1. The New Paradigm for Swaps Trading: Clearing and Trade Execution September 10, 2013 Joshua Sterling Akshay N. Belani

2. 1 Overview of Presentation Elements of Central Clearing o Intermediaries o Margin o Documentation Framework for On-Facility Trading o Trading Platforms o Execution Methods and Requirements o Treatment of Block Trades Implications of On-Facility Trading o Reporting Requirements o The Future of Uncleared/Bilateral Trading Impact of CFTC Cross-Border Guidance

3. 2 Central Clearing Where are we today? What’s coming next?

4. Elements of Central Clearing Unlawful to engage in a mandatorily cleared swap, unless submitted to a registered derivatives clearing organization for clearing and subject to certain exceptions Purpose is to reduce systemic risk by eliminating bilateral credit risk to swap counterparty inherent in uncleared swaps Reallocation of credit risk to futures commission merchant and clearinghouse/central counterparty Portability of trades (both pre-and post-default) Different costs considerations (clearinghouse margin requirements) 3

5. Clearing: Intermediaries Clearinghouse/Central Counterparty (“CCP”) o Central counterparty to cleared swaps (credit intermediation) o Registered with the CFTC as a Derivatives Clearing Organization o Collect margin from members on a gross basis o Maintain a guaranty fund to cover losses/shortfalls o Self-regulatory capacity – e.g. membership, trading surveillance Submission for Mandatory Clearing Determination o CCP submission must address sufficiency of its financial resources and ability to manage risks of relevant swap class o CFTC has 90 days to make a clearing determination o Factors taken into account include: (i) existence of sufficient outstanding notional exposures, liquidity and adequate pricing data; (ii) availability of rule framework, capacity, operational expertise and resources; and (iii) effect on mitigation of system risk 4

6. Clearing: Intermediaries (cont’d) Futures Commission Merchant (“FCM”) o Registered with the CFTC o Accepts a swap customer’s margin for cleared swaps o Margin collected from FCM on a gross basis  FCM makes margin call on customer o Initial margin used to establish position is retained by the CCP o Speculative positions require 10% buffer (held by FCM) o Customer margin/funds may be invested by FCM o FCM guarantees the performance of its customer to the CCP o FCMs are required to contribute to guaranty fund and are subject to certain financial resource requirements 5

7. Clearing: Current Status First Mandatory Clearing Determination released November 2012 o Covered Interest Rate Swap Classes: Fixed-to-floating swaps Basis swaps Forward rate agreements Overnight index swaps o Covered Index Credit Default Swap Classes: USD-denominated untranched CDX.NA indices referencing North American corporate credits Euro-denominated untranched iTraxx Europe indices referencing European corporate credits Compliance dates generally track CFTC “phase-in” schedule March 11, June 10 and September 9, 2013, except: October 23, 2013 for iTraxx index swaps Other determinations forthcoming Swaps may be cleared voluntarily; choice raises certain implications for asset managers 6

8. Clearing: Clearing Trade Flow 7 Clearinghouse End-User floating fixed FCM A floating fixed floating fixed Dealer FCM B

9. Clearing: Initial Margin and Liquidation Horizons CFTC rules establish methods for determining minimum levels of initial margin a CCP must collect from its FCM members Liquidation Horizons: Required initial margin must be determined based on the following liquidation horizons and a 99% confidence level: o One day for futures and options o One day for swaps on agricultural commodities, energy commodities, and metals o Five days for all other swaps o But, the CFTC may establish shorter or longer liquidation horizons 8

10. Clearing: Protection of Customer Margin Legal Segregation with Operational Commingling (“LSOC”) o FCMs and CCPs must segregate cleared swaps and customer collateral from their own obligations and the obligations of non-customers o FCM holds customer property in an omnibus customer account separate from its own assets o Upon a “double default” clearinghouse can access collateral of FCM and defaulting customer o Clearinghouse would not have access to non-defaulting customer collateral o Mitigates “fellow customer” risk  but raises potential issues with operational risk and investment risk 9

11. Clearing: Protection of Customer Margin Risk profile varies significantly from bilateral arrangements Operational Risk: Shortfall in segregated account due to negligence, fraud, etc. Investment Risk: Losses resulting from an FCM’s investment of customer funds o CFTC Rule 1.25 Permitted Investments: U.S. obligations and U.S.-guaranteed obligations; state bonds, municipal securities CDs, commercial paper, corporate debt guaranteed by the U.S. government; money market funds o Recently narrowed to exclude investment in non-U.S. debt instruments 10

12. Clearing: Legal Documentation Futures Agreement o Designed for exchange-traded futures and options o Not standardized documentation  each FCM has its own version o Provisions apply to cleared derivatives if not otherwise addressed by the Addendum FIA-ISDA Cleared Derivatives Transactions Addendum o Industry standard form supplements the futures agreement to allow clearing of swaps o Covers swaps, forwards, options or similar transactions (whether executed bilaterally or on a SEF/DCM) that are submitted to and accepted for clearing by a CCP o Allows parties to tailor terms specifically for cleared derivatives o Section 7: upon close-out FCM’s actions must meet “Liquidation Standard” (good faith, commercially reasonable efforts to produce a commercially reasonable result) FIA-ISDA Cleared Derivatives Execution Agreement o Bilateral agreement between two executing parties  original trilateral agreement was rejected because deemed in violation of open access rules o Sets forth mechanics for trade affirmation/rejection and give-up to FCM o Establishes timeline for submission/clearing and waterfall for a failure to clear 11

13. Clearing: Key Documentation Review Points Futures Agreement and Cleared Derivatives Addendum o Margin levels (clearinghouse vs. FCM house margin calculation) o Liability for trades that fail to clear o Timing for margin delivery (exception for intra-day calls by CCP) o Notice periods for increase in margin o Credit limits/notice of decrease (daily vs. aggregate limits) o Events of default (grace periods, MAC, adequate assurances) o Portability (incoming and outgoing) o Timing for termination by FCM (timeframe for customer to port positions) Cleared Derivatives Execution Agreement o Determining Party upon clearing failure o Interest rate o ERISA issues 12

14. 13 On-Facility Trading Where are we today? What’s coming next?

15. On-Facility Trading: Framework Fundamental shift away from bilateral trading o Execution likely to happen at multiple trading facilities o Traders may execute on multiple venues (liquidity), using multiple FCMs (limits) and at more than one clearinghouse (products/liquidity) o Credit lines need to be accessible across multiple venues without restricting front office’s trading decisions Exchange trading is required for trades that are mandated to be cleared and that are made “made available to trade” (“MAT”) Types of Trading Facilities: Swap Execution Facilities Designated Contract Markets 14

16. On-Facility Trading: Intermediaries Swap Execution Facility (“SEF”) o Multiple-to-multiple platform for trading swaps only o Must provide CFTC-mandated functionality for executing “Required Transactions” o Must provide impartial access to all ECPs and independent software vendors (aggregators, front-end trading software, order routing systems, etc.) o Participants must sign user agreement and submit to the jurisdiction of the SEF to gain access o Many SEFs are in the process of registration, while some are or will soon be “provisionally” registered Designated Contract Market (“DCM”) o May allow access to both retail customers and ECPs o Permits trading of swaps and other products, like futures 15

17. On-Facility Trading: SEF Status As of September 4, 15 firms have filed for registration as SEFs: 360 Trading Networks BGC Derivatives Markets Bloomberg DW SEF GFI Swaps ICAP SEF (US) LLC ICE Swap Trade INFX SEF Javelin SEF MarketAccess SEF SwapEx (State Street) TeraExchange tpSEF trueEx TW SEF 16

18. On-Facility Trading: Issues to Consider Pre-trade or post-trade credit checks o Facilities may offer the option to “ping” the participants’ FCMs to get pre-trade clearing approval o Use caution  obtaining pre-trade certainty utilizes outstanding credit line, even if trade is not consummated o Trading facility may provide FCM with a “kill switch” to shut off credit line Post-trade allocation of block trades o Parties must provide allocation information to SEF/DCM (for reporting) as soon as technologically practicable o Key challenge will be multiple FCMs for managed accounts o Important to engage with SEFs to confirm workflow 17

19. On-Facility Trading Overview 18 Clearinghouse Participant FCM A floating fixed floating fixed Participant FCM B SEF/DCM SDR

20. On-Facility Trading: Key Differences Between SEFs and DCMs 19 DCMSEF Trading System (Required Transactions) Order Book RFQ “in conjunction with” Order Book ProductsFutures Options on futures, commodities and swaps Swaps Block trading permittedYes Market AccessRetail and InstitutionalECPs only

21. On-Facility Trading: Required vs. Permitted Transactions Permitted TransactionsRequired Transactions Not Required to be cleared ORRequired to be cleared AND Has not been Made Available to Trade OR Has been designated Made Available to Trade AND Above Block LevelBelow Block Level CFTC’s rules outline criteria for which swaps will be required to be traded on a SEF or DCM: 20

22. On-Facility Trading: “MAT” Determinations MAT determinations made by self-certification or CFTC approval. The following six factors are considered in making MAT determination: o Whether there are ready and willing buyers and sellers o The frequency or size of transactions o The trading volume o The number and types of market participants o The bid/ask spread o The usual number of resting firm or indicative bids and offers Must provide “Order Book”; may provide RFQ procedures Market participants must trade on the DCM or SEF by later of: 30 days after MAT determination; or Swap is required to be cleared The CFTC will maintain a list on its website of all swaps for which a MAT determination has been made. No MAT determinations have been announced yet. 21

23. On-Facility Trading: Order Book 22 All market participants can enter, observe and execute against bids and offers o Displays levels and sizes being posted (anonymous) Execution may be based on price-time priority or another trade matching algorithm Requirement for at least certain participants to expose orders to market for 15 seconds prior to crossing, subject to adjustment by SEF SEF must determine that a shorter time delay would allow market participants to have a meaningful opportunity to execute against the first order.

24. On-Facility Trading: RFQ System 23 Requires a non-binding request to a minimum of 2 other market participants for Required Transactions o RFQ minimum of 2 in 1st year o Increases to 3 after 12 months from October 2 compliance date o Response to request may contain time limit Requirement of no affiliation with requesting party SEF facilitates communications between the parties No obligation to trade on response Resting orders from the Order Book must be presented, but requester not required to execute off of order book, even if a better price Quotes are not required to be publicized to the broader market

25. On-Facility Trading: Implications for Reporting 24 A SEF/DCM reports certain initial trade data under the CFTC’s real-time reporting and “SDR” reporting rules Responsibility for reporting continuation data will generally depend on whether trade is cleared But swap dealer, SEF/DCM, and CCP generally responsible for required reporting rather than non-dealer counterparty Block trades and large notional off-facility swaps: Public dissemination of trades will be subject to delay; amount of delay will vary depending on several factors Reported as above a specific cap size, rather than actual notional amount Must elect status as block trade or large notional off-facility swap

26. On-Facility Trading: Effect on Uncleared/Bilateral Trading 25 Swaps subject to a MAT determination cannot be traded bilaterally unless above block size Certain requirements apply in order to aggregate individual trades at a block level BCBS/IOSCO released policy framework regarding margin requirements for uncleared swaps on September 2, 2013 Provides for financial firms and systemically important non- financial entities to exchange initial and variation margin Required initial margin must be determined on the basis of a 10-day liquidation horizon and a 99% confidence level

27. CFTC Cross-Border Pronouncements Final Cross-Border Order Expires in stages, terminating on December 21, 2013 Interim “U.S. Person” definition expires October 9, 2013 Relief mainly applicable to non-U.S. swap dealers Some relief also available to non-U.S. branches of U.S.- based swap dealers Final Interpretive Guidance Effective from July 26, 2013 Adopts more expansive “U.S. Person” definition Order and Guidance divide CFTC swap rules into Entity- Level and Transaction-Level Requirements 26

28. Impact of CFTC Cross-Border Approach Gating question is whether either counterparty is a “U.S. Person” as defined by the CFTC Key components of definition: Entity organized in the United States Entity with principal place of business in the United States Fund that is majority-owned by U.S. persons Exception for non-U.S. funds that are publicly offered only to non- U.S. persons and not offered at all to U.S. persons If there is a U.S. person counterparty, requirements generally apply “Substituted Compliance” may be possible in some cases, but CFTC must make determination But, consider timing of other regimes, like EMIR 27

29. Thank You for Participating 28 Joshua Sterling Partner T 202.373.6556 F 202.373.6001 joshua.sterling@bingham.com Akshay N. Belani Counsel T 212.705.7860 F 212.702.3613 akshay.belani@bingham.com

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