1. Information Security Identification: External QE AND BEYOND: TURMOIL IN THE CURRENCY MARKETS Presented by Simon Derrick February 2015

2. Information Security Identification: External THE ECB AND EXTRAORDINARY MEASURES On June 11th the ECB introduced a negative deposit rate (announced on June 5th) On September 4th the ECB announced it was decreasing the negative deposit rate from 10 bp to 20bp. On January 22 nd (3 days before the Greek election) the ECB announced its first programme of Quantitative Easing. o Monthly purchases of EUR 60 Bn lasting until at least September 2016. o To continue until there is a sustained adjustment in Eurozone inflation. o Purchases to be made by national central banks (rather than the ECB) o Greece excluded 2

3. Information Security Identification: External THE CURRENCY IMPACT 3

4. Information Security Identification: External OTHER CENTRAL BANKS REACT On January 15 th the Swiss National Bank abandons its “minimum exchange rate” policy. It also lowers the interest paid on sight deposits to -0.75bp and moved its target range for three month LIBOR to between -125 bp and -25 bp. Over the space of three weeks the Danish National Bank cuts its key policy rate four times to end up by February 5 th at -0.75%. A range of other central banks globally (including those of India, China, Canada and Australia) make early moves to ease monetary conditions. 4

5. Information Security Identification: External QE: THE CURRENCY IMPACT (1) The two things that should be impacted by large scale quantitative easing polices are the price of the assets being purchased and the price of the currency the assets are being purchased with. The first QE operation of the modern era was launched by the BOJ in March of 2001. o The initial size of the "Rinban" operations was set at JPY 400 Bn and appeared to have little currency impact. o tipping point reached in December 2001 when the bank increased its operations to JPY 800 Bn a month. o USD/JPY started to rise rapidly, rising from JPY124 to JPY133 over the next two months. o Move came despite the Federal Reserve cutting its target rate for Fed Funds by 25 bp to 1.75% on December 11th 2001. o Also marked the point that Japanese investors began to push money into overseas markets in search of higher yields and international investors returned to using the JPY as a funding vehicle for carry trade activity. 5

6. Information Security Identification: External THE CURRENCY IMPACT (1) 6

7. Information Security Identification: External QE: THE CURRENCY IMPACT (2) 7

8. Information Security Identification: External AND NOW? EUR had already come under pressure in the summer of last year following the move to a negative deposit rate by the ECB. However, outflows from the EUR have moderated since mid- November. Is something else going on? 8

9. Information Security Identification: External WHAT MIGHT BE HAPPENING April 3rd 2012. The FT's chief foreign affairs columnist Gideon Rachman publishes an article called "The time bomb no one can defuse." o "It is significant that, behind the scenes, a debate about the break-up of the EUR is also taking place among senior figures in the German establishment." o “There was always a group of top German economists - call them the Bundesbank tendency - who had deep misgivings about the whole single currency project. Now some of these German sceptics believe their concerns are being vindicated and are even suggesting that - despite the current calm in the markets - Greece may have to leave the EUR within months” o “One scenario doing the rounds in Frankfurt and Berlin is that the crisis could be provoked by the Greek elections, which are likely to be held in early May. A new Greek government might seek to unpick the latest debt deal, provoking a chain of events leading to Greece leaving the EUR.” Jan 5 th 2015. Der Spiegel publishes an article called "Grexit Grumblings: Germany Open to Possible Greek Euro Zone Exit" o "The result is that officials in Berlin and Brussels no longer subscribe to the so-called "domino theory," which held that a Greek collapse would be followed by others. It has been replaced by the "chain theory," which holds that the entire chain would become stronger were its weakest link to be eliminated. Indeed, Berlin officials fear that giving in to a new, leftist government in Athens would further call into question controversial austerity and reform policies -- an eventuality that would be welcome in France and Italy, countries where reform has not been welcomed with open arms.“ Angela Merkel's spokesman Steffen Seibert dismissed the Der Spiegel article on January 7th: o "I don't know of any such plans, and certainly the political leadership in the chancellery is not looking at such scenarios“ (Reuters) However…. 9

10. Information Security Identification: External WHAT GREECE WANTS On January 30 th the new Greek finance minister, Yanis Varoufakis gave a joint press conference with Jeroen Dijsselbloem, chairman of the eurogroup. o He stated that Greece "is working from the standpoint of the best possible co-operation with its institutional partners and the International Monetary Fund but not with a (bailout) programme that we think is anti-European." Mr. Varoufakis also gave an interview to BBC's Newsnight programme the same day. o "Suppose a friend of yours were to come to you and say that he or she had difficulty paying the mortgage because of a reduction in their income - they lost their job or something like that. They have a great idea on how to solve this problem: they would get a credit card and draw money from it in order to meet the mortgage payments for the next few months. Would you advise them that they should continue to take these tranches of loans from the credit card in order to deal with what is essentially an insolvency problem?". Details of what the new Greek government is proposing emerged in the Financial Times on February 2nd. o The government will no longer call for a headline write-off of Greece's EUR 315 Bn of foreign debt. o Instead, it will request a "menu of debt swaps," including two types of new bonds. The first type, indexed to nominal economic growth, would replace European rescue loans, and the second, termed "perpetual bonds", would replace European Central Bank-owned Greek bonds. o Mr Varoufakis said this proposal would be a form of "smart debt engineering" that would avoid the need to use a term such as a debt "haircut." o Greece hopes to secure a four-month "bridging programme" under which the ECB would promise to keep Greece's financial system afloat by continuing to supply liquidity on favourable terms after the current deal expires on February 28th. 10

11. Information Security Identification: External GERMANY’S POSITION Chancellor Angela Merkel o Jan 16: She tells Frankfurter Allgemeine Zeitung that she prefers that Greece remain in the eurozone, but notes that the basis of all European efforts is the principle of solidarity before individual effort and responsibility. o Feb 1: She tells Die Welt: "There was already a voluntary waiver by private creditors; Greece has already been exempt from billions by the banks. I don't see a further debt haircut." Finance minister Wolfgang Schaeuble o Jan 27: He tells ARD television that "There's no question of a debt haircut … Greece isn't overburdened by its debt servicing … We can't imagine how Greece, without a continuation of this programme, can continue on a reasonable economic path. But the election was just yesterday and the government was formed with remarkable speed. Now we have to give the government the time to make its decision. We're ready to continue the programme but it's Greece's decision." o Feb 2: He tells Reuters: "We want Greece to continue going down this successful path in the interests of Greece and the Greeks but we will not accept one-sided changes to the programme.” Bundesbank president Jens Weidmann o Feb 5: Reuters quotes him as saying that the “no bailout” clause is the key to market discipline and that Euro-zone states remain fully responsible for the consequences of their own autonomous fiscal decisions. Echoes ECB Executive Board member Juergen Stark’s comment to Il Sole 24 Ore on Jan 6 2010: o “The markets are deluding themselves when they think at a certain point the other member states will put their hands on their wallets to save Greece.” He added: “The Treaties envisage the non-rescue clause and the rules must be respected.” 11

12. Information Security Identification: External THE ECB’S RESPONSE TO GREECE On January 31 st ECB council member Erkki Liikanen told broadcaster YLE: o "We (ECB) have our own legislation and we will act according to that... Now, Greece's programme extension will expire in the end of February so some kind of solution must be found, otherwise we can't continue lending. I don't believe that one can hide from the realities in the economy." o When asked about the possibility of a debt haircut he said: "A significant debt restructuring has been carried out with private investors. The ECB cannot fund a state directly, which is what it would mean in this case." On January 31 st ECB Vice President Vitor Constancio said at an event in Cambridge, England: o “There will be no surprises if we find out that a country is below that rating (required for their sovereign debt to be taken as collateral at the bank’s liquidity auctions) and there’s no longer a programme that that waiver disappears.” o On February 4 th the governing council of the European Central Bank decided to exclude the use of Greek sovereign debt as collateral at the bank’s liquidity auctions. o By way of explanation it said that this was “in line with existing eurosystem rules, since it is currently not possible to assume a successful conclusion of the programme review.” 12

13. Information Security Identification: External MARKET’S DIVERGE European markets show little sign of contagion o German 10-year yields hit record lows around 0.3% in late January o In Italy and Spain 10-year yields ended January around 1.65% and 1.46% respectively. o In contrast, in Greece yields on the recently issued 3-year bonds topped 19% while 10-year yields rose to above 11%. 13

14. Information Security Identification: External FLOWS HIGHLIGHT THE DIVERGENCE 14

15. Information Security Identification: External SO WHAT NOW? The decision by the governing council of the European Central Bank to exclude the use of Greek sovereign debt as collateral at the bank's liquidity auctions leaves Greek banks with a choice. o Find new collateral that the ECB will accept o Pay back to the ECB the amount they have borrowed against Greek sovereign debt (the FT estimates this could be up to EUR 50 Bn). On the assumption that they will be unable to find sufficient alternative collateral his means that they must turn for assistance to the Bank of Greece and its ECB supported Emergency Liquidity Assistance programme (ELA). This leaves the Greek government: with little room for compromise in the negotiations ahead of the end of the current programme on February 28th. The reason for this is simple:” o A failure to agree a new programme (or to agree on an extension of the existing programme while further negotiations take place) would allow the ECB (should it decide to) to withdraw support for ELA via the Greek central bank and therefore leave Greek banks struggling for liquidity. o In order to prevent a full scale collapse the Greek central bank would, in turn, be forced to find other means of supporting the banking system (presumably by exiting the eurosystem and issuing its own currency). 15

16. Information Security Identification: External CYPRUS: A PRACTICAL GUIDE Tuesday March 19th 2013 o The deal with the “troika”was rejected by the Cypriot parliament with 36 votes against, 19 abstentions and one not present for the vote. Wednesday March 20th 2013 o Detailed notes seen by Reuters of a call among members of the Eurogroup Working Group referred to "open talk in regards of (Cyprus) leaving the euro zone". Thursday March 21st 2013 o The ECB told Cyprus that ELA to banks Laiki and Bank of Cyprus would be cut off if the government failed to agree on a plan by Monday. The statement said: “Thereafter, Emergency Liquidity Assistance could only be considered if an EU-IMF programme is in place that would ensure the solvency of the concerned banks.” More than two-thirds of the ECB’s governing council backed the deadline o Reuters quoted a “Senior Eurozone official” as saying that a collapse of the financial sector in Cyprus could force it out of the euro zone. Friday March 22nd 2013 o The Cypriot parliament approved a sweeping bank restructuring package on Friday night. The measures would enable the government to wind down Laiki, dividing it into a “good” and “bad” bank. Lawmakers also voted to nationalise pension funds. o The package also included capital controls, giving the government authority to limit financial transactions in times of crisis. Monday March 25th 2013 o A deal was reached in the early hours of the morning after what was described by the FT as a stormy meeting of the Eurogroup that lasted almost 12 hours. o The new programme saw Laiki Bank closed and its EUR 4.2 Bn in deposits over EUR 100 K placed in a “bad bank” The remaining smaller deposits were transferred to Bank of Cyprus. Deposits over EUR 100 K in Bank of Cyprus were frozen. o Eurogroup head Jeroen Dijsselbloem said that no bailout money would be used to recapitalise Bank of Cyprus, meaning authorities had to calculate how much cash from the bank’s large deposit holders was to be “bailed in.” o The FT also reported that President Anastasiades threatened to pull Cyprus out of the EUR in an attempt to protect large depositors. 16

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