that portfolio changed.

Euromoney’s interview with Emíilia Pires takes place in the Palácio de Governo, the Portuguese-era government palace facing Dili’s harbour, at 9.30pm on a hot evening in July. She looks tired, and a little wild of hair, after spending part of the day dealing with petitioners (earlier in the day a protest has been quelled with tear gas just around the corner) and the rest of it lobbying parliament, but presses on with an interview despite the lateness of the hour. She is certainly not lacking in energy or spirit: the first ever East Timorese graduate of an Australian university (La Trobe), and someone who fought her way from refugee status following Indonesia’s invasion of Timor in 1975 to being a public servant in the Victorian state government, she is one of a number of Timorese who have studied in Australia (Alfredo Pires, a cousin, is another example and the president, José Ramos-Horta, has held Australian permanent residency) and come back after liberation to help rebuild the country.

An hour in her presence leaves little doubt of her conviction to get things done, and the Petroleum Fund is on her agenda for change. She appointed a working group to look at the structure and approach of the fund. “When we took over government there were some studies being done on whether we had an optimal investment strategy,” she says. “From those studies it was clear we do not have.” With today’s cautious investment approach, she says the 3% that the fund’s founders believe to be a sustainable withdrawal would not be sustainable at all. “That immediately tells us we need to do something.”

She hasn’t yet decided what – her advisers still have to come back to her with a better strategy -  but she confirms it will involve “more active investment. I hope before the year is over we should have a new strategy, and know what are the areas where we should revise the law, and I should be able to submit it to parliament.” As a first step the fund has initiated contract negotiations with the World Bank and Bank for International Settlements as non-commercial external investment managers.

Pires is also under scrutiny because of another measure her government has taken: it’s started pulling more money out of the fund than it is generally allowed to do.

On May 23, the Council of Ministers approved the final draft of the Mid Year Budget for 2008, allowing for spending of US$773.3 million, the vast majority of it to be taken from the fund. Based on the sustainability calculations, only about $396 million should be taken out of the fund this year; the government is taking an additional $290 million above that level, a figure Emíilia Pires confirms to Euromoney. The Petroleum Law does allow these occasional larger withdrawals provided they are approved by parliament, but some are alarmed that this starts a bad trend.

Tomas Freitas, director of a Timorese NGO called Luta Hamutuk, says “the fund is under threat” because of this approach. The protests on the morning of Euromoney’s visit are partly to do with this budget, and in particular the fact that $1.4 million of it is allocated to the purchase of luxury cars for members of the national parliament. Some external observers, while acknowledging the need for investment now (and especially the impact of food price hikes), privately say they wish the extra money had been taken from World Bank or Asian Development Bank loans, freely available and at favourable rates, rather than from the fund itself, because of the precedent it sets.

Emíilia Pires is characteristically passionate in her defence of the government’s position when asked about commentators who think the funds should not be withdrawn. “I don’t understand how they think that, because right now if you don’t invest in the people, what future have we got? There’s not enough schooling, or quality of schooling. We are suffering from dengue, malaria, you name it.  Should we take more? Of course, logically we have to, otherwise where is the future generation? For me it’s just irrational to think otherwise.”

The approach would probably have attracted less criticism but for the fact that Timor has not previously managed to spend its more modest budgets. In the 2006-7 fiscal year, the budget was set at $328.6 million, of which only $160.4 million was paid – a cash-based execution rate of just 49%. An inability to spend the money it has begs the question whether a greater sum can usefully be employed now. Perhaps the biggest problem is human resources, and there are no end of programs geared towards giving specialist education to a generation of Timorese, notably in petroleum and geology, but it will take time to come through.

East Timor is still a volatile place – Ramos-Horta was shot three times in a failed assassination attempt in February, and it is still rare to go a minute on Dili’s streets without seeing a vehicle marked with UN insignia. But it has a great chance. It is not short of advice: Minister of Economy and Development João Mendes Gonçalves recently set about collating the various macro and economic research and development studies that have been conducted for Timor since 1999, and has so far collected 1700 of them.

But it will eventually go its own way. As Alfredo Pires says: “We seem to have a lot of experts, but sometimes we have experts who have never lived in a poor country. They may have the mathematics and economics right but it’s about individual cases. It comes back to people and the leadership.”

BOX: Banking in Timor

Timor’s banking system is a reflection of its history. There are three banks with a presence, all foreign, one each from the country that colonised it (Portugal), occupied it (Indonesia) and helped liberate it (Australia): Caixa Geral de Depósitos, Bank Mandiri and ANZ respectively.

These banks are arguably seen as a method for capital to leave Timor rather than to come into it. “Apart from the Portuguese bank, the others are not giving any loans to people,” says João Mendes Gonçalves, Minister of Economy and Development. “They claim this is mainly geared to the risks associated with the loan, and we understand all that, our legal framework is not complete yet.” Instead, “they are in deposits from people, transferring money overseas, and getting commission from that.”

ANZ itself, which set up in January 2001 even before Timor’s formal independence, says it supports “both international firms and a fast-growing Timorese client base”, offering savings, transactional banking products, and international services, for personal customers, commercial clients, government and non-government organisations. A spokesman says ANZ “sees a number of opportunities… to play a strong role in the development of Timor-Leste as a nation,” including facilitating foreign investment, lending, and providing banking services to the public sector.

Timor is, though, witnessing the birth of its own banking sector. The Institute of Microfinance Timor-Leste was established under the UN-led transitional administration, with a mandate for poverty reduction. It has grown but been impeded by law, unable to take more than $1 million in total deposits, or to give loans higher than $5000. In July, it changed hands. “We reached an agreement that for the better future of the institution, it would be better if it came to the government,”  Gonçalves  says. “We would strengthen it and ensure they expand into other districts, transforming it into the first national bank of East Timor.”

The country does need a banking sector, because it barely has a private sector to speak of and has no hope of developing one without access to credit. Plenty needs doing before western banks are likely to commit further, though, starting with a bankruptcy law; Gonçalves says he is about to send a draft law to the Ministry of Justice.

For the future, there is also talk of a national development bank to support Timorese entrepreneurs. Gonçalves says he has lobbied the World Bank, ADB, IFC and another group to come in with the government in putting in $3 million apiece to a development fund.

  To see this article in its published form click here: http://www.euromoney.com/Article/2017101/East-Timor-The-worlds-most-important-sovereign-wealth-fund.html

Army chiefs rarely find themselves touting potato recipes, but these are remarkable times. So it was that Bangladesh’s general Moeen U Ahmed – who under the military-backed interim government commands much of the real power in this country of 158 million people – found himself addressing a press conference at the Dhaka Radisson in May urging people to eat more spuds.

Moeen’s entreaties were designed to ease pressure on rice, and represented one of the more oblique side effects of a food crisis which at its peak, more than doubled the price of imported rice to Bangladesh.

The vagaries of the international staple food markets may seem a curiosity from a distance, but Bangladesh is very much at the sharp end of the world soft commodities boom that has made others rich. The increase in minimum rice export prices from India from US$425 per ton in October 2007, to US$1,000 per ton in March 2008, feeds directly through to people in importing countries who are absolutely on the survival line already. (Bangladesh gets most of its rice imports from India.) The Centre for Policy Dialogue, a key local think-tank, estimated that during the first quarter of 2008, the section of the population below the poverty line – which already spends 46% of its income on rice – experienced an income erosion of 36.7%. As JP Morgan’s economist David Hernandez has noted: “If you are looking for a symbol of how higher food prices are now really hurting poorer countries, then Bangladesh is it.”

And high prices are bad enough; but in the worst circumstances this year, countries like Bangladesh couldn’t get rice at any cost. Twice, in April and May, Bangladesh put out tenders for rice and didn’t receive a single response, a function of panicked export bans in many of the world’s biggest exporters, among them India, Vietnam, Cambodia and Thailand.

On top of everything else, Bangladesh also faced poor returns from two of its key rice harvests after the impact of one of the cyclones (this one called Sidr) that so frequently blight the country.

Things looked rather apocalyptic back then, but three months on, Bangladesh has managed to step back from the brink, chiefly because of a bumper boro harvest, the single most important of the year, which yielded 17.3 million tonnes on its own. Just as important, Bangladesh struck a deal to import 500,000 tonnes from India; and, to the relief of all, international price prices have started to fall. So the country and its poor live to fight another day. But the experience has been alarming.

Euromoney met with Dr Mirza Azizul Islam, the financial advisor (the equivalent title of finance minister) in Dhaka in August to get his perspective on the impact of food prices and what it means for Bangladesh. “Bangladesh being a net food importing country, it did have a significant impact on domestic prices,” he says with some understatement. “In a globalised world, you cannot insulate domestic prices from the international price levels.”

Getting past it was a combination of luck and judgement. The government ensured there was adequate electricity for irrigation, tried to stamp out instances where dealers refused to sell fertilisers at official prices, and increased the procurement costs of rice to give a sufficiently good margin to make life bearable for the farmers (and to stop them succumbing to the attraction of producing other, non-staple crops). But he acknowledges some fortune too. “We were lucky that the last crop of rice was a bumper crop,” he says. “All this worked to ensure that, at least in terms of available quantity, there is no shortage. But that does not fully address the pricing problem.”

In a country with so many in poverty – studies tend to estimate 40-45%, or at least 60 million people – there’s no choice for a government other than to try to help them out. Bangladesh extended its social protection net, both in terms of the number of people it covered and the quantum of financial entitlement within it, and launched a new programme called the 100 Days Employment Guarantee Scheme, ensuring at least one person in each poor household should get at least some employment, typically in some form of rural infrastructure.

While that keeps the wolf from the door at an individual level, it’s an inevitable drag on an economy that wants to grow. The fiscal budget in June doubled subsidies in fertiliser, petroleum and rice, although some pass-through prices have been adjusted since; these subsidies accounted for 14% of the total budget, or 2.3% of GDP. “A substantial amount,” Mirza says. Citi economist Anushka Shah in Mumbai puts subsidies at 38% of total government revenue expenditure, and 12.5% higher in the 2009 financial year budget than 2008.

Multilateral assistance has helped – the ADB is already in for $170 million of budgetary support, and the World Bank was at the time of writing likely to commit $130 million, Mirza says – and Bangladesh has made strides in improving domestic revenue collection, but the feeling is nevertheless of a bandage applied to an inoperable wound. At 6% in recent years, there’s certainly nothing wrong with Bangladesh’s recent GDP growth but obligations like this can’t help it grow. Citi expects a decline to 5.7% in financial 2009 and probably a further slide from there.

In such an environment, what does the minister think of the export bans that have done so much to raise food prices? Mirza is pragmatic about the behaviour of other countries in the region. “This was driven by their own domestic considerations,” he says. “As prices rose they came under pressure to reduce domestic prices to satisfy their own electorates. But it does affect importing countries. And of course it is very difficult to generate any global or even regional consensus on the right approach.”

If that sounds stoic from a country that found itself in such a perilous situation, it’s perhaps because Bangladesh launched an export ban of its own in May, on non-aromatic rice. But, as Mirza says, that was something of a gesture, a shout in the dark. “For Bangladesh, I would say it was more of a symbolic kind of exercise, because in any case Bangladesh does not export non-aromatic rice.” Of course not – its population needs to eat it. But Mirza is less placid when it comes to some of the solutions that have been proposed in recent months, particularly the idea that came out of Thailand to form a rice cartel, somewhat in the style of OPEC.

“Obviously the Thai proposal of some sort of international cartel didn’t go very far, because if you look at Asean countries other than Thailand and Vietnam, they’re all rice importers. Obviously, they didn’t support this particular proposal.” There is, besides, a considerable technical flaw. “One cannot hold the rice for a very long time,” he says. “In the case of oil, you simply don’t extract it: you don’t have to store it. But once farmers plant rice, they have to harvest it. Because of that it becomes very difficult to operate a cartel.”

More broadly, though, the thinking behind the idea bothers Mirza. “The important point is what would be the objective of such a cartel. If the object is to manipulate prices to the disadvantage of importing countries, that is not something that is morally defensible.”

He has more sympathy with an idea being supported from the Philippines, of creating an international rice buffer against emergency need. “There has been some talk at the regional level: at the last summit of the SAARC countries [South Asian Association for Regional Cooperation, held in Colombo] some governments agreed to rationalise the SAARC food bank. That is something one could attempt; to the best of my understanding there doesn’t have to be any physical movement of food, you simply earmark a certain portion of any particular country’s reserve to make it available to any other country belonging to the food bank, as and when they might need it. But we’ll have to see.”

Mirza, like anyone else, has difficulty working out where commodity prices go from here (Bangladesh is also an importer of oil and has suffered accordingly with that too). Rice prices have come down, as has wheat, but “longer term factors indicate that even though the price has come down it will probably not come to the level prevalent a year or two ago.” Part of it is about demand: Mirza notes that as people move above their poverty line, their demand for food increases more than proportionately, which means that as wealth grows in places like India, China, Vietnam and Bangladesh itself, the demand for rice and other crops grows dramatically too. The arguments on the supply-side are well known, from diversion of agricultural land to biofuels and urban development, to natural disasters from the Australian drought to Bangladesh’s own floods and cyclones.

Visiting Bangladesh one is struck by how much and yet how little it has in common with its high-population peers. The world’s truly populous emerging markets – India, China, Brazil, and to an extent Pakistan, Indonesia and even Vietnam – are engines of global growth, turning their vast numbers of people into an advantage through manufacturing and the emergence of a wealthy middle class. Bangladesh is right up there in population, ranking sixth or seventh in the world, yet its growth rates lag the other names on the list, and in particular it doesn’t turn up in emerging market equity portfolios or the hit lists of foreign investors or private equity. FDI was just $625 million in 2006, the last available number, a considerable fall from the previous year; it was over $16 billion in India the same year.

Does Bangladesh have a chance to join that club? “I think it has,” says Mirza. “For one thing labour costs in Bangladesh have remained cheap. On the human resources side, even if the percentage of people coming out of [top] schools is not all that high, the absolute number is quite large. Third, our private sector has become a lot more dynamic now. And young entrepreneurs are emerging, mostly sons and daughters of established businessmen who have been educated abroad, come back home and tried to make their enterprises more professionally managed. Farmers are learning to switch crops, adopt new seeds, and use greater irrigation.”

But there are, as Mirza says, “substantial problems.” Perhaps the biggest is infrastructure, particularly power. Bangladesh has gas reserves, “but the findings by local researchers suggest that if we can’t discover new gas fields the country may run into a serious shortage by 2050.” That’s bad news for a country already heavily dependent on petroleum imports.

From the foreign investment perspective, there is another problem:  politics. The government in which Mirza serves seized power last year on the justification that both the major political parties who have run Pakistan since 1991  – two women, Begum Khaleda Zia of the Bangladesh Nationalist Party and Sheikh Hasina of the Awami League, have alternated in power since then – were fundamentally corrupt. Both leaders were imprisoned on corruption charges, and the interim government – which initially said it was taking power for three months – said it would clean things up before allowing democratic elections. Progress has not been smooth: the government has taken more and more time as it said it was purging phantom voters from the electoral roll, but has become increasingly heavy-handed, arresting between 10,000 and 12,000 local leaders and politicians in a two week period starting May 28. Elections are now slated for December, but even then it is not clear who, if anyone, is going to participate in them.

Mirza acknowledges that “there is still a bit of uncertainty in some countries where people are not too sure what will be the result of the next election: will there be a stable government? Will the same sorts of people who were responsible for endemic corruption come back to power? But I think these uncertainties will disappear within the next few years. And if we can improve the electricity supply situation through the exploitation of oil, I think we stand a good chance of creating something like 7% growth.”

Things are happening – the forthcoming IPO of Grameenphone will be the country’s largest ever float, and a major investment by NTT DoCoMo in a local telco is an important step. (See the separate article for more on these transactions and the outlook for privatisation.) But there is no question that wholesale foreign participation needs stability to give it enough comfort to come in.

“Of course the most important issue is going back to democracy: democracy by the people, for the people,” says Mamun Rashid, managing director and country officer for Bangaldesh at Citi. But he does not feel the transition has been a barrier. “The entrepreneurs of this country, and the electorate, do not mind accepting a bit of reduction in GDP growth and accepting an interim government to clean up and pave the way for future sustainable success.”

Rashid, who leads a Citi office enjoying growing momentum not just in corporate transactions but particularly microfinance, is extremely bullish on his country, from its low cost labour to the excellent spoken English. “Bangladesh has shown in the past that despite its natural calamities it is very much on a growth path,” he says. “Bangladesh is not floods. Bangladesh is not natural calamity. Bangladesh is not corruption. Bangladesh has a story to tell.”

But while it tells it, it’s a tough job for policymakers. Balancing the twin pressures of inflation and the need for growth is a tough job in any market, but it is nowhere tougher than in a nation where people are constantly on the threshold of not having enough to eat. All being well Mirza and his team will hand over power to a new team after the December elections; that team, like others before it, will take custody of a country with so much potential and yet so much to lose.

Asiamoney, August 2008

There is a rumour doing the rounds that Nomura has amassed a war chest for acquisition: that the Japanese bank is so intent on realising its long-standing ambition to be a global force that it has built Y300 billion of funds to deploy on new purchases. Is that right?

No, says president and CEO Kenichi Watanabe. It’s actually Y500 billion.

Nomura has been mocked before for failing to deliver on its grand vision of being a global force. But one certainly can’t doubt its intent. At a time when global investment banks are being rocked by write-downs, Nomura – which had its own problems with sub-prime – sees opportunity, and Asia will be at the heart of it.

“I am very interested in looking at these assets [financial institutions that have become acquisition targets as a result of the credit crunch],” Watanabe tells Asiamoney. “We look at it from two angles. One is trying to capture capabilities we currently do not have, and the other is trying to capture a talented human resource pool. And, given that the US and European financial institutions have become more concerned about focusing on their core competencies, we are being shown offers. It is a very good chance to take advantage of the current environment.”

Watanabe will be selective about what comes up – he’s not interested in commercial banking assets, for example – and confirms Asia will be the focus of acquisitions. In time he would like the rest of the world to make up 30% of Nomura’s earnings, which, while not quite the heady level of 50% aimed for by Nomura’s top brass in the bubbly days of the early 1990s, would certainly be a step forward from the level today (since the bank had to take on significant write-downs in its US business, overseas operations strictly speaking accounted for a negative proportion of group earnings in the last financial year).

But stop us if you’ve heard this before. One Nomura leader after another has come in hoping to succeed where others have failed. Indeed, it is argued by some that Noboyuki Koga, Watanabe’s predecessor in the top job, stepped down to take responsibility for failing to diversify away from its dependence on Japan. There’s no questioning its force in Japan – Y72.2 trillion in domestic retail client assets alone, a figure Watanabe wants to turn into Y110 trillion in three years – but translating it overseas has been consistently challenging. What is the new man, installed this year, going to do differently?

Upon arrival Watanabe made a grand statement to Nomura’s shareholders and customers, and you can still find it prominently displayed on the Nomura website. “I intend to shift Nomura Group’s approach away from merely responding to the changing market environment to focus more on creating change ourselves.”

But what does this mean? “Usually when you look at the corporate leadership of multinationals and Japanese companies, they would normally say they adjust their business according to the changing business environment,” he says. “My ambitious tone in that statement was to be more aggressive: a proactive stance where we aim to create change ourselves.”

Watanabe intends to start creating that change in Asia. “Nomura was born in Asia, its roots are here. In Japan Nomura was able to be part of creating change, within the capital markets, the financial markets, and in regulations. And as a result Nomura went from a minor to a major company. Now, in Asia, the economies and financial markets are changing and evolving, and Nomura would like to be part of that change, and to promote it. Nomura can grow alongside its clients in these countries.”

Watanabe is speaking to Asiamoney on the edges of the Asia Equity Forum the bank has held in Singapore for five years, and considers the event to be an example of trying to engage directly in Asian market growth. Asia is clearly, increasingly, a focal point: even with a 400-strong cut in US headcount already announced, Watanabe acknowledges that “we ourselves have limited managerial or corporate resources” and so will have to be focused. “Rather than looking at the global investment banks who have been betting on everywhere and hoping that one of them goes well, we will be focusing towards Asia.” Plenty is happening in the region: a new corporate advisory business was launched in Shanghai this year, and in the Middle East Nomura this year became the first Asian bank to receive a licence from Saudi Arabia’s Capital Markets Authority.

Watanabe has clearly realised Nomura can’t do this organically, hence the interest in acquisition. This underpins measures like the recent issuance of Y120 billion in subordinated bonds, and the borrowing of subordinated loans from other Japanese financial institutions.  He is keen to distinguish the recent capital raising efforts from those raised by US banks simply to stay solvent. “The capital we have raised so far is something we intend to use for growth rather than replacing [losses]…If the opportunities do exist, we are ready to use that buffer of Y500 billion for the growth opportunities we deem fit for our strategy.”

Y500 billion goes a lot further these days than it used to, both because of the declining value of potential acquisitions, and the relative strength of the yen against the dollar. But for Nomura to do what it really wants to, will it be enough? “Currently, we think the amount we’ve raised so far is appropriate for what we are seeing,” he says.”

But what makes Nomura’s ambitions particularly striking is the fact that the bank is in a pretty average state today. It logged a Y67.8 billion net loss in the 2007-8 financial year (although one can make a case to say that US GAAP accounting makes things look worse than they are, since they require the consolidation of private equity investee companies), with net revenue down 27.8% year on year (to Y737.3 billion). That doesn’t seem a particularly strong base to build from.

But Watanabe has actually been startlingly specific about what he wants to change, and the quantum he wants it to change by. The most strident example of this is in the global markets business, which many see as emblematic of Nomura’s failure to grow overseas in the way it had planned to. This division made losses in 2007-8, hit by the global credit crunch. Yet Watanabe wants this division to be generating Y200 billion of pre-tax income within three years. Bullet points on investor presentations call for a “top class fixed income house in Japan and Asia”, “tier one in Asian equities”, with a strong asset finance business besides. How?

“I think the figure of Y200 billion is ambitious, looking at where the market is right now,” Watanabe admits. “But although global markets had to make the losses because of market conditions, we also instructed global markets to try and recover what they lost through the markets as well. That’s one reason we thought the figure was appropriate, to push them to go.” Also, he sees opportunity in broadening the range of this business through fixed income and equity products (today it is seen as heavily reliant on structured bonds), and expresses an interest in moving into distressed assets. “This is an area where we want to try to learn more on how to value such assets. If we were able to do these things we think the Y200 billion no longer looks quite that ambitious.”

Across the board, there are similarly high hopes. At the same time as building a global competitive financial services group, Watanabe is demanding an average consolidated return on equity of 10 to 15% in the medium term. It can look a little too good to be true.

Watanabe has implemented some structural shifts in the bank, changing the top management structure so that there is a much higher responsibility for risk management. “Rather than just measure risk, we would like to try to apply management methods where we try to anticipate risk… It’s the CEO and COO’s role now to try to make sure we can predict risks.”

It’s natural this should be the case after the bank’s troubles in the US, in which it painfully exited RMBS business. He is almost alarmingly honest about what happened. “From a credit risk perspective, we didn’t really see the problems,” he says. “If you just look at the figures you can’t really see the story behind it. One example was subprime, where we did not know that the overall hurdle for people to be able to borrow money to buy homes in the US was low. That’s something that we did not know about.” The medicine for this business has been bitter indeed: as a result of the exit from the US RMBS business, Nomura booked losses of around Y73 billion in the second quarter of 2007-8 alone, and RMBS 140billion in the first half. Residential mortgage exposure was Y266 billion as recently as June 2007; it’s now all but gone. Headcount, outside of the asset management and Instinet businesses, is in the process of being halved, with overall cuts of 400 people, net. Several executive officers took 30% pay cuts for a year in penance.

That suggests a less risky business for the future. “One of the things we’ve tried to do, but maybe failed, is a quite highly leveraged business. The US investment banks have been leveraging off their balance sheets and making huge profits. Now, rather than that, we are trying to apply less leverage, although we will continue to offer derivative and structured products for our clients.” He speaks of client facing businesses replacing some of the proprietary positions the bank has traditionally used to make its money.

But this, too, makes it trickier to see just where the hoped-for huge growth is going to come from in Nomura. If there’s less leverage, and less proprietary activity, then where else? Nomura Merchant Banking, which includes the private equity activities that have made headlines in Europe over the years with acquisitions such as British pub chains, does not appear to be ready for expansion. “Given the current limited resources that we have, to try to expand our global merchant banking just outright is very risky,” he says, stressing the selective nature of the business (although nevertheless the Nomura business plan calls for a global portfolio of Y300 billion in three years ex-its investment in Terra Firma, with a constant pre tax income between Y30 and 40 billion a year). Investment banking was heavily down year on year in 2007-8, though it did turn a profit, Watanabe expects this to turn into net revenues of Y120 billion in three years; asset management is an area of increasing strength, but chiefly domestically. Here, too, expectations are big: Y43 trillion under management in three years, generating Y55 billion in pre-tax income. (That pitch-book again: “World-class player with strong investment capabilities in Japan and Asia.”)

Talking with Watanabe, it becomes increasingly clear just how key the human resources issue is to Nomura. He recognises it as a key rationale for any takeover: not just the assets and the franchise but perhaps more than anything the people. He asks with a smile if Asiamoney knows anyone who’s looking for banking work; then he asks again. The plan for the Asian arm of the investment banking division alone calls for an additional 50 people. And one might argue that Japanese institutions struggle more than some others in trying to integrate a global workforce into a single group. There’s also remuneration: until recently, the bank has not had a reputation for playing top dollar among international investment banks.

Watanabe is interested in this observation, wondering what we’ve heard. But he acknowledges: “There were certain people in Nomura that felt that they were not being compensated enough for the efforts they put in.  We are trying to install proper managerial systems to make sure appraisals are done in a way that compensates people properly.” He speaks of the importance of “creating a much wider human resource pool within Nomura which can be utilised on an international basis.” He feels that in his previous role running Nomura’s domestic retail operations he did effect change, over three to four years, and believes he can do so across the group.

In closing, how confident is that he can realise the vision he has for Nomura? “I think the fact that I am giving this interview backs the fact that we are confident,” he says. He mentions Goldman Sachs, Deutsche and HSBC as examples of banks that, while globally active, still have specific home markets of unquestioned strength, and says he hopes Nomura can do the same. “Given our roots, and the fact that we were born in Asia, we are willing to try to make Asia the centre for our expansion.”