7th annual optimising otc derivatives operations mapping ...relaunch investment suitability...

7th Annual Optimising OTC Derivatives Operations

Mapping the highest impact present and future regulations for buy-side OTC Derivatives

Annual Optimising OTC Derivatives Operations In Fund Management

Mapping the highest impact present and future regulations for

November 1st 2011Tony Kirby

Relaunch Investment Suitability

Dodd-Frank► OTC derivatives► Proprietary trading► Living wills for “too big to fail”► Basel III requirements► Hedge funds► Compensation► Securitisation► Consumer / investor protection

IFRS Convergence► FASB / IASB convergence► IFRS 9 impairment► IFRS 9 hedging► Asset and liability offsetting► Single control model

FATCA► Disclosure of US

persons and assets to IRS or 30% withholding tax

Bank Levy► UK► France► Germany

Note: Many “regulations” are still only at proposal, draft or consultation stage. Nevertheless, all are expected to reach finamended between now and then, and become enforceable law within the next 2summit countries. What is shown here are the major regulatory changes, and is not meant to be exhaustive

The landscape of future regulatory reform is truly globalBasel III

► Capital and capital surcharges► Liquidity and liquidity coverage ratio► Conservation and countercyclical buffers► Leverage ratio► NSFR► Stress testing

Global Regulatory Reform► The G20 summit commitments

have led to a host of new regulatory requirements for banks worldwide

► The impact will be particularly heavy on investment banks

Schroders Global Reg Reform 2011Relaunch Investment Suitability

Retail Distribution Review (UK)► Adviser remuneration► Adviser professional standards► ‘Tied’ and independent investment

products

EU Regulation► AIFMD► EMIR► MiFID II► PRIPs► UCITS IV

Note: Many “regulations” are still only at proposal, draft or consultation stage. Nevertheless, all are expected to reach final enactment, however much amended between now and then, and become enforceable law within the next 2-3 years. This is necessary to meet the commitments made by the G20 summit countries. What is shown here are the major regulatory changes, and is not meant to be exhaustive

The landscape of future regulatory reform is truly global

“Swiss Finish”► Tougher capital

requirements for UBS and Credit Suisse than Basel III

Basel IIICapital and capital surchargesLiquidity and liquidity coverage ratioConservation and countercyclical buffers

Global Regulatory ReformThe G20 summit commitments have led to a host of new regulatory requirements for banks

The impact will be particularly heavy on investment banks

2Schroders Global Reg Reform 2011

Systemic risk regulation

Focus on market stability

and systemic risk

Enhanced prudential regulation

and supervision

Securitization —increased disclosures and

diligence; issuers required to retain some risk

Credit rating increased disclosures; management of conflict of interest; changes in regulations that rely on

Regulation; examinations; enforcement; disclosures; fiduciary standards

The US regulatory landscape under DoddThe Act lays out a framework; 300+ rules are required to build this out

Risk management — board level governance; developed risk appetite; independent risk management functions; scenario analysis and stress testing; aggregated monitoring and reporting

Liquidity management — diversified funding mix; analysis of liquidity under stress conditions; funding contingency plans; disclosure standards

Regulatory capital — address procyclicality; raising of “well capitalized” benchmarks; adoption of capital ratio ranges; enhancement of disclosure standards

Executive compensation — realign incentives; disclosure; alignment of risk/reward time horizon

“Living wills” — resolution and recovery planning for systemically important firms

Restriction on activity for banks

“Volcker Rule” — restrictions on proprietary trading and investments in private funds by banking organizations

Clearing and settlement systemsAsset managers

Heightened prudential regulation and supervision for the largest, most complex financial institutions

Greater transparency and disclosure

Consumer and investor protection measures

"The High-level Impact of Regulatory Reform on the Capital Markets”

*According to legal firm Davis Polk, 66% of Title VII were automatically-effective (‘selfmaking, and 6% of measures were automatically effective as of another date to be specified by the SEC/CFTC

Systemic risk regulation — Financial Stability Oversight Council

Credit rating agencies —increased disclosures; management of conflict of interest; changes in regulations that rely on

ratings

Regulation; examinations; enforcement; disclosures; fiduciary standards

OTC derivatives* — central counterparty clearing; capital and collateral requirements

The US regulatory landscape under Dodd-FrankThe Act lays out a framework; 300+ rules are required to build this out

Additional public company

disclosures

board level governance; developed risk appetite; independent risk management functions; scenario analysis and stress testing; aggregated monitoring and reporting

diversified funding mix; analysis of liquidity under stress conditions; funding contingency plans; disclosure standards

address procyclicality; raising of “well capitalized” benchmarks; adoption of capital ratio ranges; enhancement of disclosure standards

realign incentives; disclosure; alignment of risk/reward time horizon

resolution and recovery planning for systemically important firms

restrictions on proprietary trading and investments in private funds by banking organizations

OTC derivatives — certain derivative contracts prohibited for banks

Banks and bank holding companies

Hedge funds/private equity (PE)Insurance companies

Heightened prudential regulation and supervision for the largest, most complex financial institutions

level Impact of Regulatory Reform on the Capital Markets”

Dodd-Frank Wall Street Reform and Consumer Protection Act• Passed by Congress and signed into law by the US President (July 2010)• Request for Information (Advanced Notice of Proposed Rulemaking)• Detailed formal rule published by the relevant regulatory agency in the Federal Register - typically SEC or CFTC (open for public comment between 30 and 60 days after the posting of the rule)• The rule moves into “proposed rule” status after the comment period is closed• Final rules are published ; period for compliance with final rule may vary

effective (‘self-effecting’) as of July 16 2011; a further 22% expressly required further rule-making, and 6% of measures were automatically effective as of another date to be specified by the SEC/CFTC

Dodd-Frank Considerations

Understanding of issues polarising firms trading OTC derivatives as a result of DoddFi

rm lik

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EF

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"The High-level Impact of Regulatory Reform on the Capital Markets”4

Understanding of issues polarising firms trading OTC derivatives as a result of Dodd-Frank Title VII?

Source: Anthony Kirby/EY Intelligence 2011

53 firms

posi

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limits

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DR

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Positive onTransparency

Concerns at costs of collateral and operational risk

45%58%

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CC

P

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DR

24%

48%


Systemic risk regulation

Focus on market stability

and systemic risk

Enhanced prudential regulation

and supervision

Market abuse —revision of current regime taking tech innovation and changes to

short selling into account

Credit rating increased disclosures; management of conflict of interest; changes in regulations that rely on

Regulations reinforced by local regulators in each jurisdiction according to the prevailing legal system in each Member State• Examples at a European level include MiFID, PSD, CCD, IMD, PRIPs and UCITS IV, and • Examples at a local level include TCF, RDR, Client Asset Rules, Product Intervention,

The European regulatory landscape There are over 70 regulations and directives impacting the European financial markets

Risk management — board level governance; developed risk appetite; independent risk management functions; scenario analysis and stress testing; aggregated monitoring and reporting

Liquidity management — diversified funding mix; analysis of liquidity under stress conditions; funding contingency plans; disclosure standards

Regulatory capital — addressing pro-cyclicality; raising of “well capitalized” benchmarks; adoption of capital ratio ranges; enhancement of disclosure standards

Remuneration — realigning incentives; disclosure; alignment of risk/reward time horizon via CRD III/IV, AIFMD and local measures

“Living wills” — resolution and recovery planning for systemically important firms

Restriction on activity for banks

“Vickers Report” — [UK only] potential restrictions from separating ‘retail’ bank activity from investment bank activity, with

ringfenced protections for former

Clearing and settlement systemsAsset managers

Heightened prudential regulation and supervision for the largest, most complex financial institutions (SIFIs)

Greater transparency and disclosure

Consumer and investor protection measures


Systemic risk regulation — Financial Stability Oversight Council

Credit rating agencies —increased disclosures; management of conflict of interest; changes in regulations that rely on

ratings

Regulations reinforced by local regulators in each jurisdiction according to the prevailing legal system in each Member State; Examples at a European level include MiFID, PSD, CCD, IMD, PRIPs and UCITS IV, and Examples at a local level include TCF, RDR, Client Asset Rules, Product Intervention, §166 Notices etc.

EMIR — central counterparty (CCP) clearing; capital

and collateral requirements

landscape in overviewThere are over 70 regulations and directives impacting the European financial markets

Additional local regulatory

disclosures

board level governance; developed risk appetite; independent risk management functions; scenario analysis and stress testing; aggregated monitoring and reporting

diversified funding mix; analysis of liquidity under stress conditions; funding contingency plans; disclosure standards

cyclicality; raising of “well capitalized” benchmarks; adoption of capital ratio ranges; enhancement of disclosure standards

realigning incentives; disclosure; alignment of risk/reward time horizon via CRD III/IV, AIFMD and local measures

resolution and recovery planning for systemically important firms

[UK only] potential restrictions from separating ‘retail’ bank activity from investment bank activity, with

MIFIR/D Measures - Will formalise current banking activities in capital markets such as BCSs, HFT and OTFs, with restrictions on all

activities; new concept of depository liability per AIFMD

Banks and bank holding companies

Hedge funds/private equity (PE)Insurance companies

Heightened prudential regulation and supervision for the largest, most complex financial institutions (SIFIs)

5

Trialogue process administered:• European Commission (EC)• European Council of Ministers • European Parliament (EP)Other key supranationals include:• European Central Bank (ECB)• European Systemic Risk Board/Council (ESRC)• European Banking Authority EBA -(formerly CEBS)• European Insurance and Occupational Pensions Authority EIOPA - (formerly CEIOPS) • European Securities and Markets Authority ESMA - (formerly CESR)


OTC derivatives – Characteristics and the EMIR proposals

Measures► Compulsory clearing of contracts eligible

for clearing► Requirements for CCPs and Trade

Repositories► Exemptions► US/EU alignment► Banning certain trades in sovereign bonds► Corporate exemptions from mandatory

central clearing; powers of ESMA in determining which contracts must be cleared

► ‘Collegiate’ approach► Possible bans ‘naked’ short selling

Objectives► Greater

transparency► Reducing

counterparty risks

► Reducing operational risks.

Characteristics to date► Bilateral negotiated transactions between two parties► Counterparty specific Credit Support Agreements used to

help manage credit risk► Market structures


Characteristics and the EMIR proposals

6

Next Steps► Risk weights/margin requirements for

non-cleared contracts► Determination of extra-territoriality► Requirement for CCPs to have access

to central bank liquidity► Review clause exemption for

PFs/OPSs► Treatment of intra-group transactions

(Art 2a)► Correct treatment of FX and FX-like

instruments► Back-loading/front-loading of

transactions► Regulatory colleges?

Compulsory clearing of contracts eligible

Requirements for CCPs and Trade

Banning certain trades in sovereign bondsCorporate exemptions from mandatory central clearing; powers of ESMA in determining which contracts must be

Counterparty specific Credit Support Agreements used to


Indicative Post Reform OTC Derivative Market Flows

Trade Execution

SEF

Reporting

FCM

Settlements

Repository

Confirmation / Affirmation/ Matching

Clearing

Customer 1

Customer 2

Futures Clearing

Member 1

Non-FCM Swaps Entity

SEF / Exchange (or bilateral if none exists)

CFTC/SEC

Customer 3

PaymentsPlatform

Standard Contract Non-Standard Contract

Affirmation Platforms(MarkitWire, ICE Link)

CCP/DCO(CME, ICE Trust (US), ICE Clear

(EU), LCH.Clearnet, Eurex

Swap repository(DTCC TIW, MarkitSERV)

Futures Clearing

Member 2

Futures Clearing

Member 3


Indicative Post Reform OTC Derivative Market Flows

► Standard Contracts► All trades must go through SEF / exchange,

if one exists► If no SEF / exchange exists, the dealer

(FCM1) finds other side (FCM2) and executes bilateral trade which is then cleared through the CCP

► All trades cleared through CCP and information goes to Swap Repository for reporting to CFTC / SEC and to market participants (general information only)

► Legal agreements to be determined, likely similar to futures agreements with addendums, give up agreements and ISDA-like terms

► End user exemption to clearing requirement available

► Non-Standard (Bilateral) Contracts► Deal execution likely similar to current

practices► Deal documentation (ISDA / CSA) likely

similar to current practices► Increased margin requirements

► Reporting► Dealers report trade information to Swap

Repository or CFTC/SEC if trade is not Swap Repository eligible► Only one entity reports information

based on defined hierarchy (most sophisticated party to the trade is required to report)

Customer 4

Futures Clearing

Member 4

Swap Repositoryeligible?

No

Yes

Standard Contract


Central clearing All standardised derivatives contracts for ‘products eligible for clearing’ to be cleared through regulated ‘clearing houses’

Trade execution Recommendation that all OTC derivatives executed either on a regulated exchange or ‘exchange-like trading facility’ (e.g., SEF)

Standardisation Definitions of standardised OTC Derivatives/participants being updated to match evolving markets. ‘Swap dealer’ and ‘Major swap participant’ are defined terms, as will ‘Commercial end- user’

Controls and reducing risk

All OTC derivatives dealers and all other major OTC derivatives markets participants will be constrained by regulation, supervision, a capital regime, margin requirements and business conduct rules and tightening of standards of who may participate in those derivatives markets

Proprietary trading Volcker Rule may impact proprietary trading

Transparency Transparency of OTC derivatives markets enhanced through record keeping and reporting requirements and provision of trade data repositories

Position limits Position limits will be applied to determine risk transparency. Extra-territorial direction per CFTC?

Exemptions Commercial end users may be exempt from the need to post margin to meet the clearing requirement. There is not expected to be a broad exemption from balance sheet hedging

Regulation summary – comparison of US and EU reforms


Mandatory CCP clearing for eligible products, by standardisation and liquidity. EC wants to see competitive CCP models; FX Swaps categorised per MiFID

EC direction of travel is increasingly that 'securities eligible for clearing' move onto organised trading venues. FSA/HMT does not see the need for mandating the trading of OTC derivatives onto merely exchanges at this stage

updated to match evolving markets. ‘Swap dealer’ and ‘Major swap More standardisation:► Contract specifications► EC focus on legal terms of the contract; Standardisation needs to take the

form of legal, commercial and operational issues; Capital requirements set by CRD III/IV?

markets participants will be constrained by regulation, supervision, a capital regime, margin requirements and business conduct rules and

Reduce counterparty risk by:► Proposing legislation to establish common safety, regulatory and

operational standards for central counterparties (CCPs) ► Improving collateralisation of bilaterally-cleared contracts► Substantially raising capital charges for CCP-cleared transactions► Mandate CCP-clearing for standardised contracts. No Volcker Rule as yet

No equivalent at present

Transparency of OTC derivatives markets enhanced through record MiFID Reviews on Transparency Pre-/Post Trade; Widening use of trade data repositories (already used for IRSs, CDSs); regulators to be allowed open access vs. data privacy

The scope for manipulation set out in the Market Abuse Directive (MAD) extended to derivatives and regulators given the possibility to set position limits (FSA against)

Commercial end users may be exempt from the need to post margin Exemption for Corporates not granted. Re view clause for PFs and OPSs. Two proportionality tests will be applied per (a) an information threshold and (b) a clearing threshold

comparison of US and EU reforms

8Degree of overlap? LowHigh DKs


EMIR Considerations

Understanding of issues polarising firms trading OTC derivatives as a result of EMIR?A

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63%Cost concerns Lack of info


Understanding of issues polarising firms trading OTC derivatives as a result of EMIR?

Source: Anthony Kirby/EY Intelligence 2011

53 firms

Exp

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Eroding confidence 64% Cost concerns


MiFID II – Characteristics of MiFIR/MiFID

Objectives - MiFID II► Increased

competition and fragmentation

► Market, product and technology developments

► The financial crisis exposed weaknesses in the regulation and transparency of non-equity instruments.

► Level of investor protection seen as insufficient

Characteristics to date► New entrants and collaborations e.g. NASDAQ-OMX, Euro

consolidation and exits► Exchanges lowered spreads and changed their pricing► System outages► Best Execution challenges for illiquid instruments► Bigger footprint for HFT► Dark pool market-shares in Europe


Measures - Trading► Extending pre-/post-trade transparency

requirements to equity-like products ► A large proportion of OTC derivatives

trading will be expected to migrate onto electronic trading venues

► New category of trading venues called “organised trading facilities” (OTFs)

► Implementation of position limits► Greater supervision of HFT/algorithms;

Measures – Investor Protection► MiFID II extends COB rules to new

asset classes and changes the client categorisation rules

► Far more intense focus on the list of complex products

► MiFID II introduces far more explicit treatment of inducements.

MiFID II consultations

, Euro-Millennium, Smartpool, Baikal now overtaken by


Next Steps► MiFID II will take the form of a directive

(applied in every Member State in the EU transposed into national law) AND a regulation (applied across every Member State in the form of a single legal effect

► Effective date for these changes is likely to be late 2013 / early 2014, and much detail is yet to emerge, the magnitude of the changes.

► Leading organisations are already analysing the impact and planning.

► Common global programmes are essential to avoid duplication and rework.

► The issue of ‘third-country access’ is likely to be one of the most controversial areas.

► MiFID II measures favour open, non-discriminatory access to venues and clearing houses, but this is not explicit in EMIR.

trade transparency like products

A large proportion of OTC derivatives trading will be expected to migrate onto electronic trading venuesNew category of trading venues called “organised trading facilities” (OTFs)Implementation of position limitsGreater supervision of HFT/algorithms;

Investor ProtectionMiFID II extends COB rules to new asset classes and changes the client

Far more intense focus on the list of

MiFID II introduces far more explicit

How might asset management firms be impacted under MiFID II?

Addressing developments in Market Structures

New Market Structures

Equities

Pre-/Post Trade Transparency

Equity-like

Best Execution/ Liabilities

</> Trade Transpar. Non Eq.

</> Trade Transpar.

Commods.

MTF

Cha

nges

Dar

k P

ools

/OTF

s

HFT

Pro

visi

ons

Ord

er H

andl

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IOI M

anag

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t

EC

T

Equ

ity-li

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Non

-Eqs

incl

. OTC

Liab

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Pre

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rans

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iscl

.

Pre

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rans

p.

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iscl

.

Investment Banks

Investment Managers

Snapshot of additional requirements under MiFID II for firms with a Dodd Frank Programme

► No Dodd Frank equivalent in MiFID II for;► IOI Management for Pre-/Post Trade Transparency for Equity-like products► Best Execution Liabilities► Client Classification, Appropriateness, and Inducements within the provision of Investment Services and protection of Client ► Order Reporting and Outsourcing within System and Controls/Record-keeping

► Other Considerations;► Additional Connectivity to OTF/MTF in addition SEF’s in the US? Connectivity to SDR’s by asset class and geographic location?► Differences in legislation requirement and detail levels. For example MiFID II post-trade reporting may be set according to asse

type of instrument and liquidity. Indications are that trade reports must include a trader ID and who made investment decisiodetails for post trade reporting are also yet to be finalised but may differ from MiFID II.

► Legislation effective date timing differences► Legal Entity considerations and impacts

The level of impact of MiFID II differs in most areas for Investment Banks and Investment Managers


How might asset management firms be impacted under MiFID II?

Other Investor Protection Miscellaneous

</> Trade . .

Provision of Investment Services and Protection of Client Interests R

eg.

Supe

rvis

ion

Third

C

ount

ries

Systems & Controls/ Record-keeping

Clie

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lass

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Clie

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form

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CO

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Sui

tabi

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App

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ness

Clie

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r-R

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o-op

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Rec

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Acc

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Tran

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Out

sour

cing

Key

High MediumLowNA

11

Client Classification, Appropriateness, and Inducements within the provision of Investment Services and protection of Client Assets

Additional Connectivity to OTF/MTF in addition SEF’s in the US? Connectivity to SDR’s by asset class and geographic location?trade reporting may be set according to asset class and in some cases the

type of instrument and liquidity. Indications are that trade reports must include a trader ID and who made investment decisions. Dodd Frank equivalent

The level of impact of MiFID II differs in most areas for Investment Banks and Investment Managers


FATCA – A summary

► The Foreign Account Tax Compliance provisions of the US HIRE ACT (signed into law 18 March 2010) are designed to counter offshore tax avoidance by US

► Under FATCA, foreign financial institutions (“FFIs”) must:► Enter into an agreement with the IRS, ► Provide information identifying their US accounts and certain US owners of their customers, ► Obtain a waiver from account holders to allow information reporting to the IRS or closure of

the account, and► Withhold on “recalcitrant” account holders and account holders that are nonOtherwise….► FATCA imposes a new 30% withholding tax on certain payments (“

“passthru” payments) made to the nonIRS that it has no US accounts.

► Proposed regulations being developed but substantial a short time frame:

► Notice 2010-60 (30 August 2010) provided 'preliminary guidance on priority ► Notice 2011-34 (8 April 2011) provides refinements of certain procedures introduced in the

earlier notice and further guidance on 'priority concerns' ► Notice 2011-53 (14 July 2011) provide a revised timetable for FATCA implementation

► The FATCA provisions include (potentially onerous) new reporting requirements for foreign financial institutions. These rules are effective for FFIs from 1 July 2013.

FATCA has implications across the entire spectrum of asset managementprocesses and systems used as well as core external relationships

The Foreign Account Tax Compliance provisions of the US HIRE ACT (signed into law 18 March 2010) are designed to counter offshore tax avoidance by US persons.Under FATCA, foreign financial institutions (“FFIs”) must:

Enter into an agreement with the IRS, Provide information identifying their US accounts and certain US owners of their customers, Obtain a waiver from account holders to allow information reporting to the IRS or closure of

Withhold on “recalcitrant” account holders and account holders that are non-compliant FFIs.

FATCA imposes a new 30% withholding tax on certain payments (“withholdable” and ” payments) made to the non-participating FFI, unless the FFI certifies to the

IRS that it has no US accounts.

Proposed regulations being developed but substantial regulatory guidance required in

60 (30 August 2010) provided 'preliminary guidance on priority issues‘34 (8 April 2011) provides refinements of certain procedures introduced in the

earlier notice and further guidance on 'priority concerns' (14 July 2011) provide a revised timetable for FATCA implementation

The FATCA provisions include (potentially onerous) new reporting requirements for foreign financial institutions. These rules are effective for FFIs from 1 July 2013.

entire spectrum of asset management and will have a significant impact on the processes and systems used as well as core external relationships

Focal Points for IM Strategy in 2011 by Risk and Regulatory Priority

Top risk categories receiving special attention from Compliance and Regulatory Reform areas in 2011

(not including FATCA)

Rel

ativ

e S

core

0

TCF/

Mis

-sel

ling

Ris

k

Sov

erei

gn (E

uro)

R

isk

X-J

uris

dict

iona

l Reg

R

isk

Oth

er re

gula

tory

R

isk

e.g.

Brib

ery

Act

Out

sour

cing

/Ven

dor

Ris

k

Cap

ital/L

iqui

dity

Ris

k

Inve

stm

ent R

isk

Man

date

/Clie

nt

Inst

ruct

ion

Ris

k

Sol

venc

y R

isk

Oth

er C

ount

ry R

isk

Cou

nter

party

Ris

k

Pro

duct

/Cro

ss-

curre

ncy

Ris

k

M&

A R

isk

Con

cent

ratio

n R

isk

Common issues and challenges:► The need to identify legal entities and US/foreign persons is growing in priority; re-tooling legal entity data and building ‘lo► Investor protection is a common theme, whether focusing on the miss-selling of guaranteed products, product intervention measure

"The High-level Impact of Regulatory Reform on the Capital Markets” 13

Focal Points for IM Strategy in 2011 by Risk and Regulatory Priority

Top regulation categories receiving special attention from Compliance and Regulatory Reform areas in 2011

(size of circles refers to relative industry spend)

Prio

rity

for I

Ms

HIGH

MEDIUM HIGHLikely Impact on IMs

tooling legal entity data and building ‘look-through’ arrangements is a significant effort for many IMsselling of guaranteed products, product intervention measures and the proposed MiFID measures concerning complex products

MEDIUM

MAR

AIFMD

UCITS IV

Bribery Act

MiFID IIProduct

Reg RDR

GovernanceShort Selling

RemunerationAML

PRIPs

Solvency II

Dodd Frank VII & EMIR

ICAAP

Client Money

FATCA


What’s changing and what it means

SUMMARY OF PROPOSALS

► Closer supervision and regulation of all derivative markets in most G20 countries

► Restrictions on ‘complex’ products in EU/EEA; investor protection as a significant theme

► Enhanced transparency and information collection in every G20 country

► Comprehensive reporting of all OTC derivative transactions to authorities in most G20 countries

► A much greater degree of multilateral clearing of contracts through CCPs – mandated (US), incentivised (EU) or TBD (A/P)

► Greater standardisation of and focus on market abuse contracts in most G20 countries

► Increased electronic trading of OTC derivative contracts in most G20 countries

► Higher capital charges and collateralisation requirements for non clearing eligible trades


What’s changing and what it means

NEW BUSINESS PROCESSES:► Risk policy reviews with all counterparties► Selection of clearing brokers for cleared OTC

derivatives► Clearing process, accounts and depositories► OTC give-ups, clearing accounts► Major Swap Participant (MSP) or significant client

analysis INVESTMENTS IN INFRASTRUCTURE:► Trade reporting / electronic connectivity► Affirmation / confirmation processes and platforms► Managing and reconciling collateral calls► Changes to counterparty risk systems► More data will be required across the organisationNEW LEGAL FRAMEWORKS:► Legal documents (ISDAs) will require review and

agreement► Amendments to existing documents► New give-up agreementsIMPLEMENTATION:► Impact and CMM assessments Developing

implementation roadmaps including TOMs/TAMs, key milestones, timelines, accountability, resource requirements and infrastructure and reporting needs

POTENTIAL INCREASE IN COSTS:► Use of cash and higher grade assets for collateral► Increase in collateral for OTCs not centrally cleared


What should asset managers be doing now

03 November 2011

INTERNAL ANALYSISMandates► Review mandates more broadly, e.g. changes,

fiduciary considerations, ability to hold cash for clearing margin

Counterparty Risk► Re-consider key elements of counterparty risk

strategy in light of ability to clear OTC in the futureBusiness Models/Positions► Audit all venues for transacting across all asset

classes/across asset classes; optimize connectivity► Analysis of existing positions/eligibility for clearing► Review margin requirements including mandates to

hold excess cash for margin► Analysis of future plans for OTC usage and clearing

eligibilities; CCP interoperability for cash instruments► Pay particular attention to treasury (FX, NDFs etc.)Operating Models► Determine governance and risk appetite► Identifying changes to current processes and

systems to fit future target operating model► Identify data requirements across the business► Develop IT design and estimate cost for budget

provision and cost/benefit analysis with a focus on reporting to regulators and clients

► Summarize commercial strategy – cost / benefit analysis of clearing and possible leverage with multiple regulations in mind


What should asset managers be doing now

ANALYSIS OF SELL-SIDE ENTITIESExecuting and clearing brokers:► Review of ISDA and FCM status by dealer► Engage with dealers via questionnaires to compare:

► Services to be offered► Level of margin, both im/vm► Check if collateral transformation service offered

and on basis of what capitalization/stress testsFund Administrators:► Review outsourcing agreements► Check liability arrangements (for assets, client money

etc.)► Compare service level agreementsClearing Houses:► Build up house-view/clearing house in light of current/

future implementations (eg CME Europe, ICE Clear)► Engage with clearing houses to understand detail of

services offered and any restrictions► Compare servicesVendors:► Review service level agreements► Review risk materiality► Check liability arrangements (if any)

► Consider implications for investors► Develop investor communication strategies► Don’t forget about ‘client risk’


Ernst & Young LLP

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