1. CFA Institute Webinar
OTC Derivatives: Pervasive Regulatory Changes and Impact
on Market Participants in Asia, Europe, and Beyond
Scott Peterman, CFA Kishore Kumar Ramakrishnan
Partner, Sidley Austin, Hong Kong Director, Advisory Services, Ernst & Young
Yin Toa Lee, CFA Tate Barnes
Partner & Financial Services Leader Vice-President, Institutional Client Group,
of Ernst & Young’s Financial Accounting Deutsche Bank, Singapore
Advisory Services in the Asia-Pacific
Moderators:
Samuel Lum, CFA, Director, Private Wealth & Capital Markets, CFA Institute
Padma Venkat, CFA, Director, Capital Markets Policy, CFA Institute
20 November 2012

2. Agenda
1. Key Imperatives of Dodd Frank Act - Title VII & Global OTC
Derivatives Reform (Lee 5min)
2. Dodd Frank Act – Extra-territoriality & Cross Border
Supervision (Peterman 20min)
3. OTC Derivatives Reform – Asia Pacific & Europe
Overview (Ramakrishnan 5min)
4. OTC Derivatives Ecosystem in the Post-Dodd-Frank Era –
Capital, Margin, Clearing & Accounting Implications
(Ramakrishnan & Lee 20min )
5. OTC Derivatives Reform – Practical Industry Issues (Barnes
15min)
2

3. CFA Institute Webinar
OTC Derivatives: Pervasive Regulatory Changes and Impact on Market
Participants in Asia, Europe, and Beyond
Key Imperatives of Dodd Frank Act - Title VII
&
Global OTCD Reform
Yin Toa Lee
Partner & Financial Services Leader of Ernst & Young’s Financial Accounting
Advisory Services in the Asia-Pacific
20 November 2012

4. OTC Derivatives & Dodd Frank Act: Beauty lies in the eyes of the beholder!
4

5. 100 Years of Legislation - Size Matters ?
Regulatory
Banking / Conventional Customer Permissible Banking
Framework / Capital Standards
Securities Business Banking Protection Activities
Structure
Dodd Frank Act
Dodd Frank Reforms Process – unprecedented in scope and extent of coverage !
5

6. Dodd Frank Act: Key Imperatives of Title VII
Title Scope of Coverage
Of the 16 titles published under Dodd Frank Act I Financial Stability
[DFA] - Title VII in particular aims to regulate and
II Orderly Liquidation Authority
bring transparency in OTC derivatives [OTCD]
Transfer of powers to the Comptroller of
trading which will impact broker-dealers; hedge- III
Currency
funds; mutual funds and any end-user that trade Regulation of Advisers to Hedge funds &
IV
and clear derivatives. others
V Insurance
Bank/savings/depository institution
VI
regulation
2. Central
1. Capital & 3. Reporting VII Wall Street transparency & accountability
Clearing
Margin [SDR]
[DCO] VIII Payment, clearing & settlement provisions
Investor protection & improvements to the
IX
regulation of securities
X Bureau of consumer financial protection
XI Federal reserve system provisions
4. 5. Cross 6. Electronic Improving access to mainstream financial
XII
Registration Border Trading institutions
[SD/MSP] Implications [SEF/OTF] XIII Pay it back act
XIV Mortgage reform & anti-predatory lending act
XV Miscellaneous provisions
XVI Section 1256 contracts 6

7. CFA Institute Webinar
OTC Derivatives: Pervasive Regulatory Changes and Impact on Market
Participants in Asia, Europe, and Beyond
Dodd Frank Act – Extra-territoriality & Cross
Border Supervision
Scott D. Peterman, PhD, CFA
Partner
Sidley Austin
20 November 2012

8. Introduction & Background
At the G-20 meeting in September 2009, G-20 leaders made the
following commitments to regulate standardized over-the-counter
(“OTC”) derivatives markets:
• All standardized OTC derivative contracts to be traded on
exchanges or electronic trading platforms, and cleared through
central counterparties by the end of 2012 at the latest;
• OTC derivative contracts reported to trade repositories; and
• Non-centrally cleared contracts subject to higher capital
requirements.
As a result of these commitments, multiple regulatory reform
initiatives are taking place globally. Many of these initiatives have
extra-territorial effect. For end users with global trading operations,
it is possible that difficult compliance and choice-of-law questions
will arise as the new global regulatory landscape for OTC
derivatives evolves.
8

9. Extra-territorial Applicability:
CFTC-Regulated Swaps
• Section 722(d): ‘‘(i) APPLICABILITY.−The provisions of [the
Commodity Exchange Act] relating to swaps that were enacted
by the Wall Street Transparency and Accountability Act of 2010
(including any rule prescribed or regulation promulgated under
that Act), shall not apply to activities outside the United States
unless those activities −
‘‘(1) have a direct and significant connection with
activities in, or effect on, commerce of the United States; or
‘‘(2) contravene such rules or regulations as the
Commission may prescribe or promulgate as are necessary or
appropriate to prevent the evasion of any provision of this
Act....”
9

10. Extra-territoriality Rule: SEC-
Regulation Security-Based Swaps
• Section 772: “Rule of Construction. No provision of [the
Securities Exchange Act of 1934] that was added by [Title VII of
the Dodd-Frank Act], or any rule or regulation thereunder, shall
apply to any person insofar as such person transacts a
business in security-based swaps without the jurisdiction of the
United States, unless such person transacts such business in
contravention of such rules and regulations as the Commission
may prescribe as necessary or appropriate to prevent the
evasion of any provision of this title that was added by [Title VII
of the Dodd-Frank Act]. This subsection shall not be construed
to limit the jurisdiction of the Commission under any provision of
this title, as in effect prior to the date of enactment of [Title VII of
the Dodd-Frank Act].’’
10

11. Cross-Border Regulatory
Harmonization / Sanctions
• Section 752 requires both the CFTC and SEC to seek
harmonization with regulators in other countries by consulting
and coordinating “with foreign regulatory authorities on the
establishment of consistent international standards” for
derivatives regulation.
• Section 715 gives both the CFTC and SEC leverage:
“. . . if the [relevant Commission] determines that the
regulation of swaps or security-based swaps markets in a
foreign country undermines the stability of the United States
financial system, either Commission, in consultation with the
Secretary of the Treasury, may prohibit an entity domiciled in
the foreign country from participating in the United States in any
swap or security-based swap activities.”
11

12. EU OTC Derivatives Rules –
Overview and Extra-territorial Reach
In the EU, the rules requiring OTC derivatives to be centrally
cleared and traded on trading platforms are being addressed in
two separate pieces of legislation:
1. European Market Infrastructure Regulation (“EMIR”) – EMIR
governs the central clearing and OTC derivatives data reporting
requirements. EMIR applies from 1 January 2013 onwards.
2. MiFID II – “MiFID II” refers to the comprehensive review of the
existing Markets in Financial Instruments Directive (“MiFID”)
which, among other things, requires all OTC derivatives to be
traded on trading venues. MiFID II is currently going through the
EU legislative process (involving the European Parliament and
Council of the European Union); not expected to apply until early
2015.
12

13. International Coordination of OTC
Derivatives
• Dodd-Frank Act and EMIR/MiFID II anticipate the need for
international coordination of OTC derivatives reforms and
regulation. EMIR and MiFID II apply to OTC derivative contracts
eligible for clearing/trading on trading venues that have a
“direct, substantial and foreseeable effect within the EU” or
where such obligation is necessary or appropriate to prevent
the evasion of any provision of EMIR/MiFID II.
• Dodd-Frank where activities relating to CFTC-governed swaps
have a “direct and significant connection with activities in, or
effect on, commerce of the United States”.
13

14. More Work to Be Done
• There is not yet clarity as to the meaning of the words “direct,
substantial and foreseeable effect within the EU.”
• There is a similar lack of clarity on the analogous Dodd-Frank
Act wordings (“direct and significant connection with activities
in, or effect on, commerce of the United States” and “without
the jurisdiction of the United States”).
• Thus U.S. and other non-EU firms face uncertainty in relation to
clearing and trading obligations under EMIR and MiFID II,
respectively. Conversely, EU firms and other non-U.S. firms
face uncertainty under broadly similar provisions in the Dodd-
Frank Act.
• Is there a need for further rules and amendments to the Dodd-
Frank Act and EMIR to close regulatory gaps and avoid
arbitrage between the EU, U.S. and other major jurisdictions?
14

15. SEC Enforcement Actions
 Section 929P explicitly authorizes SEC
enforcement actions (but not private actions)
involving “conduct within the U.S. that
constitutes significant steps in furtherance of a
violation” or “conduct occurring outside the
U.S. [that] has a foreseeable substantial effect
within the U.S.”
Note: no comparable statutory provision for CFTC
enforcement.
15

16. CFTC Proposed Rules on
Registration
CFTC indicated that a person who “engages in swap dealing
activities and regularly enters into swaps with U.S. persons”
would likely be required to register as a swap dealer.
Proposed CFTC Rule 1.6 would prohibit activities conducted
outside the U.S., including entering into transactions and
structuring entities, to willfully evade or attempt to evade any
provision of the federal commodities laws (including rules)
enacted under the Dodd-Frank Act and would subject these
transactions or entities to the swap provisions of the commodities
laws.
Proposed CFTC Rule 1.3(xxx)(6) would permit the CFTC to
consider whether “willfully structured to evade” factors may also
be considered in determining whether a person is a dealer or
major participant. “Sham transaction” test, “lack of a legitimate
business interest”, intent test.
16

17. Open Questions
• When does swap dealing activity by a non-U.S. person with
non-U.S. affiliates of U.S. persons or with other non-U.S.
persons have a “direct and significant connection” with or
effect on U.S. commerce?
• What about non-dealing swap transacting activity with non-
U.S. affiliates of U.S. persons or with other non-U.S. persons?
• Are non-U.S. affiliates of U.S. persons (particularly dealers)
treated as U.S. persons when they TRANSACT (or DEAL)
with non-U.S. counterparties?
17

18. Foreign Banks’ Perspective
• Comment letter February 17, 2011: Permit comprehensively
regulated and supervised foreign banks to continue to book
their global swaps using a centralized booking model out of a
well-capitalized and comprehensively regulated booking center
in a non-U.S. jurisdiction.
• Swap dealer registration should be through the central booking
non-U.S. branch of a foreign bank.
• Apply home country regulation for capital and margin
requirements for non-cleared swaps.
18

19. Foreign Banks’ Perspective
Apply U.S. transaction requirements to foreign dealer’s swaps
activities with U.S. counterparties, but not to its swaps activities
with non-U.S. counterparties. Two alternative registration
approaches suggested:
(1)registration and regulation of just the foreign (non-U.S.) branch
or separately identified department or division; or
(2)registration of a U.S. affiliate of the foreign bank to conduct
swaps activities with U.S. counterparties; the foreign branch that is
the booking center for swaps with U.S. counterparties but that
does not otherwise deal directly with U.S. counterparties could
also register solely with respect to its acting as a booking center
for swaps with U.S. counterparties.
19

20. Dual Regulatory Regime in U.S.
• Title VII of Dodd-Frank provides for comprehensive regulation
of OTC derivatives markets
─ Significant market participants will be required to register
with either or both the SEC or the CFTC depending on the
categories of OTC derivatives in which they transact
• Title VII generally bifurcates regulation of OTC derivatives
between the CFTC and the SEC
─ CFTC having jurisdiction over swaps
─ SEC having jurisdiction over security-based swaps
─ Shared jurisdiction over mixed swaps and security-based
swap agreements
20

21. Statutory Definitions
• Title VII substantially amended the CEA, the 1933 Act and the
1934 Exchange Act
─ Added detailed statutory definitions of “swap,” “security-
based swap,” and “mixed swap”
─ Provided interpretation and clarification with respect to
various products, including OTC derivatives, Title VII
instruments, and non-Title VII instruments
─ The Final Rules clarified the characterization of certain
products that would otherwise be uncertain under the
statutory definition
─ Characterization is generally made at the inception of the
trade, unless the instrument is materially modified
21

22. Elimination of CFMA Regulatory
Exemptions
• Eliminates almost all exemptions from the U.S. federal
securities and commodities laws created by the Commodity
Futures Modernization Act of 2000 for over-the-counter (“OTC”)
derivatives. Permits the filing of petitions to extend Commodity
Exchange Act (“CEA”) section 2(h) exemptions for 1 year for
transactions in “exempt commodities,” e.g., metals and energy
products, and electronic commercial markets whose participants
are limited to “eligible commercial entities” and whose products are
limited to exempt commodities.
• All of the following discussions of Title VII of DFA are
conditioned upon ongoing rulemakings being conducted by the
CFTC and SEC.
22

23. Swaps under Title VII of the DFA:
SEC/CFTC: Bifurcated Regulation
• Creates a two-regulator structure regime for OTC derivatives,
OTC market participants and OTC markets based on whether
the OTC derivative is a “swap” or a “security-based swap” (an
“SB swap”). The CFTC is given jurisdiction over swaps that
are not SB swaps. The SEC is given jurisdiction over SB
swaps. (Swaps in agricultural commodities are prohibited
except to the extent specifically permitted by the CFTC.)
Participants in both swap and SB swap markets will therefore
be subject to regulation by both the SEC and the CFTC, as in
the case of a dually registered broker-dealer/futures
commission merchant. The base definition of a “swap” is
sufficiently broad to include virtually any OTC derivative with
the important exception of options on individual securities or
any group or index of securities (whether broad-based or
narrow-based) and certain other limited exceptions.
23

24. Treatment of Specific Products
24

25. General Product Characterization
25

26. Swaps
Title VII instruments where the underlying is:
1. “Non-security” assets (commodity, dividend, interest rates,
etc.)
2. A broad index of securities or multiple underlying products
• Broad index CDS, correlation swap, dividend swap, total
return swap, variance swap
• Security-based swap agreements
3. A swap itself
• Guarantee of swap, options on a swap
4. An exempt security
26

27. Security-Based Swaps
1. Title VII products where the underlying is:
─ A security or a narrow security index
• Narrow index or single security CDS, correlation swap,
dividend swap, total return swap, variance swap, certain
contracts for differences
• OTC option on a single non-security loan
─ A municipal security
2. Definitions of “security” under 1933 Securities Act and 1934
Securities Exchange Act have been amended to include
“security-based swaps”
27

28. Mixed Swaps
1. Title VII products where the underlying is:
─ Certain CFTC-regulated rates, indices, currencies and
commodities will be treated both as swaps and security-
based swap
─ Narrowly defined
─ Regulated by both the SEC and the CFTC
2. Parties may request a joint CFTC/SEC order permitting
compliance with specified provisions of either the Commodity
Exchange Act OR the Securities Exchange Act
28

29. CPO Registration Required
• Commodity pool operator (“CPO”) essentially means a sponsor
or promoter of commodity pool, meaning fund that trades any
futures, futures options and (soon) non-securities based swaps
and FX contracts.
• Applies to managers of funds of funds that invest in pools.
• CFTC takes view it has jurisdiction over non-U.S. CPO of any
pool sold to U.S. persons.
• CFTC has eliminated Rule 4.13(a)(4) sophisticated investor
exemption used by most non-U.S. CPOs.
• Effective late April for new pools and 31 December 2012 for
existing exempt pools.
29

30. Available Registration
Exemptions
• CFTC Regulation 4.5―Regulated Persons
─ an investment company registered under the U.S. Company
Act (i.e., a mutual fund)
─ insurance companies subject to state regulation
─ banks, trust companies and other financial depository
institutions subject to state or federal regulation
─ a trustee of, a named fiduciary of or an employer
maintaining a pension plan that is subject to ERISA
• CFTC Regulation 4.13(a)(3)
30

31. De Minimis Exemption
• CPO must satisfy either one of two trading limit tests:
─ the “initial margin” test
• aggregate initial margin, option premiums and required
minimum security deposit (for retail forex transactions)
required to establish commodities interest positions,
determined at the time the most recent position was
established, does not exceed 5% of the liquidation value
─ “net notional value” test
• aggregate net notional value of commodities interest
positions, determined at the time the most recent
position was established, does not exceed 100% of the
liquidation value of the pool’s portfolio, after taking into
account unrealized profits and unrealized losses on any
such positions it has entered into
• No hedging exemption
31

32. How to claim a 4.13 exemption
CPO eligible to claim an exemption under Regulation 4.13 must
•furnish to prospective participants in the pool
─ a statement that the person is exempt from registration with
the CFTC as a commodity pool operator and that therefore,
unlike a registered commodity pool operator, it is not
required to deliver a disclosure document and a certified
annual report to participants in the pool; and
─ a description of the criteria pursuant to which it qualifies for
such exemption from registration; and
•file a notice of exemption with the NFA, which sets forth basic
information regarding the commodity pool operator and commodity
pool, in each case, no later than the time it delivers a subscription
agreement
32

33. Limited Relief Available
• CFTC Regulation 30.4(c)―Non-U.S. Futures/Options
Trading. (1) trading is limited to non-U.S. futures contract or
foreign options transaction; (2) trading is for non-U.S.
commodity pool whose securities are registered under the
Securities Act or otherwise exempt from registration; and (3) no
more than 10% of the participants in the commodity pool
(determined by value) are held by or on behalf of U.S. persons.
• CFTC Regulation 30.5―Non-U.S. CPOs. (1) is located
outside U.S.; (2) is otherwise required to be registered with
CFTC solely because the CPO trades non-U.S. futures/options;
(3) receives confirmation from NFA that Regulation 30.5
exemption applies; (4) engages in all non-U.S. futures/options
transactions through registered FCM or a non-U.S. broker with
a registration exemption; (5) designates an agent for service of
process in U.S.; and (6) provides access to records to the
CFTC or U.S. Department of Justice upon demand.
33

34. Alternatives to Registration
• Stop trading commodity interests.
• Don’t accept U.S. investors -- don’t manage U.S. money.
• Only manage U.S. money through true managed accounts and
have less than 15 of these.
• Don’t trade “Commodity Interests.”
• Don’t trade “Commodity Interests” for U.S. investors/clients.
• Find a “CPO-for hire” so the non-U.S. adviser can live under the
less than 15 CTA client exemption.
• Trade “Commodity Interests” only in a way that the 4.13(a)(3)
measurement is simpler math.
• For pure non-U.S. pools, register and obtain certain relief under
Advisory 18-96.
• Register and obtain relief under Rule 4.7 (note new annual
audit requirement).
34

35. CTA Registration Requirement
• Applies to firms that advise others as to futures and (soon) FX
and non-securities based swaps.
• Jurisdictional analysis same as for CPOs.
• CFTC has eliminated portion of 4.14(a)(8) exemption that
applies to CTAs that advise 4.13(a)(4) pools and whose advice
on commodity interests is solely incidental to advice on
securities.
• Not as common for CTAs to rely on this exemption as it is for
CPOs to use 4.13(a)(4).
35

36. Available Alternatives
• Exemption for CTAs that advise fewer than 15 clients in a 12-
month period, with a pool counting as a single client and non-
U.S. clients not counting for non-U.S. CTAs, and don’t hold
themselves out as CTAs in the United States.
• Exemption for SEC-registered IAs whose business does not
consist primarily of acting as a CTA and do not act as a CTA to
a pool that is primarily engaged in trading commodity interests
• No CTA registration requirement if advise only pools for which
CTA is also the CPO (registered or exempt).
• Exemption for CTA which provides advice only to non-U.S.
pools whose interests are sold only to non-U.S. persons where
no person conducts marketing activities in the U.S. and the
advice on commodity interests is solely incidental to advice on
securities.
• Register as CTA and obtain some relief under Rule 4.7.
36

37. CPOI / CTA Registration Process
• Requires Form 7R for firm and Form 8R for each principal
and associated person (“AP”).
• Electronic filing.
• Unlike Form ADV these are not disclosure documents
and can be done with limited assistance of counsel.
• Testing requirements for APs.
• Fingerprint requirement.
• Must join National Futures Association (“NFA”).
37

38. Risk Disclosure Requirements
• NFA’s Guide for CPOs and CTAs about Disclosure
Documents
http://www.nfa.futures.org/nfa-compliance/publication-
library/disclosure-document-guide.pdf
• CPOs under CFTC Rule 4.24(g)
• CTAs under CFTC Rule 4.34(g)
http://ecfr.gpoaccess.gov/cgi/t/text/text-
idx?c=ecfr&rgn=div5&view=text&node=17:1.0.1.1.4&idno=17#
17:1.0.1.1.4.2.7.5
38

39. CFA Institute Webinar
OTC Derivatives: Pervasive Regulatory Changes and Impact on Market
Participants in Asia, Europe, and Beyond
OTC Derivatives Reform – Asia Pacific & Europe
Overview OTC Derivatives Ecosystem in the
Post-Dodd-Frank Era – Capital, Margin,
Clearing & Accounting Implications
Yin Toa Lee
Partner & Financial Services Leader of Ernst & Young’s Financial Accounting
Advisory Services in the Asia-Pacific
Kishore Kumar Ramakrishnan
Director, Advisory Services, Ernst & Young
20 November 2012

40. While aligned to the G20 commitments, the
region’s proposed OTC reform frameworks appear DFA vs. OTCD Reforms in AsiaPacific:
to be overly regulated when compared to the This is not “United States of Asia”!
maturity & depth of the OTCD markets in each
location, with each market adopting a divergent Key Reform Provisions – Coordination Matrix
approach to OTC reform Countries Central Clearing Reporting Execution Capital/Collateral
Maturity – OTC Reform vs. OTCD Market Depth Hong Kong No regulations currently
Singapore No regulations currently
Reform
Maturity
5 Japan
4 Australia Japan Korea No regulations currently
Korea
Australia No regulations currently
3 Singapore
India No regulations currently
Taiwan No regulations currently No regulations currently
2 Malaysia
India
Taiwan
Hong Kong
Source: Malaysia Analysis No regulations currently
FSB Publications, EY No regulations currently
1 2 China
Indonesia
3 4 5 China No regulations currently
Recent Developments from the US / APAC to consider…
Source: EY APAC OTC Regulatory Regime Review
1. Circle sizes represent relative OTCD market size. Currently Asia represents less Market
than 10% of the global OTCD market, of which Japan accounts for less than half
(~4% of global market size) Maturity
Over the last 8 weeks, many regulatory developments
Key Observations:
• Imbalance between OTC reform framework vs. immaturity of
markets in the region
! have unfolded in U.S. and APAC:
a.Entity and Product Definitions
b.Basel’s Margin Rules, and
c.CFTC Cross Border guidance
d.CFTC mandatory clearing phase-in rule
• Divergent approach of regulators in APAC
e.HK – conclusion of consultation published
• Proliferation of CCPs f.SG – Margin framework for centrally cleared derivatives
• On-shore vs. Off-shore Clearing Models g.AUS – 2 papers published by Treasury/council of regulators
h.AUS – consultation on CCP and Securities settlement systems in
• SDR: Local vs. Global Infrastructure
response to CPSS-IOSCO principles of financial market infrastructure
• Inconsistent Basel Capital Considerations 1 Substituted Compliance - Definition
Current proposed guidelines under Dodd Frank regarding satisfaction of compliance with a foreign regulatory regime allows for market participants to comply with on-shore requirements on a
case-by-case review and approve basis by the CFTC.
40

41. Regulatory alignment – US versus Europe
Dodd Frank Overlap EMIR
► Mandatory CCP clearing for eligible products, by standardisation and liquidity
► All standardised derivatives contracts for ‘products eligible for clearing’ to be cleared through High ► Differences in agent vs principal model and related local EU legislation
Central clearing regulated ‘clearing houses’ Some ► New ESMA 2012_600 focus on Indirect clearing model
► Applies for trades between US and non US counterparties ambiguity ► Mandatory clearing of ‘eligible’ derivative contracts for trades between financial counterparts and third party
entities.
► Stricter oversight of swap dealers and major participants, including stricter capital and margin
Non-cleared ► Bilateral trading on non-cleared trades possible (providing risk management is in place). Likely to hold higher
requirements. Medium
Trades capital charges and 1-3% risk weighting.
► Transactions between financial and non-financial counterparties not exempt
► Proposed rule: All relevant swaps must be traded on SEFs or exchanges ► MiFID II draft legislation proposes mandatory trading of sufficiently liquid derivatives using regulated venues;
Trade Execution Medium
► Best execution with regard to the broader market eg CCP CpR, functionality and im/vm rates. unclear how execution with regard to broader market will be carried out per MTFs/OTFs/platforms.
► Financial and non-financial counterparties must report if they exceed information threshold. Possible for
► Mandatory Trade Reporting - Details of swaps must be reported to a swap data repository as
counterparty to report OTC derivatives on behalf of another
soon as possible after trade execution and kept updated throughout the life of the swap; Reporting High
► When trade depository is registered by ESMA, reporting must be done within 120 days
Trade Reporting responsibility will depend on hierarchy of counterparties. Some
► EMIR differences around inclusion of ETDs and dual sided reporting.
► All counterparties must obtain a unique identifier and must submit parent and affiliate ambiguity
information to the swap data repository.
► Provision for omnibus and individual segregated collateral at CCP and DCM;
► Collateral eligibility restricted to cash and limited securities for im/vm for both cleared and un- Medium
Collateral ► LSOC treats all margins as operationally co-mingled but legally segregated to give credit to each customer in
cleared swaps; LSOC segregation approach ambiguity
case of a member default, but most CCPs not geared up to handle multiple accounts.
► Clearing houses must maintain assets and positions of segregation
► Initial and variation margin required for all swaps transacted with swap dealers, major swap
► Acceptable forms of collateral include cash and government bonds
Margin participants and financial end users TBC
► Where derivative contracts are not cleared through a CCP, bilateral collateral requirements will be necessary
►Margin requirements vary depending on type of swap counterparty.
for financial counterparties.
More standardisation:
►Definitions of standardised OTC Derivatives/participants being updated to match evolving ► EC focus on legal terms of the contract;
Standardisation markets. ‘Swap dealer’ and ‘Major swap participant’ are defined terms, as will be ‘Commercial end- Medium ► Standardisation needs to take the form of legal, commercial and operational issues; Capital
user’ requirements set by CRD III/IV with specific references to highly-liquid assets, and standards for
liquidity.
Reduce counterparty risk by:
► Proposing legislation to establish common safety, regulatory and operational standards for CCPs and
► All OTC derivatives dealers and all other major OTC derivatives markets participants will be Low
Controls and mandate CCP clearing for standardised contracts
constrained by regulation, supervision, a capital regime, margin requirements and business Some
reducing risk ► Improving collateralisation of bilaterally-cleared contracts
conduct rules and tightening of standards of who may participate in those derivatives markets ambiguity
► Substantially raising capital charges for bilaterally-cleared cf. CCP-cleared transactions,
► Exemption for corporates not granted unless ‘objectively measurable as reducing risk related to commercial
►Commercial end users exempt from the need to post margin to meet the clearing requirement. US activity or treasury financing’
Treasury issued a proposed determination that would exempt FX swaps and forwards from the ► Two proportionality tests applied per a clearing threshold
Exemptions definition of “swap” for most Dodd-Frank Act purposes, including registration and clearing Low ► Three-year review clause for pension funds under EMIR, but suggestion as of Apr ‘12 that PFs will need to post
► Needs to be re-confirmed post-Aug 2012; Spot FX transactions and certain physically settled collateral if trades are not centrally-cleared
commodity transactions exempt. FX options, XCSs and NDFs not exempt. ► Spot FX transactions, commercial forward FX transactions, certain physically settled commodity transactions
41 41
and inter-affiliate trading exemptions exempt.
Page 41 "The High-level Impact of Regulatory Reform on the Capital Markets”

42. Regulatory alignment – US versus Europe II
Dodd Frank Overlap EMIR
► Transactions between SDs/MSPs and other SDs/MSPs: SD/MSP must execute confirm as soon ► Transactions between SDs/MSPs and other SDs/MSPs: SD/MSP must execute confirm as soon as technologically
Medium
Trade as technologically possible and by end T+1 (with financial entities) and by end T+2 (with other possible and by end T+1 (with financial entities) and by end T+2 (with other counterparties) - Art 11 RTS
Some
Confirmation counterparties) ► Draft EU rules do not address timing requirements for confirmations between an FC/NFC and non-EU entity, and do
ambiguity
► CFTC rules do not mandate use of electronic means where available. not address: the treatment of transactions executed anonymously.
► SDs/MSPs must agree in writing on terms of reconciliation with counterparties ; reconciliation
► FCs/NFCs must agree in writing (or other equivalent electronic means) on terms of reconciliation with counterparties
Portfolio can be performed by a third party
High for OTC derivatives not cleared by a CCP.; reconciliation can be performed by a third party
Reconciliation ► Covers exchange of trade terms and valuations and reconciliation of discrepancies in material
► Covers reconciliation of key trade terms and valuations attributed under Article 11(2)
terms and valuations.
► SDs/MSPs must have policies and procedures for portfolio compression, including policies and
► FCs and NFCs with portfolio of ≥500 outstanding OTC derivatives not cleared by a CCP must have procedures to
Portfolio procedures for periodically terminating fully offsetting swaps and engaging in portfolio compression Low Some
analyse possibility of conducting portfolio compression exercises and engage in such exercises.
Compression exercises when requested. ambiguity
► No record-keeping requirement.
► Record-keeping requirements apply.
► Documentation between SDs/MSPs and other MSPs or financial entities and requested ► Under Art 14 EMIR draft RTS, FCs/NFCs concluding transactions with each other must agree detailed procedures and
SDs/and, if requested, other counterparties must include agreed process for determining the value processes covering:
Medium
Client of swaps. ►1) Identification, recording and monitoring of disputes relating to recognition or valuation of contract and exchange of
Some
Documentation ► Documentation must include: 1) Status disclosure on SD/MSP (e.g. whether insured depository collateral.
ambiguity
institution); 2) Notice about effect of acceptance of a swap for clearing by a DCO. Record keeping ►2) Resolution of disputes in a timely manner, with a specific process for those disputes that are not resolved within 5
requirements apply. business days.
► FCMs, SDs and MSPs must appoint a CCO reporting to its board/senior officer, who must among
► Authorised firms are required to maintain a permanent and effective compliance function that operates
Designation of other things submit an annual report to the CFTC on the firm’s policies and procedures and Medium
independently, but neither the proposed EMIR measures (post-trade) nor the proposed MiFID Review measures (pre-
the CCO compliance with the CEA and CFTC regulations (after review by the board/senior officer). 17 CFR ambiguity
trade) stipulate the specific need for a CCO function.
§3.3.
► SDs/MSPs must establish and maintain business continuity and disaster recovery plans (and
►Authorised firms are required to establish, implement and maintain an adequate business continuity policy aimed at
specifies the components of that plan and procedures for its testing and maintenance). There are
BCP High ensuring the preservation of essential data and functions and maintenance of investment services and activities (or
requirements to notify the CFTC of disruptions and to provide emergency contacts. Plans to be tested
where not possible timely recovery).
annually by an independent internal or external party. 17 CFR §23.603
► Per CP12/22, the FSA proposes to introduce ‘client money sub-pools’ into the CASS regime featuring legally and
► Safeguarding and verification of client assets is referred to at a high level. operationally separate client money sub-pools comprising the margin held in a particular net client transaction account
Safeguarding ► Could include verification of assets by independent public accountant. Medium at a CCP and the client money the clearing member holds in relation to that transaction account.
Client Assets ►§763 features detailed stipulations on how client assets should be treated for security-based ambiguity ► If the clearing member became insolvent and a CCP ported the positions to a backup clearing member, the
swaps, featuring conditions where segregation is required and prohibition of co-mingling. insolvency practitioner would be able to make the margin that the insolvent clearing member held as client money in
relation to the transaction.
► Data transfer to third countries outside the EU can only take place in compliance with the Data Protection Law, and
provided the recipient state ensures an adequate level of protection.
► SDs/MSPs must give advance disclosure to counterparties of: the material risks of the Low
► The adequacy of a non-EU state's level of protection must be assessed in light of all circumstances surrounding the
Disclosures transaction; the material characteristics of the particular swap; and material incentives/conflicts of Some
data transfer operations in force in that state and its professional rules and security measures, such as 1) the nature of
interest (including price and mid-market price). ambiguity
the data; 2) the purpose and duration of the proposed processing operation or operations.; 3) the country of origin and
country of final destination; 4) rules of law, both general and sectoral.
►Third country ‘mutual recognition’/Member State of Reference approach based on satisfying various tests, e.g.:
►§722(d)/§772(c) - the provisions of the DFA relating to swaps shall not apply to activities outside
►1) Appropriate regulatory cooperation arrangements are in place;
the US unless those activities; 1) have a direct and significant connection with activities in, or effect Low
Extra- ►2) Third country where the non-EU AIFM is established is not listed as a Non-Cooperative Country and Territory by FATF
42
on, commerce of the US; or 2) to prevent the evasion of any provision of the DFA. Some
territoriality requirements on money laundering and terrorist financing;
►CFTC is proposing ‘Substituted Compliance’, based upon mutual recognition on an authority-by- ambiguity
►3) Third country fully complies with the standards laid down in Article 26 of the OECD Model Tax Convention on
authority basis and broad comparability of regimes.
Income and Capital .

43. DFA vs. OTCD Reforms in Europe*
* Source: ISDA
43

44. OTC Ecosystem in the post Dodd Frank reforms era
Global OTC derivative reforms has resulted in the creation of a completely new
OTC market landscape comprising of a new infrastructure and service offering
#1; 2 : New Market Participants
1.Swap Dealers [SD]
2. Major Swap Participant
8. Post Trade Reporting [MSP]
#6; 7; 8 : New Risk
Mgmt Approaches
7. Collateral / Margin OTC Derivatives Market
3. CCP’s
Requirements Microstructure
6. Capital Requirements 4. SEF’s
#3; 4; 5 : New Market Entities
5. SDR’s
44

45. OTCD Reforms – Key Challenges to Buy Side
Overview of buy-side response to swaps reforms
Buy-Side
► Analysis of executing and clearing brokers and clearing houses:
• Determine execution venue ► Questionnaires and comparisons of services to be offered
• New Legal Framework ► Level of required margin (initial and variation)
• Reconcile internal valuations ► Collateral eligibility
with external broker / CCP’ Default waterfall model
Pre-Trade ►
• Assess total cost of trade
[capital; clearing; electronic
connectivity]
► Operating model
► Identify changes to current processes and new processes
• Trade on single / multiple SEF’s ► Identify data requirements and gaps across the business
• Leverage electronic trading
► Develop IT design and estimate cost for budget provision
methods viz., CLOB, RFQ,
Trade • Identify new data requirements
for risk capture/assessment
► Conducting readiness assessments including:
► Analysis of existing positions / clearing eligibility
► Analysis of future plans for OTC usage and clearing ability
• Margin management with CCP ► Review of margin requirements
• Intraday margin calculations ► Evaluation of counterparty risk and resulting changes to business /
• Clearing broker relationship operating model
Assessing impact of and performing gap assessments on proposed
Post-Trade management ►
and final rules
• Increase in collateral for OTCs
not centrally cleared
45

46. Risk Management in the Post Dodd-Frank Era –
Capital & Margin Framework for Cleared vs. Un-cleared Swaps
p g p
Dangerous Intersection of Basel, Dodd Frank and Prudential Regulatory regimes
1. Dodd Frank Act [DFA] sets up separate margin rules for uncleared swaps and allows CCP's to set up initial and variation
margin rules approved by CFTC / SEC
2. Prudential regulators [federal reserve, federal deposit insurance corp (FDIC) and office of the comptroller of the
currency(OCC)] have proposed a set of rules on margin for uncleared trades applicable for banks including bank holding
companies[BHC's]. In fact, for banks and BHC's - prudential authority rules override the DFA rules.
a. For high risk counterparties - margin requirements [both initial and variation margins - IM and VM] are set out using a
table or through regulator-approved formula established by the bank
b. For low risk financial counterparties such as pension funds -> no margin is required until the bank's exposure to each
counterparty is less than or equal to USD 30 million or 0.2% of the bank's tier-1 capital and margin rules come into
effect only to the extent the exposure exceeds the limit.
c. For low risk non-financial counterparties such as end users - no IM or VM is ever required
3. Basel capital rules related to OTC derivative transactions
a. Basel rules require that a regulated entity to hold capital to cover counterparty credit risk on a CCP both for: (a) its
trade exposure to CCP (b) its default fund contribution to a CCP
b. Basel capital rules for trade exposure to CCP offer multiple risk weights:
i. Qualifying CCP – 2% capital charges if collateral is segregated from client, CM and double default scenario
ii. Qualifying CCP – 4% capital charges if collateral is not segregated against joint default of CM and other
clients of CM
iii. Non-Qualifying CCP – 20% capital charges i.e., if non-qualifying CCP is a bank
iv. Non-Qualifying CCP – 100% capital charges i.e., if non-qualifying CCP is a corporate financial institution
Additionally, CM will have to apply a risk weight of 1250% [broadly equivalent to one-to-one for deduction] to
their default fund contributions (both funded and unfunded)
46

47. Risk Management in Post Dodd-Frank Era –
CFTC Margin Requirements for Un-cleared Swap Trades
Type of Counterparty
Proposed Rule
Swap Entity [SD/MSP] Financial End-User Non-Financial End-user
Initial Margin Zero: Swap entity is not allowed to a. High Risk – Zero a. CFTC – no specific
Threshold establish an initial margin threshold b. Low-Risk – Lesser of requirement; threshold
amount for other swap entities and IM between $15-$45 million and per credit support
must be collected at or before the 0.1% - 0.3% of Tier-1 arrangement
execution of any un-cleared swap regulatory capital b. Prudential Regulator –
subject to MTA $100,000. credit exposure limit set
by swap entity
Variation Margin Zero Same as above Same as above
Threshold
Frequency of At least once per business day At least once per business day Same as above
collection of variation
margin
Segregation of IM Independent [non-affiliated] third party Not mandatory but can request Not mandatory but can
custodian request
47

48. Risk Management in Post Dodd-Frank Era –
International Working Group on Margin Requirements Proposal – July 2012 [Basel; IOSCO; CPSS]
Proposed Rule Proposed Rule Summary
► All derivatives not centrally cleared covered under this proposal
► Exempt FX swaps and forwards with maturity less than 1 month to 1 year?
Scope of coverage ► Full – two way margining with zero thresholds
– Products covered ► Two way margining with single threshold
/ scope of ► Two way margining with higher threshold for transactions b/w prudentially regulated entities
applicability ► Two way margining with three threshold covering system
► Cash / Gold
► High quality government and central bank securities
► High quality corporate bonds
Eligible Collateral / ► High quality covered bonds
Treatment of ► Equities included in major stock indices
collected margin ► IM – to be collected on a gross basis; cash and non-cash collateral collected as IM should not be
re-hypothecated or re-used
► Full variation margin should be collected b/w a firm and its affiliates
► Overseas branch treated as equivalent to legal entity as the headquarter and hence margin
requirements of headquarter jurisdiction is applicable to its branches
► US bank vs. UK bank -> respective home country margin rule applicable
Cross border ► US bank vs. UK subsidiary of Swiss bank -> respective home country margin rule applicable
implications ► UK subsidiary of US bank vs. UK bank -> UK margin rules applicable
► UK subsidiary of US bank vs. UK subsidiary of Swiss bank -> UK margin rules applicable
48

49. Cleared vs. Bilateral Trade - A Case in Point
Margin Implication for a Margin Implication for a sample
Initial Margin
Asset Product Type sample un-cleared Cleared Transaction Remarks
Requirement (% of
Class notional exposure)
transaction
Credit: 0-2 year
2 Swap clear requires only 1.8% of the However, the proposed margin grid from BCBS
duration
IRS [2-year swap] 1% – 2% in Initial Margin notional exposure for a swap of the does not recognize netting, so the margin
Credit: 2-5 year same tenor schedule for uncleared swaps on active accounts
5 will end up becoming relatively more expensive
duration
Credit 5+ year A buy-side firm looking to
10
duration trade an uncleared CDS A buy-side firm looking to trade CDS
product would require to that is centrally cleared at ICE would a. Basel proposal on margin requirements for
Commodity 15 post 10% of the notional indicatively need: uncleared swaps does not distinguish
upfront towards Initial a. 2.8% of the notional for the protection between index-linked vs. single name CDS
5 year CDS
Equity 15 Margin for buy side buyer [i.e., $280,000] b. Also it does not differentiate on the margin
b.while it charges 4.5% towards initial requirements between the protection buyer
e.g., 5 year $10 million margin for the protection seller [i.e., vs. protection seller
Foreign
notional CDS would cost $1 $450,000]
ExchangeCurr 6 million towards initial margin
ency
Interest Rate:
0-2 year 1
duration Implications of differential treatment of margin requirements between cleared and un-cleared swap trades:
Interest Rate: a.Not differentiating between seller and buyer of credit protection could be a major oversight. For e.g., if one buys a protection on
2-5 year 2 using 5 year CDS at 200 bps – the “MOST” the counterparty loses would be 2% * 5% = 10% of the trade notional while the
duration protection seller of the CDS transaction defaults – I could be down under by more than 90% of the notional – hence, its important
to differentiate between the margin requirements for protection seller vs. protection buyer
Interest Rate:
b.Low risk counterparties have a definite advantage while entering into an uncleared swap trade with banking counterparty [as
5+ year 4
opposed to a non-banking counterparty]– as banking regulations have a much lower IM and VM requirements than DFA does.
duration
Other 15
49

50. Accounting offsetting criteria
IFRS U.S. GAAP
Two condition must exists to offset a A right of offset exists when all of the following
General Criteria
financial assets and a financial liability: conditions are met:
Each of two parties owes the other determinable
A legally enforceable right of set‐off exists
amounts
in all circumstances; and The reporting party has the right to offset the
There is an intent to settle net or amount owed by the other party
simultaneous settlement The reporting party intends to offset (exception
provided when there is a MNA)
The right of offset is enforceable by law
Accounting Policy Offsetting is not optional; therefore it is not A debtor having a legal right of offset has
an accounting policy option. Offsetting is the option to offset the related asset and
required when the conditions are met liability and report the net amount. The
accounting policy must be applied
consistently to the same class of
transactions.
Number of Counterparties Two or more Only two
Rights to set‐off Unconditional Conditional
Focus Gross fair values Net fair values
50

51. Key accounting differences
The key differences between the models
relate to:
• Conditional right to set-off (under a master
netting agreement) criterion under U.S. GAAP
• Existing US GAAP ‘exception’ for derivatives in
relation to the intent criterion between the two
models
51

52. Industry Response to OTCD Reforms: Picking the right battles
Dodd Frank [DF] Effective areas of engagement in harnessing and delivering valuable and
Response Dimensions sustainable business transformation
Re-evaluate
► Text
Assess the impact of DF legislation across the balance sheet covering each
business line; region and customer segment
business strategy
and seize new ► Revise the business approach by refining the revenue model including pricing
revenue and value proposition to the client e.g., client clearing, collateral
opportunities transformation, asset securitization
► Reallocate capital to businesses by aligning to risk-adjusted profitability and in
Optimal capital the process effectively manage economic and regulatory capital allocation
allocation & capital ► Incorporate economic and regulatory capital allocation into business processes
management as one of the proxies for performance measurement
coupled with ► Reduce the trapped liquidity pools by reconfiguring the funding approach and
aggressive cost thereby enabling the businesses in meeting the new requirements – i.e. LCR
management – key etc.,
to navigating
► Rationalize costs by either “eliminating,” “streamlining,” or “re-distributing”
regulatory tsunami
costs along the business-line; corporate center and support functions
► Streamline and simplify the legal structure in the context of Dodd-Frank where
Enhance risk and
feasible
regulatory
compliance ► Automate manual risk management and regulatory compliance processes
capabilities by where possible by integrating data from different sources and eventually
ensuring “customer- develop a comprehensive view of risk as an enabler of effective response
first” theme is ► Fortify dynamic risk reporting capabilities with appropriate detail within specific
embedded in the risk lines of business
& compliance ► Enhance the capability to access “data” swiftly and accurately that will
dimension eventually pay off in the form of improved risk transparency
52

53. Industry Response to OTCD Reforms – getting ready for the new normal
53

54. CFA Institute Webinar
OTC Derivatives: Pervasive Regulatory Changes and Impact on Market
Participants in Asia, Europe, and Beyond
OTC Derivatives Market Reform:
Practical Industry Issues
Tate Barnes
Vice-President, OTC Derivatives Clearing, Institutional Client Group
Deutsch Bank, AG (Singapore)
20 November 2012

55. The Business of Clearing (1)
• Major Investment required for a global OTC clearing
provider: Connectivity to CCPs, n x Guarantee Fund
contributions.
• Profitability of clearing houses: CCPs are not government
owned utilities, they have a profit motive. Fragmentation of
CCPs across Asia-Pac and limited demand from non-members
(i.e. end clients) could mean that not all CCPs offer ‘client
clearing’.
• Profitability of client clearing for direct clearing members:
Estimates of the fee pool vary wildly, however the experience of
market participants is that clients are very price sensitive and
that the fee pool will be relatively small.
55

56. The Business of Clearing (2)
• Return on investment: The investment that direct members are making
in people and infrastructure suggest that it will take many years for OTC
clearing businesses to be profitable after costs.
• Barriers to entry to offering OTC clearing services will likely be
high for a number of reasons:
─ Utility like pricing is a natural barrier to new entrants entering the market.
─ The long term return on investment profile of being a global OTC clearing provider is a
disincentive to new entrants.
─ Client demand for experienced in-country support across the Asia-Pacific region
means that unless a clearing broker has critical mass in a particular country, providing
local support will not be cost effective (most dealers are off-shoring support functions
to low cost regional hubs).
• For the reasons noted above, only a limited number of global OTC
clearing providers will be eventually exist.
56

57. Competitive Environment:
Controlling risks or creating them? (1)
• Whilst OTC clearing creates some standardisation (e.g. zero
thresholds for mark to market payments), the key commercial
and risk terms are still negotiated between clearing members
and their clients.
• As with other business lines, clients negotiate heavily with
clearing members on commercial and legal terms. Unlike other
business lines, however, where an appropriate balance of
risk between client and dealer has emerged in the market over
time (through experience of defaults, etc), no such balance has
been found for OTC clearing. Clients are taking advantage of
this to extract favourable terms from their clearers.
57

58. Competitive Environment:
Controlling risks or creating them? (2)
• Is there a land grab going on amongst OTC clearing providers,
or are market participants simply reacting to a massive amount
of client demand for the service? Either way, clients' ability to
negotiate heavily with clearing providers has the potential to
expose clearing members to liquidity and other risks.
• Clearing providers' willingness to provide 'guaranteed
portability' to clients has the potential to destabilise non-
defaulting clearing members in a default scenario.
58

59. Legal Resources (1)
• There is a massive demand for professional legal services
with experience in negotiating OTC clearing related
documentation.
• As some elements of the legal documentation and the
regulations are completely new to clients (e.g. LSOC), the legal
negotiation process often involves a lot of education which
extends the time required to negotiate the documentation.
• The phasing of mandatory clearing has not resulted in a
phasing of demand for legal services. No one wants to clear
first, no one wants to clear last… everyone wants to be ‘in the
middle’.
59

60. Legal Resources (2)
• Across the market, there is active legal negotiation
taking place with over a hundred clients globally,
with several hundred more to begin formal legal
negotiation during 2013.
• Whilst the number of clients which are ultimately
expected to implement client clearing runs into the
hundreds, the number of individual funds runs into
the thousands.
60

61. Small OTC Derivative Market
Participants (1)
• There are a large number of clients who trade clearable OTC
derivatives in very small volumes which makes finding a clearer
difficult (clearing brokers will often have a minimum overall
clearing fee which would be uneconomic for occasional
users of OTC products).
• Where infrequent users of OTC derivatives can find a clearer,
they will usually only appoint one (because it wouldn’t be
economic to pay two clearers’ minimum fees).
• With no ‘guaranteed portability’ in the event of the default
of their clearing member, clients with only a single clearer
face the prospect of their positions being unwound by the
CCPs, potentially exposing them to losses.
61

62. Small OTC Derivative Market
Participants (2)
• Some clients may stop using OTC derivatives and
hedge using exchange traded instruments
instead. Gap risk from hedging with imprecise
instruments may expose clients to increased risks.
• Will some clients cease to hedge altogether,
resulting in greater volatility of earnings?
62