counterparty risk seminar - k&l gates · term asset-backed securities facility (talf) 11/25/08...
TRANSCRIPT
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Counterparty Risk Seminar
Thursday, March 5, 2009
Presented by:
Gordon F. Peery, Of Counsel, Investment Management, K&L GatesDaniel F. C. Crowley, Partner, Public Policy and Law, K&L GatesChad Dale, Partner, Bankruptcy, K&L GatesBrian Gallagher, Asset Management Industry Professional Practice Director, DeloitteVan Hatziyianis, Head of US OTC Services, NYSE EuronextMarisol Collazo, Vice President, Business Development, Deriv/SERV Trade Information Warehouse
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Program Agenda
Welcome and Introductory Remarks
The state of the $684 trillion OTC market Major industry, legal and exchange developments
K&L Gates LLPProgram Design and Your Questions
Submit additional questions to [email protected]
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Overview Of The Current Economic Crises & Prospects For Market Reform
Presenter:
Daniel F. C. Crowley Partner, Public Policy and Law K&L Gates
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Overview
The Bush BailoutThe New AdministrationObama Financial Stability PlanTALFTreasury Blueprint RecommendationsG30 Report RecommendationsLegislative Reform IssuesDerivatives RegulationHedge Fund RegistrationThe Playing Field
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The Bush Bailout
Emergency Economic Stabilization Act (EESA)Troubled Asset Relief Program (TARP)Capital Purchase Program (CPP)Targeted Investment Program (TIP)Automotive Industry Financing Program (AIFP)
Federal Reserve “Liquidity Facilities”TAF/FSLF/PDCF/AMLF/CPFF/MMIFF/TALF
FDIC Liquidity Guarantee Programs
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The New AdministrationPresident Barack Obama & Vice President Joe Biden
The AgendaRevive the economy (stimulus)Provide affordable, accessible health care to allStrengthen the public education and social security systemsDefine a clear path to energy independence and tackle climate changeEnd the war in Iraq responsibly and finish the mission in Afghanistan
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Timothy Geithner Secretary
Department of the Treasury
President of the Federal Reserve Bank of New York (2003–2008)Under Secretary of the Treasury for International Affairs (1998–2001)
Lawrence SummersDirector
National Economic Council
Secretary of the Treasury (1999–2001)Deputy Secretary of the Treasury (1995–1999)Under Secretary of the Treasury for International Affairs (1993–1995)
Ben Bernanke Chairman (until 2010)Board of Governors of the Federal Reserve
Member of Board of Governors of the Federal Reserve (2002–2005)Professor at Princeton University (1985–2005) and Stanford University (1979–1985)
Economic Policy Team
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Mary SchapiroChairman
Securities and Exchange Commission
CEO of the Financial Industry Regulatory Authority (FINRA) (2007–2008)Chairman & CEO of NASD (2006–2007)Chairman of CFTC (1994–1996)
Gary GenslerChairman
Commodity Futures Trading Commission
Under Secretary of the Treasury for Domestic Finance (1999–2001)Assistant Secretary of the Treasury (1997–1999)
Financial Industry Regulators
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Chairman Chris Dodd (D-CT)Senate Banking Committee
Oversight of Emergency Economic Stabilization Act implementationDevelop financial regulatory system that ensures institutions are regulated and supervisedConsumer protection in the areas of mortgage lending, credit card lending, and investor rightsHousing
Chairman Barney Frank (D-MA)House Financial Services Committee
Oversight of Emergency Economic Stabilization Act implementationIncrease affordable housing and access to loan modificationExecutive compensation
Key Congressional Leaders - Priorities
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Chairman Tom Harkin (D-IA)Senate Agriculture Committee
2008 Farm Bill implementationAgriculture paymentsChild NutritionConservationCommodities trading
Chairman Collin Peterson (D-MN)House Agriculture Committee
2008 Farm Bill implementation and current agricultural conditionsAgricultural-based renewable fuelsConservation and environmentFederal crop insurance and risk managementAgriculture trade and international food aidAgriculture research and promotion Biotechnology
Key Congressional Leaders - Priorities
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Obama Financial Stability Plan (FSP) – 2/10/09
Capital Assistance Program (CAP) – 2/24/09Supervisory Capital Assessment
“Stress Test” for top 19 banks with assets >$100B“Cumulative mandatory convertible preferred stock”
CPP equity convertible to CAP equityFinancial Stability Trust
Public-Private Investment Fund – (tbd)Public-Private Capital: Initially $500 billion; up to $1 trillionPrivate sector pricing of assets
Consumer and Business Lending Initiative Expansion of TALF to include additional ABS collateralUp to $1 trillion – 3/3/09 Launch (3/17/09 Subscription Date)
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Obama Financial Stability Plan
Transparency, Accountability, Monitoring, and ConditionsTougher standards for firms receiving “exceptional assistance”Require plans to generate new lending, monthly reportsRequire commitment to mortgage foreclosure mitigationRestrict dividends, stock repurchases, and acquisitionsProhibitions on lobbying, contracts posted on financialstability.gov
Homeowner Affordability and Stability PlanLow cost refinancing for “responsible” borrowers through GSEs$75B Homeowner Stability Initiative for “at risk” borrowersDrive down overall mortgage rates (purchase of GSE MBS and debt)
Small Business and Community Lending Initiative under SBA
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Term Asset-backed Securities Facility (TALF)
11/25/08 – $200B; 2/10/09 – $1 TrillionAuto loans, small business loans, credit card receivables, student loans; MBS, other? Non-recourse loan
$10M minimum3 yrs; fixed (100 BPS over 3-yr Libor) or floating (100 BPS over 1-mo Libor) rate
Borrowers eligible for 1 floating and 1 fixed rate loan/moHaircuts from 5% to 16%, depending on ABS
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Merge CFTC and SECDevelop objectives-based regulatory structure:
Market stability regulator to address overall financial market stability (Federal Reserve)Regulatory quid pro quo for governmental capital/liquidityPrinciples based vs. rules based regulationBusiness conduct regulator to address standards for business practices and consumer protectionCreate Optional Federal Charter for Insurance
Treasury Blueprint Recommendations
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G30 Report Recommendations
Require systematically significant financial institutions be subject to prudential oversight; banks should be supervised by one prudential regulator
Improve effectiveness of prudential regulation through international coordination; enhance resources available to regulators and central banks
Strengthen institutional policies and standards
Increase transparency and realign risks of financial markets and products
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Legislative Reform Issues
Capital Markets RegulationCredit Rating AgenciesDefined Contribution PlansHedge Funds and Other Alternative InvestmentsPrivate Equity and Sovereign Wealth FundsCDS and Other OTC Derivatives TradingCredit Card IssuersMortgage “Cram Down” by Bankruptcy JudgesFederal Tax Issues – the 2010 “Train Wreck”
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Derivatives Regulation
H.R. 977, the Derivatives Markets Transparency and Accountability Act of 2009 (Peterson)
All prospective OTC transactions settled and cleared though a CFTC-regulated designated clearing organizationEmpowers CFTC to suspend trading in naked credit default swaps Authorizes CFTC to initiate and prosecute criminal violations ofCommodity Exchange Act
S.272, the Derivatives Trading Integrity Act of 2009 (Harkin)
Eliminates distinction between “excluded” and “exempt” and regulated commoditiesRe-categorizes most swaps as futures contractsRequires that all futures contracts trade on designated contract market or a derivatives transaction execution facility
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Hedge Fund Registration
S. 344, the Hedge Fund Transparency Act (Grassley/Levin)Requires hedge funds to register and file annual disclosure forms with SECRequires hedge funds to comply with the SEC record-keeping standards
H.R. 713, the Hedge Fund Study Act (Castle)Requires the President's Working Group on Financial Markets to conduct a study on the hedge fund industry
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The Playing Field
Financial power has shifted from NYC to WDC
Activist, unified government
Pendulum shift towards “re-regulation”
Multiple stakeholders:Labor unions, consumer groups, trial lawyersRegulators, trade associations, the “commentariat”Financial services providers (a/k/a competitors)
Goal is to navigate and favorably influence reforms
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Bankruptcy, Administration and Insolvency Proceedings, and Key Accounting Issues
• An update on the Lehman proceedings
• A typical fact pattern that implicates critical bankruptcy, accounting and documentation issues
….and the path forward.
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The Lehman Trade Fail
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Recovering Customer Property from LBI (Lehman Brothers, Inc.)
Two Deadlines in 2009 for LBI Claims
Who is a “Customer” and what is a “Customer Claim” ?
Negotiating the Release of Property
LBIE-related Issues Involving Property Release
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Practical Fixes in Legal Documentation
Derivatives Documentation
Basic Brokerage Documentation
“Suites” of Prime Brokerage Documentation
Securities Lending Documentation
New Models that Challenge Traditional Prime Brokerage
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Practical Recommendations for Handling Negotiations with the SIPC Trustee to Release LBI Property
Handling “the Phone Call” from Lehman
Negotiating with SIPC Trustee Counsel
Handling the SIPC Trustee LBI Client Documentation presented byOutside Counsel to the SIPC Trustee
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Recent Auditing, Valuation, and Reporting Issues Related to Credit Exposure
Presenter:
Brian GallagherAsset Management Industry Professional Practice Director Deloitte
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Auditing Issues
Audit of Existence of claims or balances held at counterparty
Individuals not available to respond
Audit of Valuation of amounts due from counterparty
Valuations based on likelihood of collectability
Consideration of guarantees or indemnifications from third parties
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Valuation Issues- Credit Value Adjustments
FAS 157 requirements to consider nonperformance risk
Requirements are not industry specific, and affect all institutions, especially from a derivatives perspective
However, the following categories of Investment Management clients are affected to varying degrees, to the extent derivative portfolios exist
Highly leveraged hedge fundsNon-leveraged funds
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Valuation Issues- Credit Value Adjustments
Credit spreads are a measure of the intensity of credit risk; Used (with Recovery Rate) to derive “hazard curve” (default)
Credit Risk is bilateral (in a FAS 157 world)
Certain derivatives (or portfolios of derivatives) are two-way contracts for which either party could wind up as the obligor
For two-way derivatives, the potential exposures (positive and negative) describe the extent to which each party is exposed to the other
Collateral arrangements and other credit enhancements can mitigate credit risk in one or both directions
Both credit spreads (intensity) and exposures have term structure
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FASB Staff Position No. FAS 133-1 and FIN 45-4, Disclosures About Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45
• ScopeThe FSP applies to credit derivatives, which is defined as “a derivative instrument (a) in which one or more of its underlyings are related to the credit risk of a specified entity (or a group of entities) or an index based on the credit risk of a group of entities and (b) that exposes the seller to potential loss from credit-risk-related events specified in the contract.”
Examples:
•credit default swaps;
•credit index products and
•credit spread options.
• Effective dateEffective for reporting periods (annual or interim) ending after November
15, 2008.
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The FSP requires a seller of credit derivatives to provide additional disclosures, for each credit derivative (or for groups of similar credit derivatives), even if the likelihood of making payments is remote:
• the nature of the credit derivative:approximate term of derivative
• the maximum potential amount of future payments (undiscounted) the seller could be required to make under the credit derivative (or the fact that there is no limitation to the maximum potential future payments)
• the fair value of the derivative
• the nature of any (1) recourse provisions and assets held as collateral or by third parties that would allow the seller to recover all or portion of the amounts paid under the credit derivative and (2) any assets held as either as collateral or by third parties
FASB Staff Position No. FAS 133-1 and FIN 45-4, Disclosures About Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45
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Appendix B - Disclosure Requirements for Public Entities:
B6. Disclosure requirements for collateral:
If the entity has entered into repurchase agreements or securities lending transactions, its policy for requiring collateral or other security
If the entity has pledged any of its assets as collateral, the carrying amount and classification of those assets and associated liabilities as of the date of the latest statement of financial position presented, including qualitative information about the relationship(s) between those assets and associated liabilities. For example, if assets are restricted solely to satisfy a specific obligation, the carrying amount of those assets and associated liabilities, including a description of the nature of restrictions placed on the assets, shall be disclosed.
FSP FAS 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities
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Appendix B - Disclosure Requirements for Public Entities:
B6. Disclosure requirements for collateral:
If the entity has accepted collateral that it is permitted by contract or custom to sell or repledge, the fair value as of the date of each statement of financial position presented of that collateral and of the portion of that collateral that it has sold or repledged, and information about the sources and uses of that collateral.
FSP FAS 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities
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The Role of Derivatives in Crises and the Reform of the Over-the-Counter Derivatives Market
Presenter:
Gordon F. PeeryOf Counsel, Investment ManagementK&L Gates Boston
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Agenda for this Presentation
The Role of Credit Derivatives in the Current Crisis
CDOs and Credit Default SwapsSystemic risk posed by CDSDocumentation Challenges and the Push to Standardize CDS
Principal Reforms in 2009
Industry Initiatives
The 100/500 CDS ContractThe Big Bang Protocol
Auction SettlementDetermination Committee
Questions to [email protected]
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2008: The Perfect Storm
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Depositor
CDO Investor
Trust
Investor
Swaps
$Bank
Mortgage
$ Bank
Mortgage
$ Bank
Mortgage
Promissory Note Pools of
MortgagesPromissory
Notes
Tranch
es
AAA
AA
A-
BBBBB
Interest rate swaps, credit default swaps
Investor
Investor
Investor
CDO
Promissory Note
Promissory Note
THE CHANGING FACE OF STRUCTURED FINANCE
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An agreement where whereby one party pays the other a fixed periodic payment for the specified life of the agreement.
The other party makes no payments unless a specified credit event occurs, at which point CDSs are either physically settled or settled by cash payment.
Contingent Payment upon
“Credit Event”
Fixed Fee
(in bps per period)
Protection BuyerProtection SellerReference Entity or Entities
The Credit Default Swap
The key is how a swap is settled (cash or physical settlement), the problems that result from physical settlement, and the protocols that resulted.
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In Order to Understand March 2009 ISDA Initiatives, Some Background in CDS is Necessary
How is a derivatives trade documented ?How is a derivatives trade processed ?How is a derivatives trade assigned ?Who trades CDS … and why that’s a problem;The CDS market today (and tomorrow); How a CDS is settled: the “Bond Squeeze”;…..and other processing problems; and,
What the Fed and ISDA are doing about all of this.
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Schedule•Makes elections and changes
to standard provisions•Incorporates credit support annex
Confirmations
• Incorporate Definitions• Specify economic terms of each Transaction• Include Transaction-specific modifications• ISDA PAUG Confirmation Templates• Master confirmations• Incorporate definitions and annexes
1992 (or 2002) Master Agreement•Governs legal and credit relationship between the parties•Includes representations, events of default/termination events, covenants•Incorporates schedule and confirmation
Credit Support Documents•1994 Credit Support Annex (New York law)•1995 Credit Support Annex (Transfer-English law) •1995 Credit Support Deed (Security Interest-English law)
Definitions (e.g.)
2003 Credit Derivatives Definitions 2002 Equity Derivatives Definitions2000 Definitions
How a Derivatives Trade is Documented (correctly):
Annexes (e.g.)2008 U.S. Emissions Allowance Transaction Annex2004 Gas Annex2003 Power Annex
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How is a Derivatives Trade Processed ?
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How is a Derivatives Trade Processed ?
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ISDA
Who Trades CDS and how this Creates Systemic Risk
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One Look at the CDS Market with an Exchange
ISDA, with modifications
Dealers (as “Members”)
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How a CDS is settled and the “Bond Squeeze”
With Physical Settlement, after a Credit Event, the Protection Buyer must provide “Deliverable Obligations”
If the Buyer doesn’t own them, they must be purchased;
If CDSs outnumber bonds, a “Bond Squeeze”occurs.
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…and Other Problems Presented by CDS
CDS are customized and difficult to process through an exchange;
CDS processing and paper confirmation problems; and
CDSs were novated without consent of the remaining party.
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46Source: Operations Management Group
What the Fed and ISDA are doing about all of this: Electronic Processing Initiatives
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CDS Novations Processing
Email is discontinued for consent to credit derivatives novations.After December 31, 2008, the names of Major Dealers’ customers continuing to request novations by email are to be submitted to each Major Dealer’s primary regulator; and After February 28, 2009, Major Dealers will only accept novation consent requests on eligible products submitted on electronic platforms and will not accept paper or email.
Currently, the following electronic novation consent solutions are available to all industry participants:
DTCC Deriv/Serv. DTCC’s novation consent application is currently available via GUI or MQ line. Electronic consent requests through DTCC can also be submitted via another service provider, including the following platforms, which will themselves feed the messages through DTCC accordingly: Bloomberg, Markit and Tradeweb;T-Zero.
What the Fed and ISDA are doing about all of this:
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Early March 2009: The ISDA Big Bang Protocol
New, North American CDS Contract
Referred to as the “100/500 contract”
Purpose: standardize variables100 or 500 basis point spreads60-day lookback for Credit Events90-day lookback for Succession EventsThe status of the Modification Credit EventAuction HardwiringAdherence Details and Timing Available TODAYSupplement to the 2003 Credit Derivatives Definitions
The Determinations Committee
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Systemic risk: Central CDS Clearing
Competing conceptions of a central clearinghouse:
Central clearinghouse: transparency
Central counterparty: centralized credit and collateral
The Trade Information Warehouse is not a clearinghouse.
Central clearinghouses (e.g., NYSE Euronext Liffe) already exist for various types of trades; Liffe works for iTraxx Europe.
CME / Citadel – not live for CDS (yet)ICE / C-Corp – not live for CDS (yet)NYSE Euronext Liffe / LCH.Clearnet – Bclear platform (live)
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ANY QUESTIONS?
Please submit questions via email to:
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European Central Clearing of CDS and Status of Central Clearing in the United States
Presenter:
Van HatziyianisHead of US Wholesale ServicesNYSE Euronext - CDS on Bclear
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United States
• Cash Equities
• Options
• Futures
• Fixed Income
• Listings
• Market Data
Europe
• Cash Equities
• Options
• Futures
• Fixed Income
• Listings
• Market Data
Asia & S. America
• Qatar: 25% stake in the Doha Securities Market1
• China: opened Beijing office
• India: 5% stake in both National Stock Exchange and Multi Commodity Exchange
• Japan: strategic alliance with Tokyo Stock Exchange
• Brazil: BM&F Bovespa investment
NYSE Euronext Operates The World’s Leading and Most Liquid Exchange Group
1. Expected to close in Q1'09, subject to regulatory and other approvals
Other
Cooperation Agreements:• Abu Dhabi• LuxembourgSelected
Technology Arrangements:
• Doha Securities Market
• Tokyo• Bursa Malaysia• Philippines• Warsaw• BM&F Bovespa
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Derivatives Trading
24%
European Cash Trading
22% US Cash Trading
12%
Market Data15%
Listings14%
Software and Technology
Services6%
Other5%
NYSE Euronext Revenues Are Highly Diversified
Note: Based on Q3 ‘08 non-GAAP pro forma results for NYSE Euronext. Net revenues exclude activity assessment fees, liquidity payments and routing and clearing fees. Source: NYSE Euronext.
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CDS Clearing via NYSE Liffe
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Key Points – CDS Clearing via Bclear
The only CDS clearing solution live today (iTraxx European Index as of Dec. 22, 2008)Regulated by the FSA in London, approved by the SEC for US customersA pre-negotiated market that adds all the benefits of processing and clearing, without forcing you the market on to an exchange traded modelProcessed using Bclear, our proven solution for OTC derivativesAccount segregation, allowing customer accounts to be isolated from dealer positionsKey agreements in place with ISDA and MarkitFully cleared by LCH.Clearnet Ltd.31 major banks and brokers have signed up to the revenue sharing scheme for CDS
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Multilateral market
NYSE Liffe CDS - A Pre-negotiated, Truly Multilateral Market
LCH.Clearnet Ltd.
AAA
CCC
EEE
BBB
DDD
30
25
602530
35
40 45
AAA
CCC
EEE
BBB
DDD
30
5
10
45
40
20
10
Bilateral market
A centralized clearing house serves as the seller to every buyer and buyer to every seller, eliminating direct counterparty risk found in the bilateral market.
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NYSE Liffe CDS – Summary of Clearing BenefitsStreamlined Front to Back Operations
Virtually all trades are confirmed on T+ 0 Initial trade notifications in your back office within minutes
Novation are no longer requiredMultilateral market with all positions held against LCH.Clearnet, novation between counterparties become redundantGive-up/take-up model allow positions to be passed between counterparties easily
Compression and balance sheet capital efficienciesAll trades in the same product are netted daily, significantly reducing outstanding notionalAdditional balance sheet benefits via cross-margining with other Liffe CDS contracts
Central clearing through LCH.Clearnet LtdThe most experienced global clearer of OTC markets, active and well capitalised
Mark-to-market Valuations and REDMarkit provide daily market-to-market valuations for 4pm London timeLiffe CDS trades and positions are stamped with RED identifiersBoth are provided to users at no additional cost
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Liffe credit default swaps reference ISDA 2003 credit event definitions, and cash settle into the results of ISDA credit event auctions
In order to deliver a true multilateral centrally cleared environment, our approach features additional standardisation:
A defined determinations process for credit events, to which allcontracts are bound
Automatic application of subsequent ISDA updates and amendments to existing contracts
Cash settlement for all contracts, with a facility for physical settlement when pan-European settlement infrastructure will allow
This standardised multilateral approach allows trading with a wider range of counterparties, even without ISDA bilateral agreements in place
Our member relationships and account structure fully support the sell and buy side, and offers account segregation
NYSE Liffe CDS – A Standardised Contract
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For a multilateral centrally cleared environment, a binding credit event decision process is essential
Determinations for Liffe cleared contracts will be made by an independent credit event Adjudicator:
A leading financial QC appointed by Liffe to make an independent determination
Decisions will be based on the existing ISDA concepts of Publically Available Information, the facts of the potential credit event, issuance of ISDA protocols, and other market events
Liffe Clearing Members (typically major CDS broker/dealers) will be able to participate in a Market Advisory Group (MAG) call to present additional facts to the Adjudicator
The Adjudicator’s Terms of Reference have been specifically developed to minimise the risk that a decision would diverge from market consensus
Full details are available in Liffe’s contract documentation
We stand ready to adopt universal market determinations when they become available, and strongly encourage the development of such standards
NYSE Liffe CDS – Credit Event Determinations
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NYSE Liffe CDS – Trade Entry Example
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NYSE Liffe – CDS Trade Flow Example
Buy-side firm Broker-Dealer
Sales trading
TradeRegistration
System (TRS)
TradeRegistration
System (TRS)
1. Pre-negotiatedtrade
BclearBclear
Operations
BclearBclear
Operations
Dealing desk
Clearing& margining
systems
Clearing& margining
systems
2. Trade input to proprietary systemsor directly into Bclear
4. Electronic trade confirmation back
to trader
DTCC
3. Trade arrives at Exchange for validation and
processing
Trade Information Warehouse
Trade Information Warehouse ‘Bronze’ record
sent to DTCC
5. Trade details viewed and claimed via Exchange’s
Trade Registration System (TRS)within seconds of trade
validationby the Exchange
or
via back office systemslinked to Exchange’s systems
Regardless of methodtrades are confirmed
T+0
LCH.Clearnet
API
Liffe
Clearing Processing
System
Clearing Processing
System
7. Clearing and margining –statements to
customers in T+1 viewable on-
line
Risk / trade capture systems
Risk / trade capture systems
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LCH.Clearnet as Central Clearer
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A global leader in clearing, LCH.Clearnet is the:
Global #1 Clearing House in OTC interest rate swaps
Global #2 Clearing House in OTC fixed income and repos
Global #3 Clearing House in exchange traded futures and options
LCH.Clearnet will carry out risk management of CDS Index products using the same proven framework as other exchange traded, OTC and Liffe products
This framework for managing counterparty risk has been tried andtested and most recently utilised during the default of Lehman Brothers in September
LCH.Clearnet - Risk Management
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The following are the key instruments used for risk management:
Membership Criteria: these act as an entry hurdle for membership and ensure that members have sufficient financial resources and operational capabilities; members are monitored daily and are subject to credit reviews and visits, margins are often increased based on this monitoring. LCH.Clearnet monitors the ratio of Initial Margin levels to net capital at a member level, and takes action if this exceed certain levels
Variation Margin: VM is the daily mark to market mechanism for these contracts, enacted via changing Net Liquidating Value (NLV)
Initial Margin: IM ensures that there are sufficient funds to cover potential losses in a default in normal market conditions; calculated using SPAN, back-tested and reviewed regularly, IM has always been sufficient to manage defaults that have occurred
Intra-day Margin: to cater for large intra-day position or price movements, LCH monitors positions, prices and changes in margin liabilities; LCH can and regularly does call for additional margin when this is deemed prudent
Stress testing: all positions for all members are stress tested daily utilised circa 120 historical and theoretical scenarios to ensure adequacy of the post default backing
LCH.Clearnet - Risk Management
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LCH.Clearnet focuses extensively on default management, and utilised this tried and tested process during the management of the Lehman Brothers International and Lehman Brothers Special Financing defaults
This process enables business as usual for the remaining clearing members, while protecting customers of the defaulting member wherever possibleLCH.Clearnet is the only CCP with a highly formalised process for OTC products through the SwapClear service for Interest Rate SwapsThis involves significant member participation in the hedging and auction activities; this process was tested during LBSF default, for a $9 trillion portfolio, and resulted in significant collateral being returned to the administratorsAs the CDS service expands we will continue to evaluate the default management process, with a potential to introduce a more formal auction process similar to that used for SwapClear
LCH.Clearnet – Default Management
Apply Macro Hedges, as
required
Transfer customer
positions to other CMs, wherever possible
Close residual positions,
individually or via a portfolio
auction
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As stated, Initial Margin has always been sufficient in previous defaults. However, should this be insufficient there are further protections, as illustrated below
The adequacy of the Default Fund is stress tested daily and LCH.Clearnet is able to withstand the default of its largest member under the most extreme conditions, far surpassing the market events of September 2008
LCH.Clearnet – Post-Default Backing
TYPE AMOUNTFebruary 2009
DESCRIPTION
Defaulter’s margin collateral
$x (dependent on the size of the defaulter’s positions)
Cash, securities or bank guaranteesCalculated by bespoke algorithms for each sector to cover inherent market risk in relation to positionsRevalued and collected at least dailyRecourse is to margin collateral provided by the defaulter
Defaulter’s own default fund contribution
$x (dependent on the size of the defaulter’s positions)
Default fund contribution is assessed relative to the size of the member’s positions
LCH.Clearnet Ltd. capital
Up to $30M Before drawing on other members’ default fund contributions LCH.Clearnet Ltd would employ up to $30M of that year’s retained earnings
Default fund ~$850M The LCH.Clearnet Ltd default fund currently stands at ~$850MThe level of the fund is stress tested daily to ensure its adequacy under abnormal market conditions
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Looking Forward
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Q4 2008
Proposed Product Timeline
Launched on 22nd Dec 2008iTraxx Europe, Crossover and HiVol
Q1 2009 Mid 2009
Q1/Q2 2009 CDX IG, Crossover and HiVol
Single name CDSInitially index constituents
Other contracts will be considered according to customer demand (for example, index tranches, sovereign CDS)
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Euronext refers to Euronext N.V. and any company which is at least a 50% owned subsidiary of Euronext N.V. and references to Euronext below includes each and any such company as the context dictates.Euronext is part of the NYSE Euronext group. Liffe is the brand name of the derivatives business of Euronext, comprising the Amsterdam, Brussels, London, Lisbon and Paris derivatives markets. All proprietary rights and interest in this publication shall be vested in Euronext and all other rights including, but without limitation, patent, registered design, copyright, trademark, service mark, connected with this publication shall also be vested in Euronext. LIFFE CONNECT® is a trademark of LIFFE Administration and Management and is registered in Australia, Hong Kong, Singapore, the United States, Japan, the United Kingdom and as a European Community Trade Mark. No part of this publication may be redistributed or reproduced in any form or by any means or used to make any derivative work (such as translation, transformation, or adaptation) without written permission from Euronext. Euronext shall not be liable (except to the extent required by law) for the use of the information contained herein however arising in any circumstances connected with actual trading or otherwise. Neither Euronext, nor its servants nor agents, is responsible for any errors or omissions contained in this publication. This publication is for information only and does not constitute an offer, solicitation or recommendation to acquire or dispose of any investment or to engage in any other transaction. All information, descriptions, examples and calculations contained in this publication are for guidance purposes only, and should not be treated as definitive. Those wishing either to trade in any products available at Liffe or to offer and sell them to others should consider both their legal and regulatory position in the relevant jurisdiction and the risks associated with such products before doing so. Potential users of Liffe contracts should familiarise themselves with the full contract specification of the product concerned and any associated information. Bclear is operated as a clearing service by LIFFE Administration and Management, which is regulated by the Financial Services Authority as a Recognised Investment Exchange. Afirm and Cscreen are operated by LIFFE Services Limited, which is authorised and regulated by the Financial Services Authority as a service company. Those wishing to use the wholesale services should consider their regulatory position in the relevant jurisdiction before doing so.
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OTC Derivatives Infrastructure
Presenter:
Marisol CollazoVice President, Business DevelopmentDTCC Deriv/SERV LLC
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Agenda
DTCC Corporate Structure and Governance
DTCC Deriv/SERV Services
Trade Information Warehouse
Auction Hardwiring
New CDS Contract 100/500
71Confidential
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DTCC Corporate Structure
The Depository Trust & Clearing
Corporation(DTCC)
National Securities Clearing
Corporation(NSCC)
DTCC Deriv/SERVLLC
The Depository Trust Company
(DTC)
DTCC Solutions LLC
OmgeoJoint Venturewith Thomson
Financial
Fixed Income Clearing
Corporation(FICC)
European Central Counterparty, Ltd.
(EuroCCP)
MarkitSERV (pending joint
service offering withMarkit Group Ltd.)
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DTCC Deriv/SERV LLC Governance
User Governing Committee
Authority delegated by DTCC Board
12 representatives from major market participants
50% from European institutions
Barclays, BNPParibas, Credit-Suisse, Deutsche Bank, Societe Generale, UBS
(Other institutions represented: Bank of America, Bank of New York/Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley)
50% of individual representatives are resident in Europe
Operates on a not-for-profit basis – user governance approves tariffs and rebate of excess revenue, spend, strategic direction and new products
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DTCC Deriv/SERV LLC Services
Electronic Confirmation/Matching (to be contributed to MarkitSERV)
Covers OTC credit, rate and equity derivatives
Greater than 90% of credit derivative market worldwide (including all single name, index, index tranche, CDS on loans and loan indices, CDS on ABS, CMBS and RMBS and asset backed and commercial mortgage indices)
Trade Information Warehouse (for credit derivatives)
Central trade registry and public reporting of positions and turnover
All electronically confirmed CDS are registered in Warehouse (4.4 million sides; 29.2 trillion gross notional value in USD equivalent)
Central hub for life-cycle event processing and facilitation of other infrastructure providers (e.g., CCPs, trade compression providers, etc.)
Central payment calculation, netting and settlement (through link with CLS Bank), including net cash settlements for credit events
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75Confidential
DTCC Deriv/SERV Architecture
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Trade Information Warehouse (TIW)
Central Trade RegistryIndustry commitment (from Oct. 31 Letter) – TIW to be the “single, centralized source of industry portfolio statistics”
We publish weekly positions and turnover for:Top 1,000 single names (of 3,000 total names in Warehouse), both gross and net All indices, both gross and netAggregates, on a gross basis
We currently provide additional data to FRB, ECB and FSA in support of their own regulatory missions (and have committed to provide data to all interested regulators)
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Trade Information Warehouse (TIW)
Central Processing Hub Industry commitment (from Oct. 31 Letter) – will “process major life-cycle events in the TIW for all electronically eligible confirmable trades including:
• Clearing automatically processed through the TIW, where applicable.
• Compression and tear-ups automatically processed through the TIW.
• Credit Events automatically processed through the TIW.
• Successor events automatically processed through the TIW.
• Maturities, expires and exercises automatically processed through the TIW.
• Bulk events such as mass terminations and novations automatically processed through the TIW.”
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Trade Information Warehouse (TIW)
Central Processing Hub – Use to Date
• Working with 4 CCPs to support clearing efforts (ICE, Eurex, LIFFE, CME)
• Supporting the two leading compression and tear-up providers
• 13 other service providers linked to the Warehouse
• Centrally processed 9 credit events last year, with 10 new credit events currently being processed on a simultaneous basis - enabling TIW to calculate payments based on auction rates and settle through CLS where applicable
• Successor event processing in place, one event processed last year, with 3 more pending resolution of legal issues by ISDA
• All maturities are automatically processed
• 4 bulk transfers and mass terminations processed last year (including Lehman), with 3 currently pending
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Trade Information Warehouse (TIW)Central Settlement Processing
Industry commitment (from Oct. 31 Letter) – “By Nov 30, 2009: 96% of settlement volume on electronically matched transactions across market participants settled via TIW and CLS.”
Includes regular fee and coupon payments as well as net cash settlement for credit events
Currently all major global dealers centrally settle via TIW and CLSAll major currencies Multi-lateral net funding of obligationsCreates settlement certaintyEliminates nostro breaks
Example - Lehman credit event had a $72 billion in gross obligations, which netted to $5.2 billion in net funding obligations.
Efforts underway to on-board non-OMG banks and buy-side globally
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Auction Hardwiring
Big Bang ProtocolScheduled for adherence to begin on March 12nd and to close on April 7th.
It will become effective as of April 8th covering trades with a trade date of BEFORE April 8th and effective date ON or BEFORE April 8th .
This Supplement establishes the Credit Derivatives Determinations Committees, adds the Auction Supplement Settlement provisions, and creates Credit and Succession Event backstop dates
Determination Committee (DC)
There will be 5 different DCs by region (Americas, Europe Middle East Africa [EMEA], Asia ex-Japan, Japan, and Australia New Zealand).
Each DC has 15 voting members: 8 Global Dealers, 2 Regional Dealers, 5 buy-side firms.
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Auction Hardwiring
“Covered” transactions subject to the DC’s rulings
Excluded transactions are at a high-level:
• ABS & related indices (ABX/CMBX)
• LCDS/ELCDS & related indices (LCDX and LevX)
• CDS on Muni & related indices (MCDX)
• Bespoke portfolios based on CLNs
• CDS on CDO
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Auction Hardwiring
60/90 day look-back:
The 60/90 day limit on event notification will not be effective under the protocol as of April 7th.
it will be effective as of a second implementation date – June 20th
During this intermediate period, new transactions will have the 60/90 day look back applicable but the historic portfolio won’t.
This document covers historical transactions between protocol adherent firms
Credit Events will have a 60 day look-back period
Successor Events will have a 90 day look-back period
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Auction Hardwiring
Adherence to Protocol
Firms can begin to sign up for the Protocol on March 12th.
Adherence is free through ISDA; Firms send both a signed and a confirmed Adherence letter to ISDA.
Adhering Parties to the Protocol, do not need to amend the bilateral MCAs. The Protocol automatically amend market standard MCA based on the terms of the March 2009 Supplement.
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100/500 New CDS contractStandard North American CDS contract
Standardize Single Name tradingInvestment Grade names trading on a 100 bps spread and quoted with a flat curve spread High Yield names trading on a 500 bps spread and quoted as points up-front
Confirmation of “SNAC” contractsMatrix: ISDA will publish an updated Matrix that includes a new "Standard North American Corporate" Transaction Type. Master Confirmation Agreement (MCA): Firms can trade “SNAC”contracts using existing MCA’sPaper Confirmations: A standard long-form template is under development to ensure that paper trades match the intended termsof the 100/500 trades.
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100/500 New CDS contractChanges to DTCC DerivSERV Operating Procedures
Procedures to be amended to incorporate Supplement to all transactions with a Trade Date or Novation Date on or after April 8, 2009.
For transactions prior to April 8, 2009, parties must adhere to the ISDA Protocol for the Supplement to apply
Note, regardless of adherence or non-adherence to the ISDA Protocol for the Supplement, DerivSERV will perform credit event or successor event processing for all affected transactions, including those with a trade date prior to April 8, 2009. Firms will still have the option to exclude these transactions from processing for the particular event.
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100/500 New CDS contractChanges to Existing Template
There are no new fields or changes to any of the various messaging templates. The FpML committee has agreed on the valid value for the matrix as
Matrix: StandardNorthAmericanCorporateMCA: ISDA2003StandardCreditNorthAmerican
DTCC will overwrite several fields including:Effective date Payment frequency First Fixed Rate Payer Payment Date, Single Payment DateRestructuring
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Question & Answer Session
Also submit questions to:
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Panelist Contact Information
Gordon PeeryOf Counsel617.261.3269 [email protected]
Daniel F. C. CrowleyPartner 202.778.9447 [email protected]
Charles A. Dale IIIPartner 617.261.3112 [email protected]
Van HatziyianisHead of US OTC Services NYSE Euronext212.656 [email protected]
Marisol CollazoVice President, Business Development Deriv/SERV Trade Information [email protected]