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Perspective

December seemed to bustle for three weeks and then sigh as people attended to year end projects, then escaped for a holiday with friends and family. But the mood was spoiled at month end by bombings in Bangkok, earthquake in the Pacific and the hanging of Hussein. Although western society takes some time to party for Christmas, it was ironic that at the time of peace and goodwill, the President of a country invaded without due process was hung to death in a dark and dirty room. It is not the spirit of humanity that Jesus lived and died for. Even an atheist like me has learned that punishment begets violence, not rehabilitation. I hope we can help each other to do better.

The passionate words of Martin Luther King below, which were sent to me in December, were made poignant in 2006 as the rallying call for peace was picked up by global leaders from the US to China.

"Through our scientific genius, we made of the world a neighborhood, and now through our moral and ethical commitment, we must make of it a brotherhood. We must all learn to live together as brothers or we will all perish together as fools. This is what we must learn. It simply means that every nation must be concerned about every other nation; every individual must be concerned about every other individual."

At this extraordinary moment in evolution we must realise that all is one.

Investment, Finance & VC

Stocks rose more than Wall Street strategists predicted in 2006. The S&P 500 gained 14% the Dow Jones Industrial Average rose 16% and the Nasdaq Composite Index increased 9.5%. This was partially underpinned by the Federal Reserve halting two years of interest-rate increases and energy prices falling 22% from a July record. On the last trading day of the year, US stocks declined, trimming their best annual gain since 2003 after forecasts for warmer weather dragged down energy shares. Crude fell below $60 a barrel for the first time in December. A gauge of energy shares had the steepest fall in the Standard & Poor's 500 Index as the U.S. National Weather Service said temperatures are higher than normal in most of the US.

Stock markets across Asia saw strong growth in 2006, reflecting Japan's steady economic recovery and the red-hot growth seen in China and India. Japan's benchmark Nikkei 225 index closed its last day of trading this year at 17,225.83, up 7% on 2005. The Hang Seng index in Hong Kong closed at 19,964.72, up 34.2% on the year. India's main Sensex Index gained 46% in value in the past year - its fifth year of consecutive growth. Australia's benchmark S&P/ASX 200 index rose to 5,669.9, up 19% on the year. The Morgan Stanley Capital International Asia-Pacific Index climbed 15%. Analysts are generally optimistic about prospects for shares in 2007 despite concerns about the US economy.

Asian stocks and currencies have surged in recent months as investors have pumped money into the region, with benchmark stock indexes hitting records this month in China, India, Australia, Indonesia and Singapore. Reflecting the underlying volatility of the region's markets and reminding us about the markets' risks and the challenges facing policy-makers in an increasingly inter-connected global economy.

In Europe, the FTSE 100 closed at 6220.8 in London, a gain of nearly 11% in 2006. The Dow Jones Stoxx 600 Index posted an 18% increase for the year.

America's GDP growth has been faster than Europe's, but that is mostly because its population has grown more quickly too. Dig deeper, and the difference shrinks. Official figures of productivity growth, which should in theory be an important factor driving currency movements, exaggerate America's lead. If the two are measured on a comparable basis, productivity growth over the past decade has been almost the same in the euro area as it has in America. Even more important, the latest figures suggest that, whereas productivity growth is now slowing in America, it is accelerating in the euro zone.

So, contrary to popular perceptions, America's economy has not significantly outperformed Europe's in recent years. And to achieve this not-much-better-than parity, America has had to pump itself full of steroids. Since 2000 its structural budget deficit (after adjusting for the impact of the economic cycle) has widened sharply, while American households' saving rate has plunged, causing the current-account deficit to swell. Over the same period, the euro-area economies saw no fiscal stimulus and household saving barely budged.

America's growth, thus, has been driven by consumer spending. That spending, supported by dwindling saving and increased borrowing, is clearly unsustainable; and the consequent economic and financial imbalances must inevitably unwind. As that happens, the country could face a prolonged period of slower growth.

As for Europe, the old continent is hobbled by inflexible product and labour markets. But that, paradoxically, is an advantage: it means the place has a lot of scope for improvement. Some European countries are beginning to contemplate (and, to a limited extent, undertake) economic reforms. If they push ahead, their growth could actually speed up over the coming years. Once investors spot this, they are likely to conclude that the euro is a better bet than the dollar.

The US housing market has underpinned US economic growth. As US housing deflates, the US economy will have the wind taken out of its sails. Real Estate and the Post-Crash Economy by Barry Ritholtz shows that mortgage equity withdrawal has been responsible for more than 75% of GDP growth:

Thai controls on foreign investment were implemented to stem its currency's surge. The Thai central bank imposed tough measures to curb foreign inflows in an attempt to weaken the baht, which hit a nine-year high versus the US dollar. The measures included a 10% penalty on foreign funds invested for less than a year. Thai authorities did an abrupt about-face 2 days later, rescinding the controls on foreign stock investments but maintaining curbs on bonds.

India is the second biggest foreign investor in London, and will contribute over £33 million to the capital's economy in 2006/7, according to a new estimate by inward investment agency Think London. India accounted for 18% of foreign investment in 2006, second only to the US. Think London has helped 36 Indian firms set up in the capital since mid 2005, creating 840 jobs. London was voted the top European city to locate a business this year, for the seventeenth time in a row.

Responsible Investing

WWF and SAM Group collaborated on a study modelling impacts of rising costs of carbon dioxide emissions on the valuation of German utility RWE, the biggest private carbon emitter in Europe. WWF, which criticises the embedding of full carbon costs in electricity prices since ETS provides free carbon allowances, and Sustainable Asset Management Group, which manages the Dow Jones Sustainability Indexes (DJSI), joined forces to produce the study, Carbonizing Valuation: Assessing Corporate Value at Risk from Carbon. It finds that RWE could lose up to 17 % of its shareowner value if it continues on a "business-as-usual" strategy that fails to take increasingly stringent carbon limits into account. This study will be presented in a joined launch event with the "Carbon Disclosure Project Report 2006 on Utilities" end of January 2007 in London.

RWE is a good case study for assessing the risk to shareowner value from rising constraints on corporate carbon emissions, which regulators are implementing in order to internalise the cost of carbon pollution that companies have until now pushed on to the public. As the largest German electric utility, RWE is a poster child for illustrating how climate change impacts companies when the emission of carbon dioxide becomes increasingly regulated. The 2005 European Union Emissions Trading Scheme created a market-based carbon cap-and-trade system that constrains big carbon emitters such as RWE, forcing them to factor carbon into their business decisions. On the other hand, the company announced this week it is under investigation by the German Federal Cartel Office on charges of illegally factoring the costs of CO2 into electricity prices, exemplifying the risks of walking a tightrope between carbon and regulatory constraints.

SAM Group said. "[T]he European Commission [recently] rejected nine out of ten National Allocation Plans (NAP) for the next phase of the EU Emission Trading System; this illustrates that in the long term the carbon price is going to climb high and those companies and investors need to take note." The European Commission (EC) has slashed 7% from proposed NAPs that European countries submitted, with Germany bearing the biggest brunt of cuts--by 32 million tons. The EC justified the cuts as requisite to meet the projected 80% reduction in carbon emissions by 2050 necessary to stabilize the level of carbon in the atmosphere at 450 parts per million (ppm) and avoid catastrophic climate change, according to scientific consensus.

BankTrack, a Netherlands-based coalition of NGOs seeking to hold banks accountable for their social and environmental responsibility, issued a guide to best practices entitled The Do's and Don'ts of Sustainable Banking. An Implementation Guide accompanied the Collevechio Declaration upon its introduction, and the BankTrack manual updates these original recommendations to keep abreast of developments in sustainable banking since then.

GreenBiz reviewed more than 500 news and feature stories on GreenBiz.com and its sister sites during 2006 to choose the year's Top Ten stories. GreenBiz notes that "it would have been easy to home in on the headline-grabbers: our addiction to oil, An Inconvenient Truth, the Stern Review -- oh, and that U.S. election in November. All critical developments, to be sure. But I prefer to focus on how companies are responding to these and other developments -- and leveraging them to derive business benefit and leadership status". The quick summary: While a couple of new issues or companies gained traction last year, 2006 did not offer any sea change in how companies are addressing environmental challenges. Rather, the year saw a continuation of existing trends: big companies moving in the right direction, but most having a long, long way to go.

1. Wal-Mart Goes from Zero to Hero
2. Alt-Fuel Vehicles Get in Gear
3. Carbon Neutral Brings Hope and Hype
4. Financial Sector Takes on Climate
5. Investors Flex Their Muscle on Climate
6. Renewables Become the New Recycled
7. Water Rises as a Business Issue -- and Opportunity
8. Computer Industry Plugs in to Green
9. Green Chemicals Become Supercritical
10. Green Becomes an Engine of Growth

Venture Capital

Scrutiny of hedge funds continues with Germany declaring that the G8 is to study whether hedge funds pose a risk to their economies.Germany is set to take over the presidency of the G8 next year and it wants a study into whether hedge funds are "insufficiently transparent".

Rubicon is raising an inaugural fund using a fund structure that has some echoes of the approach being taken by Stage 1 Ventures on the East Coast. It is an alignment of interests approach whereby LPs pay no fees, but are charged a 30% carried interest. The fund will actually be a series of separate funds for each portfolio company ($500,000 - $2.5 million each from Rubicon). This would entail more administration depending on the contract details and the culture of investor/manager relationship. But it is a more aligned approach than the traditional one and it will be interesting to see how both Rubicon and Stage 1 fare, and who they secure as limited partners. (The aligned fund structure designed by GRI Equity also offers the benefits of coherence of interests between investors, manager and investments in an efficient, transparent structure.)

Emerging Markets Private Equity Quarterly Review, Vol. II, Issue 4 gives a review of 2006 private equity in emerging markets from EMPEA's point of view, summarises recent deals and gives a list of events that some of you might like to pencil into their calendar.

According to the Exit Poll report by Thomson Financial and the National Venture Capital Association, 21 venture-backed companies raised $1.835 billion through IPOs and 56 venture-backed M&A deals were reported in the fourth quarter of 2006 . The data reflect another year of heavy reliance on the M&A market for VC investment exits with a total of 58 venture-backed IPOs raising $5.3 billion in 2006 and 335 M&A transactions with a total disclosed value of $16.6 billion for the full year. In 2006 venture-backed M&A deal volume was down slightly, but disclosed value rose (even though the number of disclosed values dropped). There was a slight increase in VC-backed IPOs, and a more significant rise in amount raised.2006 venture-backed activity in both the IPO and acquisition markets varied only slightly from 2005 levels although these transactions realized higher valuations. The year 2006 marks the second strongest IPO year in terms of dollars raised out of the last six years and it is also the third strongest of the last six in terms of average IPO amount. There were 17 venture-backed IPOs on non-US exchanges for the year and three of those were in Q4.

Quarter/Year	Total M&A Deals	M&A Deals with Disclosed Values	*Total Disclosed M&A Value ($M)	*Average M&A Deal Size ($M)	**Number of IPOs	Total Offer Amount ($M)	Average IPO Offer Amount ($M)
2001	353	16	16,798.9	101.8	41	3,489.9	85.1
2002	318	152	7,916.4	52.1	22	2,109.1	95.9
2003	291	123	7,726.1	62.8	29	2,022.7	69.8
2004	33	186	15,440.6	83.0	93	11,014.9	118.4
2005	347	168	16,094.4	95.8	56	4,461.0	79.7
2006	335	146	16,613.0	113.8	58	5321.1	91.7

Proxy advisory firm Glass Lewis is being acquired by Xinhua Finance. Shanghai-based Xinhua purchased an initial 19.9% of San Francisco-based Glass Lewis in August 2006 and the purchase of the remaining 80.1% is expected to close in early 2007. "XF is not well known, but critics are already questioning whether a company assumed to have close ties to Beijing should influence sensitive corporate voting outcomes around the world," stated the December 15, 2006 edition of Global ProxyWatch from Davis Global Advisors. The newsletter also noted that GL may no longer be perceived as free from conflicts of interest: "Parent XF owns investor relations firm Taylor Rafferty, whose clients are mostly corporates."

The Carlyle Group and Dah Sing Banking (Hong Kong) have agreed to acquire a 24.99% stake in mid-sized Chinese lender Chongqing Commercial Bank. No financial terms were disclosed, although Reuters valued the deal at around $100 million, with Dah Sing taking a 17% stake and Carlyle taking a 7.99% stake.

Solarfun Power Holdings Co Ltd., a China-based manufacturer of photovoltaic cells and modules, priced 12 million American depository shares at $12.50 per share ($11.50-$13.50 forecast), for an IPO take of approximately $150 million. It will trade on the Nasdaq under ticker symbol SOLF. Shareholders include Citigroup Venture Capital, Hony Capital, LC Fund III and Good Energies Investments Ltd.

The biodiesel refinery project from Seattle Biofuels is raising up to $75 million in Series B funding. It already has secured around $43 million, according to a regulatory filing. Imperium Renewables is the first refinery project of Seattle BioFuels, a VC-backed biodiesel company founded by former venture capitalist Martin Tobias. The refinery is believed to be the largest US effort of its kind, and would be capable of supplying 100 million gallons of biodiesel per year. But such things do not come cheaply. Seattle Biofuels already has previously raised over $9 million in VC funding. Shareholders include existing Seattle BioFuels backers like Nth Power and Technology Partners.

The Carlyle /Riverstone Renewable Energy Infrastructure Fund has sold part of its equity interest in Green Earth Fuels LLC, a Houston–based biodiesel company, to Goldman Sachs. No financial terms were disclosed. CRREIF remains the company’s majority shareholder. www.greenearthfuelsllc.com

Biofuel Energy Corp., a Denver-based ethanol producer, has filed for a $300 million IPO. It plans to trade on the Nasdaq under ticker symbol BIOF. Shareholders include Greenlight Capital, Third Point Partners and Cargill Inc. The company initially plans to construct five large dry-mill ethanol plants on corn-belt sites where Cargill has a strong local presence and, in most cases, adjacent to grain storage facilities owned by or affiliated with them. www.bfenergy.com

SAM Private Equity announced that its team has agreed to buy itself out, and spin off into a new independent entity called Emerald Technology Ventures. The Switzerland-based venture capital firm will continue to focus on clean-tech opportunities, with former parent company Robeco to serve as majority shareholder. www.sam-group.com

HgCapital said it has raised € 300 million for a fund earmarked to finance renewable power projects across Europe. Backers of the fund include Dutch pension fund PGGM and the California State Teachers’ Retirement System. Portfolio companies in the Renewable Power Partners Fund include Wind Direct, developer of wind farms in the U.K. www.hgcapital.com

Environmental Technologies Fund, a London-based cleantech venture capital firm, has held a first close on more than Euro 50 million for its inaugural fund. A second close is expected next quarter. Limited partners include Swiss Re and the European Investment Fund (EIF). www.etf.eu.com

Check out a new website called AsktheVC, in which readers can submit various questions about anything from term sheets to the best industry publications.

Interest Rates and Currencies

US interest rates have been kept on hold at 5.25% for the fourth time running. As expected, the Federal Reserve opted to take no action on monetary policy - although it said it remained mindful of inflation concerns. A slowdown in manufacturing and the housing market has led some to forecast a rate cut next year, but we are not yet confident that that will occur soon.

The US labour market beat forecasts by adding 132,000 jobs in November, but the unemployment rate rose to 4.5%, according to Labor Department figures.November's extra 132,000 jobs was a marked improvement from the 79,000 new positions in October, and higher than market predictions of 110,000. Although the unemployment rate edged up, it was still just above October's 4.4% five-year low.

Also on the labour front, wages for most US workers have begun rising significantly faster than inflation for first time since late 1990s. Although some economists say economy has slowed significantly in recent months and that wage improvement may turn out to be temporary spike, the increase in wages reflects Stephen Roach's comments quoted in Geopolitics. Recent rises in wages also appear to be increasing pay for both rich and poor, after years of sharply rising income inequality. Wages have risen so quickly that some economists worry that they could push inflation up on their own, by forcing companies to raise prices.

Commerce Department figures also show that US consumer spending recorded its biggest increase since July in November. Spending rose 0.5% in November after an increase of 0.3% a month earlier. Consumer spending accounts for two thirds of US gross domestic product, and is seen as a crucial barometer of economic health. Further data from the Commerce Department also reported producers seeing a rebound in demand for big ticket goods.

Another report from the University of Michigan also showed consumer confidence remained near year highs at 91.7 despite a slight fall in December.

But internationally, worries over economic prospects have also helped depress the dollar, which remains under pressure.

The US current account deficit has kept widening, signalling that the world's largest economy is still having to foot a massive bill for energy imports. The deficit was $ 225.6 billion in the three months to the end of September, up from a revised $217.1 billion in the previous quarter. That pushed the total for the first nine months of the year to $655.9billion, well on course for an annual record.In Q3, the balance of payments gap was worth 6.8% of total US GDP. High oil prices have affected inflation and import costs worldwide, and their impact on the US could be seen in the goods deficit, which was $ 8 billion higher at $218.6 billion - imports were $480.7 billion, compared to exports of $262.1 billion. The shortfall in investment flows rose to a record of $ 3.8 billion, as the requirement for foreign investment in the US continues to be required to prop up the deficit.

While Paulson was in China complaining about trade and currency imbalances, the Economist pointed out that fixed exchange rates in the Gulf make a bigger dent in the US currency balances than the Yuan. According to the IMF, the cumulative surpluses of oil exporters could amount to $1.7 trillion in the five years to 2007, swamping China's likely stash of $ 700 billion. As the Economist notes, The petrodollar explosion has two main consequences. First, it is one of the principal causes of the liquidity that is stirring up frothy financial markets. Middle Eastern money is much harder to track than Chinese capital, because a large chunk of foreign assets are held not as official reserves but in secretive government investment funds.

Trade and FDI

Since joining the WTO five years ago, businessmen say China has had a surprisingly smooth accession that has given
a huge boost to Chinese trade and investment and, by extension, contributed to global growth. Since joining the Geneva-based trade watchdog, China has cut its average tariff to 9.9% in 2005 from 15.3% in 2001. It has also scrapped or revised more than 3,000 rules and regulations and opened swathes of the economy to foreigners.

Sure there have been disputes, but the US and Europe are just as protectionist as China. There are still complaints about a lack of protection for intellectual property rights, product standards that put roadblocks in the way of foreign producers, and caps on investment in some key sectors. But reassured that China is playing by global rules, foreign direct investors have poured more than $1 billion of capital a week into China since it joined the WTO, transforming the country into the workshop of the world. Since 2001, trade growth has averaged almost 30% a year; the percentage of the population living in poverty fell to 10% in 2004 from 16% in 2001; and China has vaulted Britain and France to become the world's fourth-largest economy. China joining the WTO has injected fresh dynamism into the global trading system, according to the World Bank. The World Bank calculates that China contributed 21% of global trade growth in 2001 and 29% of economic growth.

While European and U.S. manufacturers complain that cheap Chinese imports are destroying livelihoods, Chinese trade experts fear some of their own sectors such as automobiles could simply not compete if foreign rivals were allowed to set up their own manufacturing, distribution and service networks. China is now entering the final year of its commitments schedule. WTO accession almost put Chinese reform on autopilot for 6 years, but what happens after that? There have been some strong but vague signals from the party ("Continue unwaveringly on the path of reform"), but no concrete indication of anything.

Contrary to the spirit of cooperation of the WTO, and as part of the ongoing strategy of propaganda and litigation by the US, the U.S. Trade Representative's Office released a report five years to the day after China was admitted to the World Trade Organisation, which said that China's overall record was decidedly mixed. The Chinese government expressed regret over the USTR report saying that allegations are not objective or in line with facts. The report was delivered at a time when the dollar is under pressure from oil trade deficit with gulf states and the US is pushing for punitive tariffs on Chinese goods unless Beijing loosens exchange rate controls and allows the value of the yuan to rise, making Chinese exports more expensive. Chinese officials have championed their trade policies, citing praise from the WTO's top official, Pascal Lamy.

Since the breakdown of Doha talks the incentive to broker bilateral deals has grown. The US and China are effectively moving to a bilateral negotiation on intellectual property rights, tariffs, quotas and pricing. The EU is increasingly looking to bilateral deals (and tying labour standards to the deals). Unfortunately these trends will end up benefiting big countries and big companies to the detriment of poorer ones. Collusion is not efficient. And increasing the complexity of trade will not encourage its growth and the associated benefits of efficient resource allocation.

Against the background of negotiation over copyright and trade by China and the US and in the entertainment and IT industries, the “Gowers Review of Intellectual Property” was released by the UK's Treasury. It follows a year-long study led by Andrew Gowers, an ex-editor of the Financial Times. Its aim was to take a rational, evidence-based view of intellectual property and ways to safeguard it. To the dismay of some and the delight of others, it calls for a balance between the interests of creators and the public. This idea of balance will anger the entertainment industry. For example, the music company EMI enlisted ageing crooners to back its campaign for the length of copyright for sound recordings in Europe to be extended from 50 to 95 years, following America's lead. The study rejects this. It wants much firmer enforcement of the rules, but also says copying material for private use should be made easier. The report urges a reform of the patent system. Going to court to uphold a patent costs a company a minimum of $1.5 million; that may oblige innocent firms to pay to settle and prevents infringed parties from seeking redress. A system to protect intellectual property is meaningless if only the rich can use, or abuse, it.

Activities and Media

The pause in the rhythm of life that comes in the winter gave a welcome opportunity to rebuild parts of the garden and attend to rejuvenation of business and planning for 2007. The holiday time was fun with friends and family, though as January started and everyone left, the vacuum needed to be filled by getting back to work. December saw the shortest day in the northern hemisphere and now that the days are lengthening, spirits are lifting too.

France24 France's first international news channel has been launched into competition with BBC World and CNN. The channel has the backing of French President Jacques Chirac, who despaired at the lack of an outlet for French views in the run up to war in Iraq. But some critics have complained it has insufficient funding to compete. The network has a budget of € 86 million a year, which compares with € 900 million for CNN. France 24's 170 journalists will be spread across two parallel services in French and English. Later it will add Spanish and Arabic broadcasts.It will be able to call on correspondents from private channel TF1 and state-owned France Televisions channels, which will jointly run France 24, but there have been concerns that it is not clear who will take priority. The fanfare leading up to the launch included the channel's slogan: "All the news you're not supposed to know."

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This report has been prepared for information purposes and is not an offer, or an invitation or solicitation to make an offer to buy or sell any securities. This report has not been made with regard to the specific investment objectives, financial situation or the particular needs of any specific persons who may receive this report. It does not purport to be a complete description of the securities, markets or developments or any other material referred to herein. The information on which this report is based, has been obtained from publicly available sources and private sources which may have vested interests in the material referred to herein. Although GRI Equity and the distributors have no specific reasons for believing such information to be false, neither GRI Equity nor the distributors have independently verified such information and no representation or warranty is given that it is up-to-date, accurate and complete. GRI Equity, associates of GRI Equity, the distributors, and/or their affiliates and/or their directors, officers and employees may from time to time have a position in the securities mentioned in this report and may buy or sell securities described or recommended in this report. GRI Equity, associates of GRI Equity, the distributors, and/or their affiliates may provide investment banking services, or other services, for any company and/or affiliates or subsidiaries of such company whose securities are described or recommended in this report. Neither GRI Equity nor the distributors nor any of their affiliates and/or directors, officers and employees shall in any way be responsible or liable for any losses or damages whatsoever which any person may suffer or incur as a result of acting or otherwise relying upon anything stated or inferred in or omitted from this report.

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Private and Confidential

December 2006