POST TRADE FORUM

VIENNA, SEPTEMBER, 12TH

Philippe de Brossard

Head of Clearing for OTC

Operations and Fixed Income Clearing Solutions Program Function Owner ( FTO) Clearing

SGCIB and NEWEDGE

CLEAR OR NOT CLEAR?

CURRENT TRENDS ON THE OTC DERIVATIVES MARKET

2 16/09/2014

DISCLAIMER

Cette communication a été préparée par Société Générale Corporate & Investment Banking (“SG CIB”), un des pôles d‟activités de Société Générale.

Cette communication vous est envoyée à titre purement informatif. Rien dans ce document ne peut être interprété comme reflétant la position officielle de

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Générale à ses clients. Rien ne dispense les destinataires de ce document d'obtenir leur propre avis juridique et réglementaire.

Ce document est à usage purement informatif et il n‟a pas pour objet et ne peut en aucun cas être interprété comme constituant une offre d‟achat ou de

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comptables, juridiques, réglementaires ou fiscaux.

En préparant ce document, SG CIB a utilisé l‟information publique disponible. SG CIB pense que les informations contenues dans ce document sont fiables

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Ce document est confidentiel et ne peut faire l‟objet d‟aucune diffusion à des tiers. Il ne peut être reproduit en tout ou en partie sauf accord expresse de SG

CIB.

Société Générale est un établissement de crédit de droit français agréé et supervisé par l‟Autorité de Contrôle Prudentiel (ACP).

3 16/09/2014

INTRODUCTION

The objectives of regulators and market participants have thus become aligned. While regulators are looking to enhance prudential supervision by

requiring more rigorous capital and liquidity adequacy standards, credit institutions are looking to improve the quality of their asset base both to

reduce credit and counterparty risk and to improve their liquidity profile.

The credit crunch put the financial markets under two major reforms, the Dodd-Frank Act (US) and EMIR (Europe) are deeply impacting financial

institutions‟ operating models.

They must now generalize their credit risk through the regular exchange of collateral. This focus on collateral coincides with a regulatory trend

towards standardization of OTC derivatives and migration to central clearing. While this should increase transparency, reduce counterparty credit

risk and allow better regulatory oversight, concerns remain over loss of flexibility, increased cost of financing positions, fragmentation of exposure

(and associated loss of bilateral netting benefits) across multiple systemically important venues and disruption over the transition period.

Meanwhile financial institutions must also conform to the general increase in regulatory controls, with their accompanying demands for compliance

and transparency. This need to improve post-trade and position transparency and to provide a comprehensive view of systemic risks leads to the

requirement that all derivatives transactions (cleared & bilateral) be reported to central trade repositories.

Dodd-Frank is an Act to promote the financial stability of the United States by improving accountability and transparency in the financial system (…).

EMIR: European Market Infrastructure Regulation is the European Union legislative proposal to regulate financial markets.

Basel III and its new set of capital rules is also putting collateral management in the spotlight: a clear goal of the Basel III accord is to push trading activity

towards exchanges by means of capital charge levers. In this perspective sizeable capital charges will be levied against OTC products not being cleared

through a CCP. Furthermore, whereas CCP-cleared products were capital charge free under Basel II, this will not hold true under Basel III. This evolution

will make cross-product netting a key goal in order to reduce banks‟ net credit exposure under the emerging CCP operating model.

The impact of these reforms on collateral management is enormous: it moves it from an operational unit to a critical tool for risk mitigation, liquidity

management and revenue enhancement.

One of the cornerstones of this change is collateral optimization, which we might rather describe as active collateral inventory management

4 16/09/2014

GENERAL PROCESS TO CONFIRM AND FOLLOW A DEAL BEFORE THE REGULATION

5 16/09/2014

AFTER THE REGULATIONS

6 16/09/2014

THE TRANSFORMATION OF CLEARING IN THE OTC DERIVATIVES MARKET

In the future to come

7 16/09/2014

CLASSES OF CDS AND IRS PROPOSED FOR CLEARING OBLIGATION

Classes of CDS proposed for clearing obligation

Classes of IRS proposed for clearing obligation

EMIR DFA

Specification Currency Index Maturity CCPs Specification Currency Index Maturity

Basis Swap Class EUR EURIBOR 28D - 50Y LCH - Eurex Basis Swap Class EUR EURIBOR 28D - 50Y

Basis Swap Class GBP LIBOR 28D - 50Y LCH - Eurex Basis Swap Class GBP LIBOR 28D - 50Y

Basis Swap Class JPY LIBOR 28D - 30Y LCH - Eurex Basis Swap Class JPY LIBOR 28D - 30Y

Basis Swap Class USD LIBOR 28D - 50Y LCH - Eurex Basis Swap Class USD LIBOR 28D - 50Y

Fixed-to-Float IRS Class EUR EURIBOR 28D - 50Y LCH - Eurex - OMX Fixed-to-Float IRS Class EUR EURIBOR 28D - 50Y

Fixed-to-Float IRS Class GBP LIBOR 28D - 50Y LCH - Eurex - OMX Fixed-to-Float IRS Class GBP LIBOR 28D - 50Y

Fixed-to-Float IRS Class JPY LIBOR 28D - 30Y LCH - Eurex - OMX Fixed-to-Float IRS Class JPY LIBOR 28D - 30Y

Fixed-to-Float IRS Class USD LIBOR 28D - 50Y LCH - Eurex - OMX Fixed-to-Float IRS Class USD LIBOR 28D - 50Y

Forward Rate Agreement EUR EURIBOR 3D - 3Y LCH - Eurex - OMX Forward Rate Agreement EUR EURIBOR 3D - 3Y

Forward Rate Agreement GBP LIBOR 3D - 3Y LCH - Eurex - OMX Forward Rate Agreement GBP LIBOR 3D - 3Y

Forward Rate Agreement USD LIBOR 3D - 3Y LCH - Eurex - OMX Forward Rate Agreement USD LIBOR 3D - 3Y

Forward Rate Agreement JPY LIBOR 3D - 3Y

Overnight Index Swap EUR EONIA 7D - 3Y LCH - Eurex - OMX Overnight Index Swap EUR EONIA 7D - 2Y

Overnight Index Swap USD Fed Funds 7D - 3Y LCH - Eurex - OMX Overnight Index Swap USD Fed Funds 7D - 2Y

Overnight Index Swap GBP SONIA 7D - 3Y LCH - Eurex - OMX Overnight Index Swap GBP SONIA 7D - 2Y

EMIR DFA

Reference Index Series Maturity CCPs Reference Index Series Maturity

iTraxx Europe Main 11 onwards 5Y LCH - ICE iTraxx Europe Main 10 onwards 5Y

iTraxx Europe Main 7 onwards 10Y

iTraxx Europe Crossover 11 onwards 5Y LCH - ICE iTraxx Europe Crossover 10 onwards 5Y

iTraxx Europ HiVol 10 onwards 5Y

CDX.NA.IG 15 onwards 3Y

CDX.NA.IG 11 onwards 5Y

CDX.NA.IG 8 onwards 7Y

CDX.NA.IG 8 onwards 10Y

CDX.NA.HY 11 onwards 5Y

8 16/09/2014

CLASSES OF CDS AND IRS MONITORED FOR CLEARING OBLIGATION

Classes of CDS and IRS for which ESMA has determined that a clearing obligation is not necessary at this stage but will

continue to monitor the activity for subsequent clearing obligation determinations.

Classes of CDS monitored for clearing obligation

● iTraxx Europe Senior Financial

● iTraxx Europe High Volatility

● CDS Single Name

Other CDS mentioned in the consultation paper but with no hint regarding the clearing obligation : CDX.NA.IG and CDX.NA.HG

The consultation goes until 18th September.

Classes of IRS monitored for clearing obligation

● Interest rate futures and options classes

● Covered Bonds meeting certain conditions are exempt from clearing obligation*

● ESMA considers the following four currencies in priority: EUR, GBP, JPY, USD

Other currencies mentioned in the consultation paper but with no hint regarding the clearing obligation : JPY (in Forward Rate Agreement and Overnight Index Swap),

AUD, CAD, CHF (in all IRS classes), SEK, NZD, ZAR, KRW, MXN, PLN, SGD, HKD, NOK, HUF, CZK, MYR, DKK, INR, CLP, COP, NZD, CLF, TRY, RUB, ILS, AED

The consultation went until 8th August.

Equity are not subject of clearing obligation

Clearing obligation rules do not apply to derivatives transactions within the same legal entity

* Conditions are described on slide 8

9 16/09/2014

REGULATORY IMPACT THAT ENHANCE THE RESHAPING OF THE OTC DERIVATIVES MARKET

Frontloading

The frontloading requirement is the obligation to clear the OTC derivative contracts (pertaining to a class of OTC derivatives that has been declared

subject to the clearing obligation) that are entered into after the notification and before the date of application of the clearing obligation.

The frontloading period can be divided into two different timeframes:

● Period A: between the notification of the classes to ESMA and the publication in the Official Journal of the regulatory technical standards

(RTS) on the clearing obligation

● Period B: between the publication in the Official Journal of the RTS and the date on which the clearing obligation takes effect (the date of

application).

Frontloading is not required for:

● Derivatives which as at least one non-financial counterparty as a party as NFC are not subject to frontloading.

● For any transactions entered into prior to the publication in the Journal of an RTS specifying an asset class subject to the clearing obligation.

● For instruments of less than 6 months maturity as of the time of publication in the Official Journal of the relevant RTS.

Minimum remaining maturity of the contracts

The “minimum remaining maturity”, is the maturity of that contract as of the date of application of the clearing obligation for this contract and for this

counterparty.

● For contracts concluded in Period A, the minimum remaining maturity is set at a level equal to the maximum maturity of the contracts of this

class minus the length of the implementation period of Category 1 (6 months).

European Untranched CDS index (5 years) => 4 years and 6 months

Basis and Fixed-to-Float: (50 years) => 49 years and 6 months

Forwards rate agreement and Overnight index swaps: (3 years) => 2 years and 6 months

● ESMA considers that contracts concluded during Period B with more than 6 months before expiration on the date of application of the

clearing obligation should be subject to frontloading.

10 16/09/2014

SG ACTIVITIES ON CDS AND IRS SUBJECT TO THE CLEARING OBLIGATION

SG is able to clear with all CCP

* if Frontloading starts the 15th December 2014

** Already eligible to DFA mandatory clearing

Trade date between 1st January 2014 and 29th July 2014 with Category 1 counterparts

Classes CDS IRS

% of deals cleared 77% 94%

% of deals subject to Frontloading* 98% 67%

% of deals subject to Frontloading not cleared* 83% 5%

Number of Category 1 counterparts 11 101

Number of Category 1 US person** 5 18

11 16/09/2014

EVALUATING STRATEGIES TO OVERCOME CLEARING RISK EFFECTIVELY

Objectives to achieve

a. Reduce CVA‟s impact on OTC bilateral deals (to comply with Basel III constraints)

b. Decrease the level of Initial Margin so as to reduce or stabilize our threshold with CCP

c. Reduce counterparty‟s exposure ( CVAR) on all OTC deals

d. Reduce our leverage ratio „s exposure on all OTC cleared deals

e. Best Strategy to follow about Funding optimisation

f. To be informed by new rule book updates at each CCP

12 16/09/2014

BEST PRACTICES IN THE MITIGATION OF COLLATERAL

Collateral Optimisation

A. Overview

a. Manage all liquidity pools and the collateral inventory

b. Collateral allocation for the Repo trading desk

c. Oversight of collateral allocation decisions for margin management and portfolio optimisation

d. Funding of all cash and non-cash collateral requirements

e. Sourcing of the required types of collateral

f. Allocation of collateral costs

g. Cover: OTC Bilateral, OTC House Cleared, OTC Client Cleared, Listed Derivatives, Repo and Stock Lending

B. Platform Requirements

a. Identify the cheapest venue to collateralise a trade

b. Understand whether cheaper to clear trade or enter Bilateral margin agreement

c. Compute collateral selection based on internal price list taking into account dynamic haircuts and collateral hierarchy

d. Can plug-in internal algorithms to compute the cheapest collateral to deliver and to allocate collateral to trades based on

a number of predefined rules

e. Analyse the pledged collateral portfolio and identify the cheapest to deliver based on eligibility and relative cost

f. Identify surplus collateral either at the CCP or listed exchange that can be recalled

g. Show the most expensive collateral to hold in terms of capital requirements

h. Propose substitutions based on changing asset profiles and maturities

i. Monitor collateral limits vs. CCP and Client

j. Manage the funding and allocation of collateral based on incoming calls

k. Auto allocate collateral to trades based on a number of predefined parameters (e.g. client risk profile and tolerances,

maturity data, security rating)

l. Provide real-time optimisation by balancing assumed settlement and settled basis

13 16/09/2014

NEWEDGE PRIME SERVICES

World #1 execution and clearing broker of

Listed Futures and Options by volume

12% global market share

3.6 billion contracts executed and cleared in

2013

Access to more than 85 exchanges

€30.4bn segregated client assets on deposit

globally

Newedge in numbers

LISTED

OTC

DERIVATIVES & CASH

EQUITIES/INDICES

COMMODITIES

BONDS/FIXED INCOME

FX

CLIENTS:

CORPORATES

HEDGE FUNDS

INSTITUTIONALS

PRINCIPAL TRADING

GROUPS

CLEARING

FINANCING

CAP INTRO

STRUCTURING

CROSS-MARGINING

A global multi-asset agency prime services offer that combines scale and agility

Single point of access to more

than 130 venues via Voice / CARE

/ DMA

Open-architecture approach

Real-time consolidated view of all

orders/fills across all channels and

all markets

200+ futures brokers offer full

high-touch service

Algorithmic trading: proprietary tick

base, algo suite and synthetic

order types

Global Execution Clearing Financing and Prime Brokerage Awards

Listed and OTC

Cover all major CCPs

Proprietary multi-asset

cross-margining

capabilities

Collateral management

and transformation

STP 99% of listed

derivatives across all

markets

Single global platform

Cross-asset financing covering Fixed

Income, Equities Commodities and FX

Global, multi-asset, prime brokerage

service covering Equities, Fixed Income,

Foreign Exchange and Commodities in

cash and derivative/synthetic instruments

Value-add services include:

● Risk-based cross-margining and

portfolio-margining

● Capital Introduction

● Synthetics solutions

Mitigates risk; minimises conflict of interest; ensures clients benefit from best execution, full transparency and

anonymity

Enforced by strict information barriers

Agency Model

EXECUTION

HFM Week, European Hedge Fund

Services Awards 2014

Best Global Prime Broker – Excellence in

Service and Solutions

Best Prime Broker – Capital Introductions

HFM Week, US Hedge Fund Services

Awards 2013

Best Prime Broker – Capital Introduction

CTA Intelligence, US CTA Services

Awards 2014, Risk & Energy Risk

Commodity Ranking

Best FCM Overall

Best Capital Introduction Service

Banking Technology Awards 2013

Best Trading Platform or venue

FOW Awards

Non-Bank FCM of the Year

The Wall Street Letter, Institutional

Trading Awards 2014

„Best Broker‟ Dealer – Futures

14 16/09/2014

CROSS MARGINING : ETDS AND OTC CLEARED

Operational challenges

● Market fragmentation

● Account structures (individual accounts and segregation models)

● Risk parameters harmonization

Position netting between ETDs and OTC products

● Better evaluation of the risk of a portfolio and reinforced positions

control

● Reduced Initial Margin requirements (up to 90% IMR reduction

according to CME‟s analysis)

● Simplification of payments with a single global position

Cross Margining at the CCP

Cross Margining between OTC cleared and ETDs products

within the same CCP

CCPs offering and implementation timeline

● Eurex : Q1 2015 with their new risk model PRISMA

● CME : Q3 2015

Portfolio Margining at Newedge

Cross margining between OTC, OTC Cleared, ETDs,

Equities, Bonds … and all instruments and assets

classes covered by Newedge

● Fimatrix - proprietary risk

management platform

● Monte-Carlo VaR based on 5,000

simulations

● Supported by a centralized team of

25 quants

● Daily reporting and detailed risk

analysis, including position by

position drill-down

15 16/09/2014

COLLATERAL MANAGEMENT FRAMEWORK

1. Margin Calculation

● Recalculation of CCP provided Initial Margins (IMs)/Variation Margins (VMs)

● Scale-up/down of initial margin depending on client credit check/relationship

● Cross-CCP calculation to minimize clearing cost

2. Netting

● Net positions held across a client portfolio (legal entities, products and/or asset

classes) by fund/currency and across CCPs

3. Client Collateral Tracking

● Consolidate collateral from external sources and Integrate with custodians

● Understand eligibility rules by CCP and collateral type

● Value complex derivatives products and reconcile CCP calculations

● Track and provide a cross-CCP, cross-product view of client collateral

4. Collateral transformation

● Understand regulatory constraints

● Interpret the substitution/eligibility rules

● Integrate with Repo desk/Global Transaction Bank (GTB)

5. Clearing broker collateral optimization

● Understand regulatory constraints

● Interpret the substitution/eligibility rules

● Integrate with Repo desk/Global Transaction Bank (GTB)

6. Core services

● Reconciliation

● Reporting

● CCP Connectivity