Headline Verdana BoldWhere is Regulation Driving Hedging?18 November 2016 – Stream 3 9.30am

2

Regulation timeline – an overview 3

How will the Corporate be dealing in the future? 4

Is there a right price for a derivative? 5

Setting-up dealing or other relationships is very hard 7

Conclusions 8

Contents

3

Regulation - principally stemming from G20 meeting 2009 – response to GFC – but also IFRS & KYC

3

AML KYC

CAPITAL REQUIREMENT…...(APS 112, 180)?

?OTC

Derivative Reform

Basel Reforms

OtherReforms

2008 2009 2010 2011 2012 2013 2015 2016 2017 20182003 2014

20011999

1989

Lloyds $350mCS $535m

RBS $500mBarc $300m

HSBC $1.9bnSCB $665mING $620m RBS $100m

BNP $8.9bn

CMZ $1.45bn

2006

Reporting Central Clearing

Margining & Risk Mitigation

CVA – DVA – FVA – KVA – COLVA - MVA

2019

LCR NSFRFRTB

4

How will the Corporate be dealing in the future? (OTC Deriv Reform & Basel)

1. How is the Corporate Dealing now?Drivers:

• Efficiency

• Pricing• Security

2. How will the Corporate be Dealing in Future?

OTC Derivative Reform (Commodities, FX, Credit, Equity, IR)

• Reporting – ASIC – 2013 – CFTCs, ADIs, AFSLs; prescribed repository; 55 fields• Clearing – ASIC – 2016 – ADIs / AFSLs + A$100bn + OTC IR Derivatives (IRS,

FRA & OIS) (A$, EUR, USD, GBP, JPY); clearing houses; opt ins• Margining & Risk Mitigation – APRA – March 2017?– ADIs, Banking NOHCs,

Insurers & RSE licensees (super) + covered counterparties (financial institution) + non-centrally cleared derivatives – except settled forward FX deals & swaps; initial margin (A$12bn) & variation margin (A$3bn); models; + risk mitigation

Basel 3 & 4 (APRA)

• Capital Requirements: phased in 2013-2019, APS112 / 180 + cdt risk• Liquidity Coverage Ratio: 2015; 30 day; >100%= HQLA/Cash Out; DV• Net Stable Funding Ratio: 2018; 1 yr; >100%= ASF/RSF; DV• Basel 4 = FRTB – further capital charges for derivatives – cost transfer

Conclusion• Reporting & Risk mitigation = e-

trading & technology• Derivative costs increasing due

to cost of reporting, clearing & margining

• Cost will pass to corporate or corporate will clear / bi-lateral margin: also costly

• Clearing cheaper than bi-lateral margining

• Basel 3 & 4 increase capital costs to banks of derivatives –especially non-cleared & this cost will also pass to corporates; banks may withdraw some products

• So: e-trading; technology; ISDA CSAs; cleared derivatives?; P&L volatility; wider bank panel; disruption?

5

Is There a Right Price for a Derivative? (XVA (IFRS 13) & BBSW)

BankBank Corporate

Debt Investor

Cash

Fixed

Fixed

BBSW + %

Fixed

BBSW + %

BBSW changes 2016:• Change to calc’n methodology• AFMA transferring administrator role

CDS costs up

Bank

Influencing factors on Derivative Price (e.g. IRS):

1. BBSW /LIBOR (more expensive)2. Bank Cdt Rating Down – inc funding cost3. FVA – cost of facing un-collateralised client 4. COLVA / OIS – inter-bank collateralisation

/ variation margin cost5. MVA – inter-bank cost of initial margin

“+%” – margin charged to Corporate:1. All increased bank charges (to left) passed on2. Corporate Credit risk has increased3. Other influences? – discount factor now OIS,

not LIBOR / BBSW – it has reduced, so NPV (the price) has increased?

Basel capital charges –Increasing & being passed on;

CVA; KVAPLUS increased Admin Costs –

OTC Derivative reform

6

Is There a Right Price for a Derivative? (XVA (IFRS 13) & BBSW)

BBSW-LIBOR BBSW-LIBORFunding cost

Funding costVolatility

VolatilityTime Value

Time ValueCredit Risk

Credit RiskCDS Cost

CDS Cost

CVA

FVA

COLVA

MVA

KVA

KVA

Admin Costs

Admin Costs

DF

DF

Pre GFC / Reform Post GFC / Reform

Derivative Price Components

BBSW changes 2016:• Change to calc’n

method• AFMA departing

Notes:Overall Derivative Price Increasing:

- BBSW +- Bank Funding Cost (Credit Rating ) +

- Corporate Credit Risk +- CDS (credit risk insurance) +- CVA +

- OTC Derivative Reform:- FVA

- COLVA / MVA (inter-bank)- Admin Costs (reporting)

- Basel 3 & 4 (FRTB):

- KVA- LCR & NSFR

- Discount Factor:- Use OIS, not BBSW- So reduced = NPV +

A right price? Price is the price, but:- competition, platforms, technology

- disruption

7

Setting-up dealing (or other relationships) is very hard (KYC, Protocols, Resolutn mechs)

Conclusions:

- AML / KYC has become more onerous since 1989 & especially since 2001

- Some very serious fines have been incurred by Banks – investor aversion “Bank fine risk”

- So Bank AML / KYC compliance taken seriously & means establishing relationships is onerous & takes time

- However, with regulation driving increased hedging costs, corporates will want pricing competition

- So will need to go through the pain in advance to get wider range of banks to quote derivatives

- …and enable quotes over a dealing platform like FX Go (Bloomberg), Fxall (Reuters) or 360T (Deutsche)

Conundrum: If regulation is driving

hedging to exchanges, then KYC is lost, as

confidentiality regulations exist

8

Conclusions – Where is Regulation Driving Hedging?

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