Client Clearing In-depthThe Client SpectrumThe Client Spectrum

O iOverview Who is impacted by clearing mandates and what are p y gthe relevant timelines?

What is the scope of products impacted by clearing mandates?

Incentives and common concerns related to clearing, including commercial and risk considerationsincluding commercial and risk considerations

Overview of decisions, documentation and implementationimplementation

How will capital rules impact me? Extraterritoriality concerns for clientsExtraterritoriality concerns for clients

2

Concerns Cost

New post trade costsVariability between Clearing Brokers

EB 1

EB 2

Current Bi-Lateral Execution

Variability between Clearing Brokers Segregation

Risk of the clearing broker defaulting and the clients collateral being lost

Service Continuity

Client EB 3

EB 4Service Continuity

Current OTC derivative is a contract between two parties. When the same transaction moves to clearing the Clearing Broker will provide a service, which they can resign from

EB 5

which they can resign from Collateral availability

Variation Margin to be paid in local cash Initial Margin to be paid in high quality

government bonds Client CM CCP

OTC Clearing

go e e t bo ds

3

IncentivesM d t Mandatory

U.S. mandated USD, EUR, GBP to 50yrs and JPY to 30yrs

EMIR mandate expected in Q2-Q3 2015 Risk Reduction

EB 1

EB 2

Current Bi-Lateral Execution

Reduced systemic risk between counterparties Independent third party marking positions and

assessing risk Collateral segregated from clearing brokers Portability between clearing brokers

Client EB 3

EB 4Portability between clearing brokers

Operational Consolidated reporting Consolidated collateral, coupon, upfront

payment and interest paymentsSi lifi d ti l

EB 5

Simplified operational process Capital

Client can face CCP for capital purposes Brokers have reduced capital requirements for

cleared derivatives Client CM CB CCP

OTC Clearing

Liquidity Potential liquidity shift to cleared OTC rather

than bi-lateral

4

StandardDocumentation NEGOTIATED POINTSDocumentation

Maximum Initial Margin Limit

Daily / Liquidity Limit Pre-Funding

Credit multipliersInitial Margin

Eli ibilit it i

Trading Limit Structure

C ll t l

Core AgreementsUS: FIA/ISDA AddendumEU: ISDA Clearing AnnexEU: Modified Credit Support Annex

Eligibility criteria

Transfer mechanics

Termination Period

Collateral

Variation Margin

Triggers

Timings

Single currency margining

Action during resignation periodSupport Annex

plus

Futures and Options Agreement or baseline

t

Change LimitsTermination or changeof Service

Margin Level/Collateral eligibility

Adjust eligible products

Terms under which margin is changed

Trade acceptance Guaranteed acceptanceTerms for acceptance

agreement

Segregation/Portability Docs

What constitutes a default / ATE

Omnibus Segregation

Individual SegregationAccount structure

Interest Charges/Credits

pTrades by Trade basis Reasons for acceptance suspension

LSOC in US

Close out/course of action

Resolution/Cure period

Clearing Fees

House FeesFee structure

Default Ticket Fee

Risk Maintenance Fee

Minimum Fees

5

Global Regulatory Update:g y pUS ahead of Europe, and CFTC leads SEC in rulemaking

Although US and European regulations have similar bj ti ( d t t i k i i htobjectives (reduce counterparty risk, increase oversight

and competitiveness), they differ in scope, approach and timing.

Generally European regulatory initiatives are proceeding at a Generally, European regulatory initiatives are proceeding at a slower pace, attributable to the many individual country regulators involved in the process.

In the US, regulatory responsibility for the swap market is , g y p y pdivided between the CFTC, which is responsible for regulating CDS indices and interest rate swaps, and the SEC, which is responsible for regulating single name CDS

d itand equity swaps. The CFTC is much further along in the implementation process

and as such, our discussion within the US will primarily focus on the status of regulation as it pertains to the CFTC.the status of regulation as it pertains to the CFTC.

6

Important Recent Developments:Important Recent Developments:Trading Venues in the US; Trade Reporting in Europe

In the US, the most important recent developments have focused on the implementation of the Swap Execution Facility requirementsthe implementation of the Swap Execution Facility requirements.

In October, the first Made Available to Trade determinations were filed with CFTC by SEFs.

CFTC can approve these determinations which means that market participants must begin SEF trading 30 days thereafterparticipants must begin SEF trading 30 days thereafter.

In Europe, the most important recent development is the commencement of the trade reporting requirement

ESMA authorized 4 trade repositories on Nov 7. From February 12, 2014, all counterparties established in the EU must report

details of their transactions to a trade repository by the next working day following the conclusion, modification, or termination of the relevant contract.

Counterparties will need to agree between themselves whether to report separately, to agree that one will report on behalf of both counterparties, or to delegate the reporting obligations to a third party.

7

Status of Clearing Mandates:Status of Clearing Mandates:Client clearing in the US has commenced but EU requirements are still being developed

Mandatory clearing is under way in the US, butMandatory clearing is under way in the US, but mandatory client clearing in Europe (for both indices and single-names) is not likely until Q3 2014

European clearing on a voluntary basis has started recently. Exchange trading under MiFID/R in Europe is not expected until the end of 2015 at the earliest but inexpected until the end of 2015 at the earliest but, in the US, exchange trading under SEFs will begin soon.

The potential for regulatory mismatch has caused some uncertainty in the market.

8

M k t P ti i tMarket Participants Clearinghouses: CME, ICE, LCHClearinghouses: CME, ICE, LCH Middleware: MarkitWire (Markit Trade Manager), ICELink, TradeWeb, CME Clearport, Bloomberg VCON

SEFs: Creditex, BCG, Tullett, Phoenix, GFI, ICAP, T d b M k tA Bl b T ditiTradeweb, MarketAxess, Bloomberg, Tradition, Javelin, TrueEx

FCMs: BAML Barcs BNP Citi CS DB GS JPM FCMs: BAML, Barcs, BNP, Citi, CS, DB, GS, JPM, MS, RBS, UBS

26 (or so) active dealers( )

9

O ti l IOperational Issues Biggest concern for FCMs is middleware connectivity.Biggest concern for FCMs is middleware connectivity.

Rates - Bloomberg VCON & MarkitWire Credit - Bloomberg VCON, Clearport, ICE Link, MarkitWire FCMs cited incorrect trade mapping and lack of

responsiveness, particularly in interest rate clearing, as the number one concernnumber one concern.

Collateral models for customers: Gross omnibus Gross omnibus LSOC with excess LSOC without excess

10

Cl i Ad tClearing Advantages Bilateral derivatives will be subject to increased capital j pcharges including a higher RWA for uncleared as compared to cleared swaps, and possible CVA charges if

ll li d ll d b h b kany uncollateralized exposures are allowed by the bank. Regulators have provided incentives for buy-side participants to use central clearingparticipants to use central clearing

Opportunities for cross-product margining Favorable margin methodology for cleared products:

1 to 2-day, 95% VaR (futures) 5 to 7-day, 95-98% VaR (cleared swaps)

Uncleared swaps will be subject to 10-day 99% VaRUncleared swaps will be subject to 10 day, 99% VaR.

11

Cl i h FClearinghouse FeesEach clearinghouse will charge its members fees:Each clearinghouse will charge its members fees:

annual clearing fees booking fees g maintenance fees

Additional costs may be incurred for technology licensing and operational connectivity.

12

FCM FFCM Fees

FCMs typically agree on a fee schedule or standard charges for customers to act as their agent forcharges for customers to act as their agent for clearing.

Primarily this is in the form of ticket charges per trade and bps charged on IM (an approximate measure of balance p g ( ppsheet utilization and risk).

Charges can also include allocations for default-fund contributions owed by the FCMs to the various clearinghousesclearinghouses.

Customers can assume that default fund fees are passed from FCMs onto their clients either directly or indirectly.

13

C l ti Eff t f Cl iCumulative Effect of Clearing According to a recent study by Sapient Global g y y pMarkets, the costs of hedging duration in a post-Dodd-Frank environment will increase.

Sapient estimates that the drag on portfolio alpha in Sapient estimates that the drag on portfolio alpha in the new environment will range from between ~20bps to ~62bps for cleared trades, depending on the

d t d t 91b f t diti l l dproduct, and up to ~91bps for traditional uncleared bilateral OTC trades.

In short hedging using cleared instruments (eitherIn short, hedging using cleared instruments (either swap futures and cleared swaps) will be preferable in most if not all cases.

14

E ti t d I t R tEstimated Impact on Returns

Source: The Cost of Clearing: A Buy-side g yInvestigation, Sapient Global Markets, June 2013.

15