Interview carried out on 18 March 2014

You reported another steep fall in earnings. Why was this?

DC: Our activity level, which you could say corresponds to profit before expenses and taxes, was down by only 12% compared with 2012. However, as was the case in the first half of 2013, earnings took a major hit from the fair value adjustments to the securities portfolio required by IFRS. These adjustments, which are not required under French GAAP, had a gross negative impact of about €8.9 million and were largely to blame for the sharp drop in reported earnings.

But shouldn't this accounting adjustment be absorbed when the transactions are unwound?

DC: Yes it should. But our portfolio is not static. We are continually executing new transactions, which means that the adjustment recognized in the first half of 2013 has not yet been totally absorbed. (Editor's note: the gross fair value adjustment at 30 June was €10.2 million). However, at current levels, we can expect the impact to stabilize somewhat in the coming years, giving a better picture of our underlying consolidated earnings performance.

But the problem isn't entirely due to IFRS?

DC: No it isn't. In 2013, we were confronted yet again with a combination of factors that were detrimental to our business activity: little movement in any of the asset classes, continued weak trading volumes and very few capital transactions, which are the main raw materials we work with. Added to these purely cyclical factors, which have been unfavorable for almost 3 years now, regulatory and tax pressure has caused an opportunity loss for the group of several million euros.

An opportunity loss?

DC: That's right. The financial transaction tax prevented us from executing some transactions in French securities. As these arbitrage operations had to be abandoned, we didn't pay the FTT, but then neither did we pay corporate income tax on the profits we could have made on those "lost opportunities". Although politically shrewd, this pre-profit tax is an economic nonsense because, under the guise of generating additional tax revenues, it probably reduces corporate income tax receipts. The real tax revenue generated is hard to gauge but in my view it is close to zero, or even negative. And that's without taking into account the damage it has done to the French securities industry, mainly to the benefit of North America and Asia. I have often said this in the past few years and I will say it again, successive governments cannot keep taking measures, often very harsh ones, without causing some economic fallout, especially in a global industry. I say this with some regret as I have always fought to maintain a strong Paris market place.

You also mentioned a change of market paradigm? How did that affect 2013?

DC: I believe that the quantitative easing programs ([Editor's note: central bank programs to provide liquidity to the markets, mainly by refinancing sovereign debt)] implemented by the various central banks have profoundly changed investors' perception of risk and their behavior. So did the 2008 crisis, you'll no doubt reply! That may be true, but the 2008 crisis, although brutal, was simply the market's response to very real problems. The central banks, on the other hand, have triggered a phenomenon of risk denial by partially compensating for defaults and by helping the banks - and governments - in the hope that this will benefit the real economy. I don't know whether we should or shouldn't have used that particular "medicine" to treat the ills of the global economy in 2008. But like any medicine, I'm sure it has its side effects and that we'll soon have to stop the treatment otherwise we might well pay for it dearly one day.

The situation has lasted for more than two years now. Will we have to wait for it to return to normal before we see a return to growth for the group?

DC: In September 2012, when we realized that governments were addicted to quantitative easing, we made some strategic decisions that we worked on in 2013. These decisions will come to fruition from 2014 onwards. Both in terms of the group's structure and in terms of arbitrage strategies. We're already starting to reap the benefits even though the economic environment has hardly improved.

You spoke about adapting the organization to this new paradigm. What exactly do you mean by this?

DC: Unfortunately - or fortunately rather - we are not working in a closed world. Our main competitors are not French. The organizations that finance our activities and the investors in our funds are almost all non-French. Rightly or wrongly, they have made it clear that the fact that we operate out of Paris and France's stance towards the finance industry have made it impossible for them to work with us on a satisfactory basis. Against this backdrop, we have no alternative but to structure the group in such a way as to protect ourselves against this negative perception and loss of competitiveness. In short, if we don't set up structures that are aligned with our partners' requirements, then we will lose considerable ground to our rivals and will not be able to develop the group. These adjustments are vital; otherwise our shareholders would be justified in criticizing us for not taking appropriate action.

What will this adjustment mean in practice?

DC: As we announced at the Annual General Meeting, by late 2012 we already saw this restructuring as a strategic necessity for the group and at the end of last year we set up an Irish company called Quartys that should enable us to respond to our investors' demands. Our funds are already based in Ireland, a country with a stable environment that we know well. Ireland has implemented strict rules that are clearly in line with European law but nevertheless give the finance industry room to develop. The company should be operational as of the second half of 2014. We have also decided to set up an operation in Singapore to drive our growth in Asia, a continent that offers significant untapped potential for our business.

Ireland, Singapore… these are countries known for their attractive tax environments.

DC: If tax was the only consideration, we would have moved a long time ago. Our current teams will stay in Paris and we intend to strengthen our French R&D capability. In parallel, we are going to hire people to develop the new companies and businesses.

What will the cost be? What benefits will they bring?

DC: It's difficult to put a figure on everything and we will learn as we go, but we expect first-year costs to represent around €1 million for each of the new companies. We hope that they will turn a profit after one full year of operation, in other words by the end of 2015. I think it is premature to say what the additional earnings might be, but we're convinced that they should represent several millions of euros all other things being equal.

Unfavorable climate + new costs: does that mean the group's earnings will be stuck at a certain level with no prospect of growth?

DC: I don't believe so; in fact I'm sure they won't. From this point of view, 2013 was interesting. First of all, we saw in June that our strategies were capable of producing excellent results despite the relatively modest rise in volatility. Second, in even less favorable conditions than in 2012, we saw real growth in our activities, even though it wasn't enough to make up totally for the adverse environment, and particularly two very flat months in February and December 2013. Third, we have worked on new ideas that will come to fruition in 2014 and should compensate at least partially for the unfavourable situation.

What about the dividend in these circumstances? You can't keep distributing retained earnings indefinitely.

DC: We don't distribute retained earnings all the time. In December 2013, we took a different approach by distributing additional paid-in capital. A number of shareholders quite rightly asked us to do this in order to optimize their return on investment.

And what about the upcoming final dividend?

DC: We've always wanted to apply a dividend policy that would not threaten our growth or investment prospects. This is still the reasoning behind the Board's decisions. The contraction in transactions and volumes has made it harder for us to use the group's equity than in previous years. So that's why the Board is recommending a final dividend of €0.20 per share. This, plus the distribution paid in December 2013, will bring the total dividend for the year to €0.40 per share, giving a yield of more than 8%.

Does the current environment highlight the shortcomings of ABC's one-business model?

DC: To be totally honest, I admit that we have asked ourselves the same question, but our arbitrage universe is infinite if we can broaden our resources and our strategies. This is a gradual approach that we have to follow with conviction. We mustn't allow the steady rise in the stock market indices over the past eighteen months or so and the central banks' anti-volatility programs to deaden our awareness of risk … and unfortunately, some monetary policies are doing just that.

How can you give your shareholders more visibility in this environment, when they sometimes have difficulty in understanding the technicalities of your business?

DC: For many years, we have provided our shareholders with explanatory material so that they can follow our development. The market parameters table (Editor's note: published in every annual report since 2006), presentations at shareholders' meetings and the annual report are all there to help them gain a better insight into the favorable and unfavorable factors for ABC arbitrage. We will continue our efforts in this respect, although the best explanation of course is to produce excellent results on a recurring basis!

The asset management business is precisely one of the developments that are meant to give more visibility of your recurring results. What was the position in 2013?

DC: As could be expected, 2013 was a poor year from that point of view for ABC, with revenues of about €5 million. Here again, we were victims of the unfavorable environment. On the one hand, market parameters were simply not good enough to produce any real performance and we were unable to do any better than the global indices. However, I would remind you that these funds have done what they were originally intended to do, which was to produce returns in lively markets (Editor's note: the annualized return in 2011 was almost 19%, net of management fees) and to protect the capital in other environments. Yet here again, the quantitative easing program may have dulled investors sense of risk, which lessens our funds' appeal to those who are seeking to protect themselves against sometimes irrational markets.

Does that mean asset management is finished?

DC: Not at all. Do I need to remind you that asset management has brought in almost €15 million since 2011, on reasonable structuring costs. However, we are going to have to take account of new investor demands without detracting from the strength of our existing funds, which was confirmed during the few days of volatility in late January 2014. While keeping these funds active, in February of this year we launched a new fund that is a variation on an old strategy adapted to the new market conditions. We also plan to launch a new strategy for less volatile markets in the second quarter of 2014. The aim is to extend our ability to offer products that are effective in all, or almost all, market conditions. And hence to exceed €400 million in assets under management, which should provide revenues of more than €10 million a year.

Wouldn't it be better to focus on more profitable niche activities?

DC: As I have said, the idea is not to drop our niche activities but to provide an additional significant revenue source, especially in flatter market conditions. We have the technical resources to do this although I admit that 2012 and 2013 were hardly accommodating in that respect. Our 3-year target is clearly to develop our asset management capability to more than €1 billion, which is a significant amount for our type of industry. It won't be an easy task in a changing regulatory environment, but it's a genuine objective and we will give ourselves the means to achieve it.

All these plans will require a lot of energy. How will you make sure that you retain the best people?

DC: Our people have always been our most valuable asset. That's true today and will remain true in the coming years, as is the case in many service businesses. As I announced about a year ago, our fixed costs have risen and will rise further as we hire new people and increase pay. With the big data industry, app stores and Google attracting all the IT talent, high-potential engineers are hard to come by these days. Added to that, the regulations intended to hold in check the compensation packages of financial market engineers have in fact had the effect of driving up the salaries paid by our competitors. I said this would happen two years ago when the first measures were being implemented and it has only got worse. So that's no surprise. I think it's a pity for the shareholders and I believe there were other possible solutions. But we don't make the rules, we have to work with them. I hope to be able to hold total compensation costs (salaries + bonuses + share-based incentives) more or less constant, with growth proportionate to the increase in staff numbers.

Your staff turnover is low, aren't your teams too "old"?

DC: Our average age is about 35 and our average seniority is about 8 years. We conduct twice-yearly performance appraisals to make sure our people's skills match our needs, to listen to what they have to say, not just their problems but also their ideas and constructive criticism. In short, I would say that this length of service is about right for us as the experience and self-assurance of our older people are more useful to us with every passing day. In 2013, we appointed a new generation of managers and deputies who know the group extremely well. Given our many plans and projects, and the major new regulations both for issuers and for the finance industry, these changes had become necessary and will help our agility and our capability to be lifted a notch. That doesn't stop us from having an active recruitment program, with plans to hire at least 10 people in 2014, mainly in R&D. Young engineers, but also employees with a solid financial and/or technical background to help us reduce the time-to-market for our future projects.

Let's talk about compensation for a moment. What about the Horizon 2015 program (H2015). Won't it have a dilutive effect? Hasn't this type of program shown its limitations?

DC: The H2015 targets were set in 2010 and were built on 2 different, albeit related, pillars. The first was a strategic program designed to drive earnings growth. The target was calibrated at between €100 million and €300 million of cumulative consolidated earnings over 5 years. I will repeat what I said at the time: anything above €200 million was already very ambitious though achievable. But I said clearly that it couldn't be done without lively markets, decent trading volumes and new transactions underpinning new arbitrages. It turns out that not only have we not had this favorable environment, but also, as I said earlier, the rules of the game have changed along the way. Regulation, taxation etc. There's no point in discussing the merits of such measures, but they clearly trimmed more than €6 million from our net revenue in 2013 (Editor's note: net revenue is a measure of operating activity, combining proprietary trading revenues and third party asset management revenues) and will probably have the same effect in 2014!! Let's just say that this will do nothing to help us meet our initial targets!

What was the second pillar?

DC: The idea was to compensate our employees based on the group's performance over a five-year period, using share-based incentives to ensure that their interests were aligned with those of our shareholders. We did this with some success in 2006-2010 and we wanted to renew this source of incentive.

Why use share-based incentives in addition to salary?

DC: First of all, payroll costs at ABC should be seen in their entirety. The only thing that matters is whether the sum of salaries + bonuses + share-based incentives is consistent with our results and in line with levels of compensation offered by our competitors. From this point of view, I can tell you that our basic underlying principle - "excellent pay but only for excellent performance" - is fully respected even though there is a floor below which it is difficult to go. Secondly, share-based payment plans clearly provide a medium to long-term incentive for employees, unlike annual cash bonuses, which are necessary but must be calibrated.

What will be the program's dilutive impact?

DC: 63% of the shares allocated to the initial medium-term program have vested based on 2010, 2011 and 2012 results. The shares were purchased under our buyback program, so there was no dilution. The total cost for ABC arbitrage was about €2 million net for the three years, representing some 473,000 shares. Given our current level of activity and, barring any unexpected good fortune in 2014, the number of shares issued upon exercise of stock options will be marginal and without impact for the shareholders.

You have just implied in so many words that H2015 is unachievable?

DC: The rules of the game have changed and we now have little chance of achieving the upper range of the program, though we have no reason to be ashamed of our results with almost €100 million generated over 4 years, even before counting 2014. In this new paradigm with the new rules of the game, we have decided to set up a new 3-year program because it's hard for us to have any visibility beyond the current instability in our industry. Our aim is to get annual earnings back above €30 million. Again, if the environment is unfavorable for us, we will struggle to make that target in 2014. But as I said for H2015, and I'll say it again, our ambitions should be achievable but they shouldn't easy. That would be defeatist - something I refuse to be because I am confident in our ability to progress.

So you are launching a new program?

DC: Its code name is "Ambition 2016"! Our target is up to €90 million cumulative over 3 years from 2014 to 2016 inclusive (Editor's note: H2010 had a high target of €100 million over 5 years and H2015 had a low target of €100 million over 5 years). The principles of the program are based on strategic decisions made in 2013, both in terms of structure and business activities, which will come to fruition in 2014. Again, the idea is not to increase the risks taken by the group, but to extend our universe in 3 dimensions: the "geographic" dimension, mainly through our new operations in Asia, the "product" dimension by developing in new asset classes, and lastly the "client" dimension by developing our revenue in a segment where we have genuine credibility.

In conclusion, would you say that you are confident for 2014 and for the "Ambition 2016" program?

DC: I have every reason to be, even though I know that no battle is won without a fight and I have to admit that this is a tough one in the current environment! We still have a way to go but how can we not be confident? A positive 19-year track record, engaged, highly skilled people, continuously improving technical capabilities, ideas, goals… In short, plenty to give everyone an exciting vision for the years to come.

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