Developpments in OTC Markets

8/6/2019 Developpments in OTC Markets

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The Global Risk Transfer Market:

- A TABB Group Study

TABB Group Credit Default Swaps: Industry Projections | March 2009 1

E. Paul Rowady, Jr.Senior Analyst

V08:030 | November 2010 | www.tabbgroup.com


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Table of Contents

Executive Summary.3

Market Sizing... 9 Trading Cost Analysis24

o a era ..Clearing and Exchange Fees..31

Bid-Ask Spreads.38.

Regulatory Update and Survey Results .. 46

A endices.58

Interest Rate Derivatives......59Credit Default Swaps.66Other Ma or Asset Classes...74

TABB Group The Global Risk Transfer Market | Nov 2010 2


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Executive Summary:Introducing the Global Risk Transfer Market

OTC and exchange-traded derivatives markets aretwo interdependent components of a single global

OverviewThe Global Risk Transfer Market - GRTM

Notional Values Outstanding 2010e

risk transfer mechanism serving all users, all needs.

Mainstream and even insider views of OTCderivatives markets remain uninformed. Usingnotional values outstanding showcases size

-89%

11%

OTCDs relative to other liquid markets. When addedtogether, OTCDs represented 89% of notional valuesoutstanding at the end of 2009.

Notional turnover is an additional metric that offersnew perspective on levels of trade activity andshowcases exchange-traded derivatives market aslarge, if not larger, than OTCDs. TABB Groupestimates that ETDs will represent 55% of totalcombined notional turnover for 2010.

45%

Total Notional Turnover 2010e

Both OTCD and ETD components of the GRTM offerwholesale risk transfer; this is where they arecompetitive. The difference is that OTCDs providesbespoke risk transfer products and ETDs offer onlyhighly standardized products. The ETD market also

55%


includes a subset of products that are useful tosmaller institutions and individuals.

Source: BIS, WFE, TABB Group

OTC Derivatives (OTCDs)Exchange-Traded Derivatives (ETDs)


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Executive Summary:Growth in OTCD and ETD Markets is Highly Correlated

684

62595

90

100700

Comparing Notional Values(1998-2010e)

80

70

80

500

50

60

300

400

S$

Trillions

S$

Trillions

Tracking the siblings

A visual and quantitative correlation ofgrowth confirms that OTCDs and ETDsare two sides of the same coin. 20

30200

Both components of the Global RiskTransfer Market are simultaneouslycomplementary and competitive.

-

10

-

100

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010e


OTCD (Left-hand scale) ETD (Right-hand scale)



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Executive Summary:Market Sizing by Notional Turnover

New Market Sizing Metrics2,284

2,030

s

ETD

TABB Group estimates that total combined notionalturnover in OTCD and ETD markets for 2010 is $3.7quadrillion; ETD is often the larger of the two on this

28

24

38

23

25

US$Trillio score.

Interest rate products dominate both OTCDand ETD markets, together representing 75%of 2009 notional outstanding; short termroducts


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Executive Summary:Bid-Ask Spread Improvement Expected from SEFs

50.0

Bid-Ask Spread ComparisonSame Day, Same Time (for ETD)

Bid-Ask Spreads will fall, selectively

Potential bid-ask spread (BAS) improvement exceeds 96%

Like transaction fees, BASs are blind to labels like OTCDand ETD; BASs respond to liquidity independent of

Bid-Ask Spread Comparison

execution method.

OTCD products that meet broad needs are destined forlower costs in paradigm transformation.

3,125

1,600

30y IR Swap Future

OTC CDS Single (HY)OTC CDS Single (IG)

ETD OTC**

OTC 10y IR

.

isP

oints

gScale

600

469 400343328

200

$1,000

gScale

5y IR Swap Future

OTC CDS Index (HY)

30y T-Bond Future

S&P 500 Index Future

OTC 10 IR Swa

0.5

BaL

30y IR Swap Future

Potentialimprovement

96%

70$100L

o

OTC CDS Index (IG)

Eurodollar Future

** OTC pricing estimates reflectcombination of both dealer - to -

EurodollarFuture

OTC CDS Single (HY)OTC CDS Single (IG)5y IR Swap Future

OTC CDS Index (HY)S&P 500 Index Future

-


Source: CME, TABB Group HY = High Yield, IG = Investment Grade

13$10

Sep 2010

- -dealer (C2D) trades.

0.1OTC 10y IR Swap

OTC CDS Index (IG)

Eurodollar Future


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Executive Summary:Reform Impacts and Stakeholder Sentiment

Participants sage/focus

yourfirm?

sage/focus

yourfirm?

viewone-

forOTCD?

nspreads?

acton

issions?

onliquidity?

clearable?

newmargin

rements?

onTrade

sitories?

Reform Impacts

OTCD reforms primaryfocus continues to be:

OT

CD

by/of

ET

Du

by/of

Firms

trading

Imp

act

Im

c

om

Imp

act

%O

TC

Viewon

r

equi

V

iew

Rep

Top-Tier Dealers

and increasing overallmarket transparency forboth price andpositions.

Emerging Dealers Traditional Buy-Side

There is consensus ontactics centralized

clearing forstandardized

Hedge Funds Corporate End Users

instruments, tighterrequirements oncollateral, and clearedcontracts on a

Exchanges / Clearinghouses Inter-dealer Brokers / OTC

Execution Venues

venue butimplementation will beslow for end users,coming online in 2011


Data Providers / Aggregators Increase Decrease Same Positive Negative Indifferent

through 2013.


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Market Sizing



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Derivatives markets both OTC and exchange-traded - are too complex to beexplained by simple comparisons using notional values outstanding over

limited time frames; Notional values of derivatives can overstate systemic risksAdditional details are essential tounderstanding these markets

The financial press and mainstream media are700

Mainstream View of Global Financial Markets

as the largest in the world using notional values

outstanding over a limited time frame.

This view is overly simplistic and a misleadingdepiction of both OTCD and exchange-traded

596

547

615

500

600

ns

derivatives (ETD) markets.

Notional or face value of the underlyingtransactions only tell part of the story and imply

excessive levels of leverage and risk in OTCD300

400

U

S$Trillio

.

OTCDs and ETDs are a subset of a broadermechanism to transfer risk among a diversespectrum of participants and for a wide array ofneeds.

79 83 92 9179 80

200

y o er measures suc as no ona urnover eETD market is occasionally the larger sibling of thetwo.

Details of each asset class coupled with additionalmarket sizin metrics articularl notional turnover

58 48 33 44

-2007 2008 2009 2010e

OTC Derivatives (OTCDs) - Notional Values Outstanding


complement open interest or notional valuesoutstanding and foster much greater understanding

of the underlying products and market participants.

Debt - Market ValueExchange-Traded Derivatives (ETDs) - Notional Open Interest

Equity - Market CapitalizationSource: BIS, WFE, TABB Group


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Greater understanding of OTCD starts with direct comparison with ETD, awider range of time, and additional market sizing metrics; ETD and OTCD are

both complementary and competitivePeak = 684

62518

20

600

700


OTCD and ETD: two components of asingle risk transfer market

ETD provides the optimal market comparison(instead of the cash markets) due to their similar

14

16

500

ons

products, risk profiles, and customers. In fact,

OTCDs and ETDs are complementary andsymbiotic for product development; one is aprimary source of innovation for the other.

A broader time horizon su orts inter retation of

9.6 10

12

300

400

US$Trilli

the relationship between these markets wherenotional values have a correlation exceeding90% since 1998.

High correlation indicates that both marketshave the same or similar drivers. However in

4.9

6.7

4.2

7.8

4

6200

. ,December 2007 and leading up to the creditcrisis of 2008, the correlation shifts with theOTCD:ETD ratio peaks at 9.6 - due to increasedactivity in Credit and structured products, likeCDOs.

Peak = 95 80

-

2

-

100 Although OTCD and ETD represent significantdifferences in the needs that they serve, bothcompete to serve wholesale risk transfer needs.

As the OTCD markets adopts more of the


OTCD ETD OTCD / ETD Ratio


voluntarily and by mandate - they will beviewed more as two components of a single

market.


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A visual and quantitative correlation of growth confirms that OTCD and ETDare two sides of the same coin

684

62595

90

100700


80

70

80

500

50

60

300

400

S$

Trillions

S$

Trillions

20

30200Tracking the siblings

Standard deviation of OTCD growth is 9%as compared to over 22% for ETD (or 2.5

-

10

-

100

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010e

,

from the chart. Before the credit crisis,OTCD growth was extremely consistent,with a standard deviation of 6%.


OTCD (Left-hand scale) ETD (Right-hand scale)



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Basic asset class breakdowns demonstrate that interest rate productsdominate both sides of the global risk transfer market

Interest rate investing and hedgingrepresent the largest global liquidmarket segment

Notional Values

2009

non-existent in the ETD market, although

this may change with the launch of CDSoptions on the CBOE.

ETD equity-linked notional open interest isseveral times the ro ortionof OTCD

Commodity


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OTCD product mix has become more concentrated in swaps due to growth ininterest rate products; ETD options have overtaken futures due to adoption of

equity derivatives within mainstream strategies

70

80

90 ETD Notional Open InterestBy Product

500

600

700

ons

OTCD Notional OutstandingBy Product

Stable but evolving productmix

With few exceptions, the overallroduct mix has evolved and

Stable but evolving productmix

With few exceptions, the overallroduct mix has evolved and

20

30

40

50

200

300

400

US$

Trilli

changed slowly. For instance,

jump in ET options in 2001 signalslaunch of ISE.

OTCD or wholesale - marketsserve bulk and precision hedging

changed slowly. For instance,

jump in ET options in 2001 signalslaunch of ISE.

OTCD markets serve both bulk and

-

10

1999 2001 2003 2005 2007 2009

100%100%

-

100

1999 2001 2003 2005 2007 2009

needs.

Banks, financial firms and largecorporations use the OTCD

markets mainly to manage interestrate and currency risks that are

prec s on e g ng nee s.

Banks, financial firms and largecorporations use OTCDs to

manage interest rate and currencyrisks that are too lar e or com lex

60%

80%

60%

80%

impractically large or requireunique precision to manage in ETDmarkets.

Firms in the food, energy, andmanufacturing mainly use OTCD

to manage using ETDs.

Firms in the food, energy, andmanufacturing industries useOTCDs to manage physical

0%

20%

40%

0%

20%

40%markets to manage physicalcommodity risks for precision thatcannot be achieved in ETD.

ETD shows greater shiftsprincipally due to its diversity. For

commo y r s s or prec s on acannot be achieved in ETDs.

ETDs shows greater shiftsprincipally due to its diversity. Forinstance, rowin ado tion of


1999 2001 2003 2005 2007 2009

Futures Options

1999 2001 2003 2005 2007 2009

Swaps Options Forwards/FRAs Unallocated


ns ance, grow ng a op on ooptions in mainstream strategies isfueled by individuals and pros

alike.

options in mainstream strategies isfueled by individuals and pros

alike.


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Since OTCD activity were first published in 1998, total notional turnover inETD has consistently been greater than OTCD; Notional turnover in these

markets has been measured in quadrillions since 2004Notional turnover values shed a new - and bright - light on global derivatives marketsNotional turnover values shed a new perspective on global derivatives markets Comparisons of OTCD markets with other markets are more illustrative when notional turnover is included. Thanks to trade

repositories, this level of detail is now possible with greater accuracy, detail and regularity.

Notional turnover normalizes the activit between OTCD and ETD markets which eliminates the need for com arisons basedon the variety of contract sizes in ETD and the lack of contract sizes in OTCD.

Levels of notional turnover provide numerous additional insights into the nature of these markets including: underlyingstrategies; composition of market demographics; product maturity composition; and level of operational integrity.

The calculation of turnover frequency (TOF) - the ratio of turnover values to notional values outstanding - is the best indication

2,284

o s or erm ra ng eve s, onger erm nves men an overa e g ng. g o en n ca es grea er qu y.

The main drawback in using ETD notional turnover is due to the high levels of structural activity caused by rolling from monthto month and/or developing longer term exposures from strips of short term instruments. TABB Group estimates that up to 5%

of ETD turnover can be attributed to this type of structural activity.

2,030

38

1,8401,690

llions Notional Values Outstanding

Notional TurnoverTurnover Frequency

28

24 23

25

625

4.2

3.4

3.0

3.1

2.7

US$T

ri


80

1998 2000 2002 2004 2006 2008 2010e1998 2000 2002 2004 2006 2008 2010eDashed points are interpolated estimatesSource: BIS, WFE, TABB Group


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Turnover frequency (TOF) points to the structural makeup of a market as wellas the strategies participants implement within those markets

100

1,000

Annualized Turnover Frequency (TOF) RankingAll Derivative Markets - 2009 Diversity, automation, liquidity

TOF can become skewed with a bias to

80

800

ns

instruments with short term maturities.

Strips used to formulate longerterm exposures from short terminstruments.

How will the TOF gap change?

40400

600

TOF

U

S$Trillio

expiring months to future months

Limited participants and low processautomation limit turnover frequency, and

therefore, market liquidity.

20200

As large market segments like OTCinterest rate derivatives trade and clearmore like futures, the market will realizesignificant cost savings and greaterliquidity.

-0

The impact of doubling TOF for OTCinterest rate swaps from roughly 1 to 2- would yield an additional $350 trillion ofglobal annual trading activity.


Open Interest Turnover TOFSource: BIS, WFE,TABB Group


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On global notional turnover, ETD futures and options dominate in 2 assetclasses and very strong in a third; Account for a slight majority overall for 2009

Sizing ETD and OTCD by asset class

ETD notional turnover exceeds theircounterparts in OTCD equity-linked andinterest rates ver stron in commodities.

5% 5%

80%

100%

Relative Global Derivative ExposuresBy Total Notional Turnover of Asset Class (2009) Sizing ETD and OTCD by asset class

ETD notional turnover exceeds theircounterparts in equity-linked and interest rateOTCDs ver stron in commodities. .

Despite ETD dominance in equities, OTCDnotional outstanding is still surprisinglysubstantial . This is a strong indication ofwholesale hedging needs by large players.

56%

95% 95% 100%

68% 70%

40%

60%

.

Despite ETD dominance in equities, OTCDnotional outstanding is still substantial,indicating the use of OTCD in wholesalehedging needs by large users.

Taking outstanding values and notionalturnover together, OTCD and ETD can becharacterized as one interconnected and

interdependent market serving differentneeds. Stren thenin this interde endenc

32% 30%

0%

20%

Equity Linked Rates Commodity Other * FX Credit

Taking outstanding values and notionalturnover together, OTCD and ETD can becharacterized as one interconnected and

interdependent market serving differentneeds; stren thenin this interde endencbenefits both sides of this amazing market

Total GRTM Notional Turnover200951%

12% 20%1% 1%

80%

100%

By Notional Outstanding of Asset Class (2009) benefits both components of the global risktransfer market (GRTM).

OTCD49.4%

ETD50.6%49%

88%80%

99% 99% 100%

20%

40%


0%Equity-Linked

Rates Commodity Other * FX Credit

OTCD ETDSource: BIS, WFE, TABB Group * Other includes ETF Options (ETD)and unallocated exposures (OTCD)


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OTCD market exposures originate primarily in Europe while ETD showswaning dominance in North America; Regional dynamics changing slowlywhich will accelerate with growth in APAC markets

15%16%1,500

2,000

lions

OTCD Notional Turnover Achieving regional balanceAchieving regional balance

Europe remains the epicenter of OTCDdealing due to Londons dominance in

64%

64% 61%14%

500

1,000US$

Tril . ,

slowly ceding its dominance as US and

APAC activity grows.

The concentration is less pronouncedwhen viewed by underlying currency.

22%21% 23%

-2004 2005 2006 2007 2008 2009 2010e

Dashed points are interpolated estimates

Single-currency OTC interest ratederivatives and Euro-denominatedtrades edge out US-dollar-denominated trades, 39% versus 34%

in 2009.

35%39%

8%

8%8%

7%

10%

12%2,000

2,500

rillions

ETD Notional Turnover A surge in ETD volumes for the firsthalf of 2010 up over 30% yoy are astrong indication that reforms in theOTCD markets is causing participantsto shift some of their risk transfer

55% 58%57%

57% 54%50% 48%

37%34% 35% 40%

40%8%

-

500

1,000

,

US$ activities to ETD.

However, due to the benefits ofprecision hedging and balance sheetrelief afforded by OTCD derivatives


2004 2005 2006 2007 2008 2009 2010e

Americas EMEA APAC

Source: BIS, WFE, ISDA, FIA, TABB Group

,substitutability of ETD and OTCDtrades. ETDs do not provide balance

sheet relief.


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The distribution of collateralized counterparties by country of incorporationpaints a different picture of regional OTCD exposures; Suggests US and EUbanks, asset mgrs. and corps. are heavily engaged in hedging foreign risks

46%US and Canada

Percentage of Total Global OTCD ExposuresBy Country of Incorporation

24%Western Europe

The West dominates OTCD

How can the value of turnover be higher inEMEA, while the number of collateralized

4%

20%Caribbean

counterparties in the US and Canada behigher at the same time?

The chart suggests that US-based entities -

mainly corporations and banks are

4%APAC (ex-Japan) **

incurred through foreign trade.

Growth in Caribbean counterparties isindicative of the growth of OTCD trading byhedge funds as well as corporations in the

2%

0% 10% 20% 30% 40% 50% 60%

Other *energy sector often registered offshore.

Low utilization of OTCD in APAC isindicative of how important floating ratecurrencies are (e.g. China) and more


2009 2005 2001

Source: ISDA * Includes Latin America, Eastern Europe, and Africa; ** includes Hong Kong, Singapore and Australia

,represents for future OTCD growth.


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Dramatic change in OTCD demographics is direct link to search for multi-assetalpha by hedge funds and prop desks; ETD influenced primarily by highfrequency trading strategies

16% 17% 18% 19% 20%

Futures End User Breakdown% of Contract Volume

88%

94%

Rates

All

Corporate Use of OTCD2009 OTCD demographics

CDS and other complex structuredproducts, like CDOs, had a major

54% 55% 55%

39% 35% 28% 26% 25%

29%

49%

83%

Equity

Commodity

FXmpac on emograp cs nthe past 5 years.

Alternative asset managers andproprietary trading desks of largefinancial companies flocked to

51%50%

OTCD End User Breakdown% of Outstanding Notional

2006 2007 2008 2009 2010e

Options End User Breakdown

these new products.

Since operational integrity usuallylags the relentless search for alpha,risk management functionality waslacking in this growth.

29%

20%

30% ETD demographics

High frequency trading (HFT) hasbecome common in futures. HFT34% 35% 40% 43%

30%19% 15% 15% 15%

% of Contract Volume

8%

12%

0%

10%

2006 2007 2008 2009

firms typically become exchangemembers to lower trading costs.

Bigger retail component in ETDoptions.45% 47% 50% 45% 42%


Broker-Dealers Other FinancialCustomers Unallocated

Source: BIS, CME, Tabb Group

,is increasing for both traditional andalternative investment strategies.2006 2007 2008 2009 2010e

Broker / Dealers Other Financial Customers


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Use of OTC derivatives is common but varies widely among Global Fortune500 corporations; Healthcare and Technology sectors are most correlated toFinancial sector usage, Basic Materials and Utilities least

All

Corporate OTCD Usage

On a weighted average basis, 94% ofGlobal Fortune 500 companies useOTC derivatives, where the largest

Sector Usage of OTC Derivatives by Global Fortune 500(2009)

OTCD

Basic Materials (86) 97% 70% 85% 0% 6% 79%

Consumer Goods (88) 91% 81% 84% 1% 9% 39%

sector is Financial with 123companies in 2009.

The sample of the worlds largestcompanies span 32 countries

ea care

Industrial Goods (49) 92% 86% 86% 2% 20% 37%

Services (40) 88% 75% 85% 3% 13% 35%

Technology (65) 95% 86% 92% 6% 15% 15%

While the Financials sector does notalways skew the figures, it does havea dramatic impact on the usage

figures for Credit and Equities.Clearly, Financials firms represent a

Utilities (24) 92% 92% 88% 0% 8% 83%

Financial (123) 98% 94% 96% 76% 80% 63%

vast majority of the usage of OTCcredit derivatives and a slight majorityof OTC equity derivatives.

Healthcare and Technology

Weighted Average(w/o Financials) 93% 80% 85% 2% 12% 44%

Weighted Average(w/ Financials)

94% 80% 85% 20% 28% 48%

with Financial companies in theirusage of OTCD (at .90 and .87,respectively); Basic Material andUtilities are least correlated (at .25and .32, res ectivel . This metric


>75% < 25%

indicates the potential degree towhich specific sectors could be

impacted by pending reforms.Source: ISDA, TABB Group


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Overall, this is a tale of two equally large and interdependent components of asingle global risk transfer mechanism, each serving specific purposes forspecific end users

Unlimited ProductsOTC Derivatives

Limited Products

Exchange-Traded Derivatives

Few ParticipantsMany Participants

ETDs operate for the benefit of a broad, diversecommunity of large and small participants

Every type of market player is represented here: Fromamateur to professional, from individual to institutional, and

OTCDs operate like a wholesale market for thelargest firms w/ specific exposure requirements

An unlimited spectrum of products can be devised toprecisely address the needs of the worlds largest financial

, -

markets serve almost all global risk transfer needs at areasonable cost with speed, accuracy, and reliability.

Given its standards, fault tolerance and capacity, the ETDmarket is currently the best model we have for operational

.

The unlimited flexibility of OTCD is, therefore, the greatestsource of product innovation for ETD.

As the past few years have demonstrated, diversification ofmarket demographics without congruent operational


.

In the current environment, ETDs represent an outlet forsome risk transfer needs that were previously conducted inOTCD.

integrity created unforeseen risks.

Addressing operational integrity continues to represent

massive growth potential for these markets.


23/80

The differences between OTCD and ETD are both complementary andcompetitive, serving the broadest spectrum of end user needs

Attribute OTC Derivatives Exchange-Traded Derivatives

# Participants Limited (~30,000) Expansive (~5,000,000)

Inter-Dealer Brokers (5-20), Dealer Banks (50-

End User Types

100), Other Banks (2,000 5,000), OtherFinancial and Corporations, including securities

firms, insurance companies, asset managers,hedge funds, and proprietary trading firms(25,000+)

All of the OTC types, plus traditional asset

managers and individual investors (~5,000,000)

Product Categories

Swap (single and cross-currency), Forward RateAgreement (FRA), Swaption, Basis Swap, Cap,Floor, Exotic Swap, Inflation Swap, Debt Option,Exotic Option, Exotic Cross-Currency Swap

Vanilla options and futures (> 8,000 uniquecontracts)

Strategy Types

e g ng pr mary, nves men an ra ngsecondary; Limited annual turnover range:

1 20x

nves men an ra ng pr mary, e g ngsecondary; Broad annual turnover range:

1 100x

Outstanding Notional $625 trillion (2010e) $80 trillion (2010e)

Notional Turnover $1.7 quadrillion (2010e) $2.0 quadrillion (2010e)

Contract Open Interest NA 1.02 billion (2009)

Contract Volume NA 22.4 billion (2010e)

~ ~


, ,

Average Trade Size / Value NA / $105 million (2010e) 5.9 contracts / $103,000 (2009)

Regional Breakdown (2010e) N. America: 23%; APAC: 16%; EMEA: 61% N. America: 48%; APAC: 12%; EMEA: 40%


24/80

Trading Cost Analysis:Collateral



25/80

The main goals are clear: minimize systemic and counterparty risks andpromote price transparency; Accomplishing these goals will create new costsand cause the cost mix to shift: collateral up, spreads and commissions down

Main Components of Trading CostsShifting Paradigm, Shifting Costs

Anatomy of a Trade

There are as many as 6 primary components to the trading coststack for ETD and the proposed OTCD multilateral paradigm.The uestion is how these costs will shift as OTCDs ado t

-

Margin andCollateral

Margin andCollateralOpportunity

Costs

operational components of the ETD market.

TABB Group believes that moving from bundled to unbundledcost models does not bring into question the persistent need forwholesale and bespoke functions within the global risk transfermarket. Overall costs cate ories will shift but a re ate

Clearing

Fees

Bid-AskSpread

Spread

Implicit

Costs

. , ,transaction costs will decrease over the longer term.

-------------------------------------------------------------------------------------- Goal #1: Minimize systemic and counterparty risks Solutions: Central counterparty clearing (CCP) for standardized

instruments, and margin requirements for all transactions (both

BrokerFees *

ExchangeFees

Costs standardized and exotic, cleared and bilateral).

Cost Impacts: New margin levels and collateral requirements New clearing fees Admin/legal costs down; technology costs up

Admin andLegal Fees Admin and

Legal Fees

ro er

Fees

xp c

Costs

--------------------------------------------------------------------------------------

Goal #2: Price transparency Solutions: Increase multilateral price discovery through

exchange-like mechanisms, or swap execution facilities (SEFs). Cost Impacts:

New exchan e fees


Bilateral

Paradigm

Multilateral

Paradigm

Broker fees decrease (as volume increases) Bid-Ask spread compression (as diversity increases) Technology costs up due to multi-system connectivity

* Interdealer trades only


26/80

Increasing collateral costs is the leading concern for OTCD participants,despite collateralized OTC trades increasing 2.4x to nearly 70% and the # ofcollateral agreements estimated to increase by 3.1x to 189k since 2003

New Collateral Rules likely

Just because the use of collateral is increasing doesntnecessarily mean that trades are margined at proper levels.

Althou h an avera e of 69% of OTCD trades are

75%

70%

Percentage of Collateralized OTC TradeExposures

collateralized, specific and standard levels are currently

unknown. They will ultimately vary widely by asset class,product, end-user type.

Rates exposures are most highly collateralized at 75%;Metals are lowest at 49%. Hed e funds ost the50%

60%

highest margin levels, often exceeding 100% of netexposures followed by banks and BDs; non-financialcorporations, sovereigns and supra-national firms tendto have the lowest levels.

The cost of collateral is a capital efficiency issue; it should be

49%

40%

categorized as an opportunity cost, not a sunk cost.

With increasing and pervasive use of collateral in OTCDmarkets through CCPs, collateral cost has the potential tooutweigh all other cost efficiencies over the long term.

20%

29% 52% 55% 63% 59% 65% 66% 69%0%

10%

2003 2004 2005 2006 2007 2008 2009 2010e133 149 151

172 189100

150

ousands


OTCD FX MetalsEnergy Equity Interest RatesCredit

Source: ISDA, TABB Group

55 71

-

2003 2004 2005 2006 2007 2008 2009 2010e

Th


27/80


28/80


29/80

TABB Group estimates total global ETD margin at nearly $450 billion in 2009,representing 0.6% of notional open interest; Applying this benchmark to OTCDyields a total collateral estimate of $3.8 trillion for the same period

449

0.61% 0.75%

1.00%

400

500

Notional

ns

ETD Margin Benchmark Calculating ETD marginbenchmark for OTCD

Based on total margin levels

78

1340.25%

0.50%

100

200

300

oofMarg

into

US$

Billi

,and given the proportion of

exposures in the US relative tothe rest of the world, TABB Groupestimates that total global marginposted for ETDs in 2009 was

0.00%-

2005 2006 2007 2008 2009

Rati

US Options Margin (OCC)US Futures / Options on Futures Margin (CFTC)

nearly $450 billion, or 0.6% ofnotional open interest. ($134b +$78b / 47% = $449b; $449b / $73tETD notional = 0.61%)

Applying this level as aGlobal ETD Margin EstimateMargin as % of Notional Outstanding

4,699 2.0%5,000

tos

Applying ETD Margin Benchmark to OTCDPercentage of Notional Values Outstanding

benchmark for OTCD collateralrequirements yields an expectedlevel of nearly $3.8 trillion for2009.

1,5452,014

, ,

0.61%

0.5%

1.0%

1.5%

-

1,000

2,000

3,000

4,000

atioofMarg

in

Notional

US$Billio


Source: CFTC, OCC, TABB Group

.2005 2006 2007 2008 2009

R

Collateral Requirement (ETD Benchmark)

ETD Margin Benchmark (%)


30/80


31/80

Trading Cost Analysis:Clearing and Exchange Fees


C ti d i i ll t li d OTCD t d i fl d i l t


32/80

Continued increases in collateralized OTCD trades are influenced in large partby growing adoption of CCPs, which also bring new clearing fees and serviceopportunities; LCH SwapClear, ICE Clear and CME ClearPort lead the way

IR Swaps lead

A majority of dealer-to-dealer(D2D) OTC interest rate swapsare currently cleared by LCH

228

60

80

220

240

ds

ns

LCH Clearnet SwapClear OTC IRS ClearingNotional Amounts Cleared and Trade Registrations

Clearnets SwapClear service,including 20 currencies and

Overnight Indexed Swaps (OIS)

As of August 2010, SwapClear

61

20

40

180

200

Tho

usa

US$

Trilli

notional interest rate swapsrepresenting 61,000 traderegistrations.

Services for customer clearing are

-

IRS Clearing (two-sided) Monthly Trade Registrations

in the works, as well as clearingfor vanilla forwards and options

TABB Group estimates that asmuch as 90% of total OTC interest

89100

89%

60%

80%

100%

75

100

125

150

Trillions

SwapClear Market ShareDealer Interest Rate Swaps (IRS)

exotic will ultimately be centrallycleared.

Customer-to-dealer (C2D)transactions still remain largely

0%

20%

-

25

50U

S


bilateral, in part, awaitingguidelines on collateralrequirements.IRS Clearing (one-sided) Reporting Dealers - IRS Mkt Share - Dealer IRS

Source: LCH SwapClear

C dit d f lt t l l i i b i i t t k h ld ICE h


33/80

Credit default swap central clearing is beginning to take hold; ICE has seenconsiderable growth since its US launch in March 2009 and progress inEurope is strong as well

8

10

250

300

ds

ons

ICE Trust USIndex CDS

ICE first offered clearing for index CDS between dealers inMar 2009. A ramp-up of open interest followed the launch asdealers moved existing positions into the CCP to meet their

CDS Clearing - Overview

2

4

6

50

100150

200

Tho

usa

US$Billi regulatory commitments. Following the commitment date of

Dec 15, 2009, open interest in index CDS at ICE Trust US

have a compound monthly growth rate of 2%. Buy-sideaccess to clearing via ICE has been available since Dec 15,2009, but open interest is negligible. They will not utilize CDS

--

Open Interest Trade Volume

c ear ng un ey are requ re o or ecomes econom ca ysuitable for their investors. TABB Group expects little growthin CDS clearing until final clearing mandates are put in placeboth in the US and EU, forcing additional volume into CCPs

from both the sell-side and buy-side.

123

8

10

100

120

140

ands

ns

ICE Clear EuropeIndex CDS

Average trade size hovers around $80 million for index CDSas this is a purely dealer-to-dealer (D2D) market. Thiscompares to the average trade size of $26 million for the CDSmarket as a whole. The total open interest at ICE Trust US

4.6

0

2

4

6

-

20

40

60

80

Thous

US$Billi

ICE Clear Europe has seen a slow but steady increase inIndex CDS open interest through 2010. Transaction volumes

ICE Clear Europe Index CDS

accoun s or < o e o a ou s an ng no ona .

TABB Group The Global Risk Transfer Market | October 2010 33

Open Interest TransactionsSource: ICE, TABB Group

,size of its US counterpart. Average transaction size for indexproducts is lower than its US counterpart at $52 million

(assuming a EUR/USD rate of 1.3).


34/80

OTC energy transactions have been cleared by CMEs ClearPort since 2002;Nearly 125 million OTC contracts cleared in 2009

459500

600

700

ands

CME ClearPort OTC ClearingAverage Daily Volume

100

200300

400

Thous -

established

OTC energy clearing representedat least 98% of ClearPort volumesover the period. Figures also

-

Avera e Rate Per Contract and OTC Clearin Revenues

include FX , metals andcommodity index products.

Average rate per contract can be

impacted by volume-based

22

$3.0

$4.0

.

15

20

25

$Millions

venue, and the percentage oftrading volume executed bycustomers who are memberscompared with non-membercustomers.

$2.33

$0.0

$1.0

$2.0

-

5

10U

S

TABB Group estimates last 12months (LTM) OTC clearingrevenues of $272 million; 2009OTC clearing revenue of $260


Estimated Monthly Revenues Average Rate Per ContractSource: CME, TABB Group

m on or . per con rac .


35/80


36/80

All-in transaction costs measured in bps solidify the demarcation lines and


37/80

All-in transaction costs, measured in bps, solidify the demarcation lines andthe possibilities in the GRTM; Standard, high-volume OTCD products oftenmatch the transaction costs of the average ETD futures products at ~.05 bps

Comparison of Transaction Costs for Average ContractsClearing and Execution Venue Costs

Retail Pricing Equivalent fees at high volumes

0.86

0.7

0.8

0.9

s)

Total transaction fees for some of the mostliquid OTC products such as interest rateswaps are similar to that of highly-liquidETD futures or roughly 20-30% greater.This is true even while OTC IRS remain far

0.4

0.5

0.6

is

Points(b

from fully benefiting from increasinglyautomated execution, greater multilateralprice transparency, and greater access.

The difference between fees on an IRS trade

0.0630.1

0.2

0.3Ba

Wholesale Pricing

trade or 20-30% - represents the minimumcost reduction available due to the migrationfrom the bilateral paradigm to the multi-lateral paradigm. There is also potential forreater cost im rovements of other OTCD. .

-Clearing + "Exchange" Fees

Average ETD Single Equity Option ($3,400 / contract; CBOE + OCC)

Average OTC IRS ($124 million / "contract"; SwapClear + IDB)

products.


Average ETD Future ($150,000 / contract; CME)

US T-Bond ($100,000 / contract; CME)

Source: CME, CBOE, OCC, SwapClear, TABB Group

T di C t A l i


38/80

Trading Cost Analysis:Bid-Ask Spreads


Potential bid-ask spread (BAS) improvement exceeds 96% for OTC IR swaps


39/80

Potential bid ask spread (BAS) improvement exceeds 96% for OTC IR swaps more for other vanilla OTCDs; Like transaction fees, BASs are blind to labelslike OTCD and ETD just look at the 30y IR swap futureBid-Ask Spreads will fall, selectively

Not all derivative products are destined for lower costs andspreads. Products meeting broad needs are, however,destined for lower costs. The fact that select OTC products

50.0

Bid-Ask Spread ComparisonSame Day, Same Time (for ETD)

ave ower sprea s an some qu pro uc s s proothat exchange-traded vs. bilateral is not the only way to

distinguish the full spectrum of risk transfer products.

Bid-Ask Spread Comparison

3,125

1,600

30y IR Swap Future

OTC CDS Single (HY)

OTC CDS Single (IG)

ETD OTC**

OTC 10y IR

.

is

Points

gScale

600

469 400343328

200

$1,000

gScale

5y IR Swap Future

OTC CDS Index (HY)

30y T-Bond Future

S&P 500 Index Future

OTC 10 IR Swa

0.5

BaL

30y IR Swap Future

Potentialimprovement

96%

70

$100Lo

OTC CDS Index (IG)Eurodollar Future

** OTC pricing estimates reflectcombination of both dealer - to -

EurodollarFuture

OTC CDS Single (HY)

OTC CDS Single (IG)5y IR Swap Future

OTC CDS Index (HY)S&P 500 Index Future

-


Source: CME, TABB Group HY = High Yield, IG = Investment Grade

13$10

Sep 2010

- -dealer (C2D) trades.

0.1OTC 10y IR Swap

OTC CDS Index (IG)Eurodollar Future

Trading Cost Analysis:


40/80

Trading Cost Analysis:Conclusions


The migration from the OTCD to an ETD-like operational paradigm represents


41/80

g p p g ppotential transaction cost improvements of 75%; Over time, increasingcollateralization will overshadow these savings

EXAMPLE: $100 million notional trade

10y OTC IR Swap (D2D):Bid-Ask Spread (BAS): 50% BAS @ 0.25 bps = $1250

=

$750

$30 Trade Comparison ($)Explicit and Implicit Costs Only

.Clearing Fee: $29.70 (average)

Total Sunk Costs: @2,030Collateral: (Outright Rate = 1.5% , Hedge Rate = 0.15%)Minimum Opportunity Cost (@ 1% per annum)

Low: $15,000, High: $150,000 life of trade (10y)

$1,250

$16$486

$0

OTCD - IR Swap (CCP) ETD - 10y US T-Note Future

37%

97%

1%

Trade Comparison (%)Explicit and Implicit Costs Only

------------------------------------------------------------------------------

10y US T-NOTE Future:BAS: 50% @ 3.1 bps = $16 (rounded)Exchange Fee: $0.486 per $100,000 = $486 (average)

Clearing Fee: included in Exchange Fee

3%

OTCD - IR Swap (CCP) ETD - 10y US T-Note Future

Total Sunk Costs: $502Collateral: : (Outright Rate = 1.4% , Hedge Rate = 0.15%)Minimum Opportunity Cost (@ 1% per annum)

Low: $15,000, Max: $140,000 life of trade (10y)

------------------------------------------------------------------------------Trade Comparison (%)Including Opportunity Cost

The (sunk) cost differential between the OTCD and ETDtrades is $1,528, or 75%. This figure also represents thepotential cost improvement from OTCD paradigm shifts.

Add the minimum opportunity cost represented by propercollateralization to this com arison and the cost savin s is7% 0.11%

4%3%

0.2%NA

88% 97%


absorbed within the first year of the trade. However, sincethe use of collateral in the bilateral paradigm is growing, theexistence of this free lunch perception is rapidly fading.

OTCD - IR Swap (CCP) ETD - 10y US T-Note FutureBAS Execution Clearing Margin Opportunity Cost (Min)

Source: CME, SwapClear, TABB Group

Greater volume will yield lower trading costs; High notional and high turnover


42/80

y g ; g gOTCD products (like IR swaps, FX swaps, and CDS indices) have the greatestpotential to approach ETD pricing, or up to 89% savings, at the limit

-OTCD - Equity

1000

VolumeIncrease

Cost savings and liquidity

Roughly two-thirds of OTCD sunk trade costsare in the bid-ask spread, the other third intransaction costs. If, under the current ETD

OTCD RatesCDS

Commodity

100

Trade($)

=5x

CostReduction

pricing models, the maximum transaction costdifferential is 75% and the minimum BAS

differential is 96%, then the weighted averagelimits of sunk cost savings from the migrationof OTCDs to an ETD-like operational

FX - Spot

Cash - RatesOTCD - FX

10

ge

CostPer para gm s .

Note that some of the most vanilla IR swapsare already approaching the costs andtransparency of highly liquid ETD rates

products. In a report published on Nov. 9,

ListedDerivatives1

2007Avera 2010 by ISDA, it was concluded, in part, that:

the competitiveness of the generic swapmarket can be viewed as similar to thecompetitiveness of the US government bondmarket.

Cash- Equities

0.1

However, all increments of savings are

dependent upon liquidity, which is dependent,in large part, on access.

In order to harvest some or all of thispotential, more than just the tools of an ETD-


Average Number of Daily Trades (000s)

Source: ICAP

like operational paradigm must be adopted(as they have been) the guidelines thatgovern access and foster greater diversity

must be adopted as well.

Select OTCD products will enjoy the full benefit of savings from shifting


43/80

p j y g gparadigms; On average, dominance of bid-ask spreads in the cost structurewill mainly be replaced by transaction costs, however

New Cost StructureBuilding a Bridge Across the Global Risk Transfer MarketShifting Paradigms, Shifting Costs

(FOR ILLUSTRATIVE PURPOSES ONLY)Bilateral Paradigm: The primary implicit

cost is the bid-ask spread (BAS), whichcurrently dominates the pricing structure,

15%

50%

10%

Im licit

since price transparency and access arelow. As long as a small group of dealers

control OTCD markets, the BAS willremain wide. In the interdealer market,broker fees are additional.

10%

65% 65%Costs Transformation: Exchange and clearing

fees begin to alter the cost mix; clearingfees primarily for dealer trades; exchangefees for customer trades.

Reform Paradi m: Swa Execution

20%15%

3%30%

70%

5%

Explicit

Facilities (SEFs) and more pervasiveclearing solutions on both dealer andcustomer sides will have a material impacton transaction cost shifts. The greater useof automated execution tools will cause

15% 13% 10%5%

Bilateral Paradigm-

Transformation-

Reform Paradigm-

Limit Scenario-

BAS to compress.

Limit Scenario: TABB Group estimates thatover 90% of OTCD exposures aresufficiently standardized to be applicableto both SEFs and CCPs. Over the longer


Admin / Legal Fees Broker Fees Execution Venue Fees

Clearing Fees Bid-Ask Spread

term, and with the exception of the mostexotic trades, the cost structure of theOTCD and ETD domains will become

nearly indistinguishable.Source: TABB Group


44/80

Transformation from the largely bilateral and highly opaque OTCD market to


45/80

the more automated, multilateral and transparent ETD market will not besmooth; There will be operational switching costs on top of new trade costs

Leaning on ETDsBuilding a Bridge Across the Global Risk Transfer MarketShifting Paradigms, Shifting Costs OTCD Average Trade Costs

(FOR ILLUSTRATIVE PURPOSES ONLY)The ETD side of the Global Risk Transfer

Market provides a clear roadmap for how tobest accomplish the goals of systemic and

$100

$120counterparty risk mitigation.

The costs and uncertainty will increasebefore the return on investment in new tools,processes, personnel and guidelines will berealized.

35%

50%

75%

$60

TABB Group expects that while not all OTCDproducts will enjoy the full extent of ETDcosts efficiencies over the longer term particularly due to the ongoing utility of

certain exotic trade structures the OTCD

42%33%

13%95%

market will enjoy material cost decreases (onan average trade cost basis) principally dueto the high proportion of standard productslike IR swaps, FX swaps, and CDS.

TABB Group believes that there is both

10% 6%

13%8% 8%

Bilateral ParadigmPre - 2007

Transformation2007 - 2010

Reform Paradigm2011 - 2013

Limit ScenarioPost - 2013

precedent and potential for significant overall

trade volume growth in OTCD products oncegreater regulatory clarity is achieved. Thisassumes that greater diversity of accessbecomes central to new guidelines and/or is


Admin / Legal Fees Broker Fees Execution Venue FeesClearing Fees Bid-Ask Spread Margin

Source: TABB Group

ac eve roug srup ve nnova on.

In the meantime, ETD markets willexperience significant growth from diverted

OTCD risk transfer needs.

R l t U d t d S R lt


46/80

Regulatory Update and Survey Results


Off the back of the USs Dodd-Frank Act, OTC derivatives reform has 4i f l ll ith th l f d i t i i k d i i


47/80

primary focal areas, all with the goal of reducing systemic risk and increasingoverall market transparency

Focus High Level Concerns

It is unclear if confirmation-matching utilities could

Execution

Cleared contracts must be tradedon a registered venue (Board of

Trade (BOT) or SEF in the US).

register as an SEF.

If no SEF or BOT offers trading in the product,even if it is centrally cleared, the tradingrequirement does not apply.

Clearing

All products deemed eligible byclearinghouses and regulators mustbe cleared; most corporate end

users are exempt.

Still allows for regulators to instruct clearinghousesas to what products they must clear.

Hedge exemption may create loopholes

Posting additional collateral remains a key concernof dealers and major participants.

ReportingAll OTC derivative transactionsmust be reported to a trade

It is unclear how regulators will monitor thecollected data for systemic risk.

Dealers and major swap

Key definitions, such as dealer and corporate enduser are onl loosel defined to date.

repos ory.

transparency.


Registration

regulators; capital and collateralrequirements will be more tightlyregulated.

How firms are required to register will have adramatic impact on their capital and collateral

needs.Source: TABB Group


48/80


49/80

Trade reporting of all transactions is good for (almost) everyone


50/80

Trade reporting of all transactions is good for (almost) everyone

Focus Overview

Reporting All OTC Derivatives transactions must be reported

Highlights In the US and EU, swaps entered into on or after such date of enactment shall be reported to a registered swap data

repository In the EU a threshold will exist under which corporate end users will not have to report certain trades. A swap repository is any person that collects and maintains information or records with respect to transactions or

positions in, or the terms and conditions of, swaps entered into by third-parties for the purpose of providing a centralizedrecordkeeping facility for swaps. This would include the DTCC Trade Information Warehouse (TIW) or ICAP/TriOptimasinterest rate derivatives repository, for example.

Consequences (intended and unintended) e ey o success or repor ng s proac ve mon or ng. egu a ors nee e p rom e pr va e sec or o o so, as

the CFTCs IT budget in 2009 was only $26 million; investment banks spend an average of more than $1 billion each on ITannually.

More than 90% of CDS trades are already reported to DTCC TIW; but that only helped after the fact with Lehman. Trade repositories have been forming along asset-class lines. While this new level of post-trade transparency is

- -,cross-market risks, which is ultimately necessary to gain a true assessment of systemic and counterparty risks.

Winners and Losers DTCC This requirement will bolster the already strong position of the TIW as they move beyond CDS into equity in

2010/2011. ICAP/TriOptima, with their TIW for interest rates, is another winner here.


Regulators The tremendous amount of new data will provide the information needed to help properly monitor the market;however, the technology to help do so is complex and expensive.

Dealers Greater transparency tends to weaken their dominance over OTCD markets.

Formal registration of swap dealers, execution facilities and clearinghouses


51/80

will be similar to current broker registration with the SEC

Focus Overview

RegistrationDealers and major swap participants must register with regulators;capital and collateral requirements will be more tightly regulated

Highlights

Key goal of passed and proposed legislation, globally ,is registration of systemically-important entities.

In the US, dealers and major swap participants must register with a prudent regulator. It is unclear how the EU willsegment participants, other than expected exemptions for corporate end users.

regu a ors w e y cas a w e ne w en e erm n ng w o qua es as a swap ea er an ma or swap par c pan . sexpected that nearly 200 firms will qualify as swap dealers and the list of major swap participants will be longer still, likelyincluding non-financial companies with large trading entities, since they are systemically important.

Consequences (intended and unintended) Transactions with zero collateral posted will no longer be permitted, whether traded bilaterally or centrally cleared.

Buy-side firms may work to stay below the CFTC / SEC-defined substantial net position threshold to avoid requirementsthat come with being a major swap participant.

If one side of a trade is neither a major swap participant nor swap dealer, clearing and execution mandates will not apply.However, trades will still need to be reported.

Winners and Losers

Regulators A clearer view into who is who in the industry will add transparency aiding the management of systemic risk.

Dealers and major buy-side firms will be forced to follow onerous registration requirements, requiring considerable time


.

Some end users who are based in or active in the US will fall under the jurisdiction of the CFTC and/or the SEC wherethey previously did not. The same will be true in the EU.

While dealers and exchanges are looking to benefit from nearly every facet of


52/80

reforms, other market participants are focusing on areas of core strength

Participants -Trade

ecution

earing

Post-

rade

porting

Data

DataRepository

End User4%

Market Participant Focus Areas Study Participant Demographics

Pr

Ex C

l

Re /

Top Tier Dealers

Emerging Dealers

Dealer29%

Solution

7%

Traditional Buy-Side

Hedge Funds

Exchan e /

IDB

14%

rov er 7%

Exchanges / Clearinghouses

Interdealer Brokers / OTC ExecutionVenues

CCP18%SEF

14%

Data Providers / Aggregators

Top dealers and execution venues will look to provide not only execution access, but also liquidity aggregation and pre-tradeanalytic tools to clients.


Both top-tier and emerging dealers will offerpost-tradeservices beyond simple clearing access, creating a model that buildsupon existing prime services businesses.

Source: TABB Group

Conversations with 28 market participants showed some common ground, but


53/80

conflicting business models bring conflicting views on the impact of reforms

Participants sage/focus

yourfirm?

sage/focus

yourfirm?

viewone-

forOTCD?

nspreads?

acton

issions?

onliquidity?

clearable?

newmargin

rements?

onTrade

sitories?

Top-tier and emergingdealers believe the OTCD and

Stakeholder views onreform

O

TCD

by/of

ETDu

by/of

Firms

trading

Im

pact

Im

com

Impact

%

OTC

V

iewon

requi

View

Rep

Top-Tier Dealers ETD markets will continuetheir growth following reform,

as it will improve broadermarket sentiment.

Nearly all market playersEmerging Dealers Traditional Buy-Side

believe that bid-ask spreadswill tighten and per-tradecommissions will shrinkfollowing OTCD reform. Views

on whether this is good or bad

Hedge Funds Corporate End Users

or qu y er.

OTCD buyers, assetmanagers, hedge funds andend users, are unhappy withnew margin requirements

Exchanges / Clearinghouses Inter-dealer Brokers / OTC

Execution Venues roug on y c ear ng

mandates. It is expected toadd a considerable new costto many parts of the business.

Trade repositories are


Data Providers / Aggregators viewed in a positive light bymost stakeholders, due totransparency. Main concern is

how data will be used.Increase Decrease Same

Positive

Negative

Indifferent

Source: TABB Group

Top-tier dealers will see their preeminent market position challenged;Emerging dealers have a tough battle ahead but will establish themselves in


54/80

Emerging dealers have a tough battle ahead, but will establish themselves inthe new OTC derivatives marketParticipants Sentiment Growth Curve

Top Tier Dealers The major dealers look to continue dominating the OTCD marketdespite an acceptance that flow products, initially vanilla IR swapsand CDS, will move toward a higher volume and lower margin model.

Success

The new business model entails a combination of multi-asset primeservices offerings and a close linkage with the futures business, which

will take on the task of OTCD central clearing.

Trading and clearing businesses within the bank must be kept

High upfront costs for

technology and businessmodel changes will createa challenging environment

Time

separate under Dodd-Frank, however exactly how separate is still upto regulators. Despite the separation, it should be expected thatvalue-added services (both pre- and post-trade) and reducedexecution and/or clearing costs will be offered to those who both

execute and clear with the same firm.

in the short term.

The capital base and one-stop shopping approachmean top dealers will

remain a big part of thismar e .

Emerging Dealers Second-tier swaps dealers and the largest FCMs see OTCD reformsas their golden opportunity to break into this lucrative market.Regulators have made it clear they want execution venues to be openand clearing access to be available to all who meet the requirements. Time

Success

This will allow these new dealers to compete where they were

previously boxed out. The big FCMs will look to offer execution and clearing services that

complement the futures products traded by existing clients. This willallow current clients to trade swaps with their FCM, where in the past

Growth will be slow tostart as new rules areimplemented but, overtime, the new marketstructure will be hugely


ey were orce o go o a op- er ea er.

New dealers will also look to leverage electronic execution platformsmore than the big dealers, as they have little or no existing voice

business to protect.

beneficial.

The buy-side will see better market access and price discovery after adaptingt th t t M t t d ill littl i t


55/80

to the new structure; Most corporate end users will see little impact

Participants Sentiment Growth Curve

Traditional Buy-Side

They have demanded access to clearing since the beginning ofthe OTCD reform debate. The discussion has evolved overtime however, from buy-side firms wanting to be clearing

Success

,existing brokers.

They are generally satisfied with how they execute OTCDtoday. They find ample price discovery via RFQ platforms andvia phone. Had they wanted electronic executions, they would

All but the biggest will be exempt fromclearing so will see little short term impact.

Reform will ultimately create a moretransparency market for buy-side traders

Time

. .

Hedge Funds A move towards electronic trading for vanilla swap productscreates a host of new potential strategies for hedge funds.

The largest hedge funds in the swap space will likely be labeled

as Dealers, formalizing their importance to the market.

TimeSuccess

Dealer status will also require additional reporting anddisclosure that most hedge funds would rather avoid to protecttheir strategies.

reform.

Post-reform business will simply adaptand move on.

End Users End users in the US and Europe will be for the most partexemp rom ra ng requ remen s as ey are no v ewe as

systemically important the costs of clearing are seen as toogreat.

However, some of the largest corporation will fall under thesame category as financial firms based on their activity and

Due to exemptions, end users will see littleshort term change.

Su

cces

Time


.

These firms will likely need to transform non-cash collateral intocash collateral that can be posted at a clearinghouse.

us nesses w con nue o usederivatives to hedge risks with greatertransparency into the market.

Exchanges have the opportunity to extract new business from existing OTCmarkets; Interdealer brokers will act as strong new competition for cleared


56/80

OTC derivatives

Participants Sentiment Growth CurveExchanges /Clearinghouses(CCPs)

Exchanges see opportunity in every aspect of OTCD reform. Everynew CCP is exchange owned, exchanges are experts in executionand they already own and distribute related data to the market.

Time

Success

shape the cleared OTCD market similarly to the US futures market.

It is critical that exchanges do not assume OTCD will fit intotraditional execution and clearing models. Exchange listing will bereplaced with platforms that facilitate price discovery and executionof constantl evolvin OTCD contracts.

Execution, clearing and data allpresent huge opportunities forexchanges.

Competition will come from newangles creating a hyper competitive

. an scape.

Interdealer Brokers(IDBs) / OTCExecution Venues

(SEFs)

IDBs already control the majority of OTCD executions as dealer-to-dealer trading dominates the market.

Client -focused platforms, some independent and some dealer

owned, already have models in place to trade OTCD electronically Time

Success

that make their transition to SEFs straight forward.

In both cases, a mandate to trade certain OTCD via a regulatedplatform will only drive more trading towards IDBs and independentplatforms.

flow to the platforms.

Competition will be intense withonly a handful surviving

Aggregators

,requirements will create data for OTCD markets that never existed

before.

Traditional market data providers and existing OTCD focused datafirms see the reform as a huge opportunity to expand into newroducts.

The market will be saturated asdealers, exchanges and IDBs all

Time

Success


.

The new market data availablewill create lasting business lines

and new products.


57/80

Appendices


58/80

pp



59/80


60/80

Within Rates derivatives, a majority of activity is skewed to short term (


61/80

new insight: 3.8 million trades averaging $126 million each in Oct 10

5%4% 3%

7%

6%6%

5%

ETD RatesNotional Open Interest

71

45

73 Short Term Skews

ETD rates exposures are almostentirely short term, with maturities< 1 year. These figures are

95%96% 97% 94% 94%

2004 2005 2006 2007 2008 2009 2010e

STIR (< 1y) LTIR (> 1y) $ trillion

partially skewed by standardproduct durations of 3-, 6-, 9- and

12-months which are often rolledfrom the expiring front month to asubsequent month.

34% 33%

30% 30%

26%

26%33% 34%

30%30%

Notional Values Outstanding

191

480393

191

OTCD rates are much morebalanced across tenors - on anotional outstanding basis withonly moderate bias to maturities of1 year or less.

33% 33% 36% 32%33% 40% 40%

41% 41%

2004 2005 2006 2007 2008 2009 2010eSTIR (< 1y) MTIR (1 - 5y) LTIR (> 5y) $ trillion

29% 26% 26% Exposures by Maturity

e new n eres ra e ra erepository provides asset classdetail with bi-monthly updatefrequency and limited lag time.Because of this informationwarehouse observers can

6% 4%8%

2%

OTC Interest Rates Trade Repository October 1, 2010,

calculate metrics and conduct

comparative analysis that couldnever be done before with muchaccuracy. As of October 1, 2010,average trade size was $126

TABB Group The Global Risk Transfer Market | Nov 2010 61Source: BIS, WFE, ICAP/TriOptima, TABB Group

0 - 2y 2 - 5y 5 - 10y 10 - 15y 15 - 20y 20 - 30y 30y +

Notional Oustanding Trades (italics)

million, representing 3.8 milliontrades. The largest trades beingOIS (


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activity in the GRTM; Eurodollar futures and options alone represent 10%

1,981

ETDETD Rates and combined (OTCD and ETD) Rates represent 47% and 66%, respectively, of

estimated total 2010 notional turnover of $3.7 quadrillion.

3 exchan e rou s CME Eurex and NYSE Liffe re resent at least 80% of the ETD Rates

High concentrations, few products

1,764notional turnover figures, or $1.35 quadrillion in 2009. Estimates of notional turnover by thesesame groups in 2010 is $1.7 quadrillion. Within these 3 exchange groups, the top 10 Rates

products led by Eurodollar futures represent over 80% of notional turnover.In OTCD, 85% of exposures are in vanilla swaps, forward rate agreements (FRAs) and OISs.

CCPs handle the largest trades, which are less than 2y maturities, averaging $839 million per

36

trade; non-G14 dealers handle the smallest trades (10-15y maturities averaging $61m per trade).

NOTE: G14 dealers include Barclays Capital, BNP Paribas, Bank of America-Merrill Lynch, Citi,Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, J.P. Morgan, Morgan Stanley, RoyalBank of Scotland, Socit Gnrale, UBS, and Wells Fargo

28

2322

25

676

ions

OTCDNotional Outstanding / Open InterestNotional Turnover / VolumeTurnover Frequency

71

1.3

.

1.81.4

1.4US$Trill


1998 2000 2002 2004 2006 2008 2010e1998 2000 2002 2004 2006 2008 2010e

Dashed points are interpolated estimatesSource: BIS, WFE, TABB Group


63/80

Regional breakdowns for Rates are unique relative to their respectivesegments of the GRTM; Less concentration in APAC overall


64/80

g ;

Americas,

ETD Short Term RatesNotional Turnover - 2009

A consistent theme of this analysis is that both ETD and OTCDexposures are over-weighted to the West relative to the distributionof economic activity around the world.

Regional Breakdowns

EMEA, 47%

With at least 32% of global GDP in 2009, TABB Group expectsAPAC derivative markets to grow significantly in the future. The

main argument against this expectation is whether risk transfer inAPAC-centric interest rate derivatives is being conducted in otherregions, thereby decoupling risk transfer from geography. Though

APAC, 2%

ETD Long Term Rates OTCD

likely, it should be combated by APAC dealers and exchanges.

Of all the recent gains in transparency in OTCD exposures, regionalactivity remains among the least transparent.

Americas,62%

APAC,6%

Notional Turnover - 2009Americas,

26%

APAC, 9%

Notional Turnover 2010e

EMEA, 32%

EMEA, 65%

TABB Group The Global Risk Transfer Market | Nov 2010 64Source: BIS, WFE, TABB Group


65/80

Detailed Analysis:Credit Default Swaps


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Credit Default Swaps


CDS usage, measured by outstanding notional, has leveled out following itstwo-year decline from the peak in late 2007; Slight growth expected in 2010


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60 OTC Credit DerivativesNotional Outstanding

Outstanding notional grew to nearly $60 trillion atits 2007 peak. Major drivers for growth includelowering capital requirements, hedge against

CDS Total Outstanding Notional

40

mor gage on s, an as everage o crea esynthetic CDOs.

CDS began its slide in early 2008. Trade

compression efforts drove the majority of the drop. Although the market will see transaction volumes

-

30

S

$Trillions

41%

5%

Frank; the outstanding notional will grow onlyslightly as trade compression is now part of thestatus quo.

Exchange-Traded Equivalent

10

20

54%

o rec compar son ex s s or n . Eurex lists futures on the iTraxx index, but as of

September 2010 there was zero open interest. As centrally cleared CDS begin to grow, it is more

likely the market will see a move to cleared swaps

- Financial firms still account for the majority of CDSholdings, with reporting dealers accounting for54% of the outstanding notional in 2010.

Market Participants

.


Reporting dealers (net)Other financial institutionsNon-financial institutions

Source: BIS, DTCC, TABB Group

Usage by non-financial firms has grown to 5% frombelow 1% in 2004 driven largely by efforts tostandardize CDS contracts and the tradinglifecycle.

The credit crisis deflated a bubble in CDS holdings by special purposevehicles that peaked in 2007


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Special Purpose Vehicles (SPVs), also referred to as Special Purpose Entities (SPEs), are legal entities set up for a sole purpose;as it relates to this study. SPVs are used to hold the assets associated with Asset Backed Securities, Collateralized DebtObli ations and other like structured roducts.

SPV CDS Holdings Outstanding Notional

Leading up to the credit crisis, instead of actual mortgage bonds, SPVs would hold CDS on underlying mortgage bonds to create asynthetic CDO, since the CDS provided similar, yet leveraged, exposure to the underlying mortgage pool.

As the credit crisis caused the creation of these structured products to effectively cease and many existing SPVs to unwind, SPVCDS holdings dropped off dramatically from their height in 2007 to the end of 2009.

10,000 OTC Credit Derivatives

The low CAGR from 2005-2009 compared to the sharp growth and decline that occurred in the same period clearly defines theCDO bubble.

6,000

8,000

US$Billions

2,000

4,0004y CAGR 5%


2,559 3,696 5,639 8,460 10,778 9,216 4,608 3,888 3,119-

2005-H2 2006-H1 2006-H2 2007-H1 2007-H2 2008-H1 2008-H2 2009-H1 2009-H2Source: BIS


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Single-name CDSs, arguably the most complex product to be centrally clearedsafely, are becoming increasingly popular at ICE Trust US and ICE ClearEurope


70/80

Europe

20

25

150

175

200

Thousands

ns

ICE Trust USSingle-Name CDSs

Euro Index13%

ICE CDS Clearing - Global Notional Outstandingby Product Type

5

10

5075

100

US

$Billi US Single

22%

US Index31%

34%

--

25

300 nds Single-name CDS are complex to clear due to low liquidity and

Single-Name CDS Overview

ICE Clear Europe

o a : on(August 2010)

Single CDS are difficult to clear due to low liquidity and

15

20

150

200

250Thousa

S$Billions

.needed for margin must be done via mark-to-model process.Models must then predict how likely a credit event is. Despitecontinuous modeling of default scenarios of reference entitiesand clearing members, it is unclear how and if existing singleCDS clearin models mutualize risk as effectivel as believed.

ng e- ame s . -infrequently, margin must be calculated via marking-to-model,with assumptions on default likelihood incorporated. Despitecontinuous modeling of default scenarios, it is unclear howand if existing single CDS clearing models mutualize risk aseffectivel as assumed.

-

5

-

50

100U

Open interest for single CDSs has grown more quickly in theUS than Europe as new legislation in the US is set andregulations are forthcoming. Assuming an FX rate of 1.3,

Single-Name Central Clearing

Open interest for single CDSs has grown more quickly in theUS than Europe as new regulations are forthcoming.Assuming an FX rate of 1.3, average trade size in the US and


Open Interest TransactionsSource: ICE, TABB Group

average trade size in the US and Europe are similar at nearly$8 9 million / trade. The growth in single CDS clearing fallsin line with their increasing popularity over index CDSs asdiscussed earlier.

Europe are similar at nearly $8 - 9 million per trade. Thegrowth in single-name CDS clearing is a result of theirincreasing popularity over index CDS.

CDS contracts that reference corporate debt account for the majority ofoutstanding notional with over 80% held in Europe and the Americas


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Japan3%

Asia Ex-Japan

Top 1000 Reference Entities - Net Notionalby Country

LCDS1% RMBS

1%

Top 1000 Reference Entities - Net Notionalby Type

Other10%

NZ2%

Sovereign17%

Other8%

State Body1%

Europe41%

Americas41%

Corporate

72%

CDS usage is primarily focused around the hedging and investing against corporate debt. Corporate debt accounts for nearlythree-quarters of the outstanding notional among the top 1000 reference entities.

Sovereign debt has also become a focal point for CDS traders following the European debt crisis that came to a head in the spring

Total New Contracts - Quarterly


Source: DTCC

. CDS contracts exposed to risks in Europe and the Americas account for over 80% of the top 1000 contracts. This is among the

main reasons why the global focus on OTCD reform has been placed at the feet of US and EU legislation and regulation.

Total turnover of CDSs is up since early 2009, although net notional changehas been negative


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12175

100125 Change - Total Number of Contracts

The net change in number of opencontracts from January 2009 toSe tember 2010 was u nearl

CDS Trading Volume

The net change in number of opencontracts from Jan-2009 to Sept-2010 was nearl 187,000. The net

56

(63)

62

(3)

42

(29)(25)

-

25

Thou

sands

187,000. The net change in notionaloutstanding during the same period

however was down $3.4 trillion. Trade compression efforts, netting

via clearin houses and the entrance

change in notional outstanding duringthe same period, however, was a

decline of $3.4 trillion.

Trade compression efforts, netting

(75)

(50)Sum of changes = 186.900 contracts

,of more short term traders are drivingvolumes up while keeping notionallevels in decline.

Average trade size has remained

v a c ear ng ouses, an e en ranceof more short term traders are drivingvolumes up while notional levelscontinue to decline.

Average trade size has remained

684 814

-

500

1,000Change - Total Notional Outstanding

trade, however TABB Group sees ashift towards smaller trade sizes asthe move towards an electronicallytraded, centrally-cleared worldbegins.il

lions

steady at roughly $24 million pertrade. TABB Group sees a shifttowards smaller trade sizes as theactivity moves toward anelectronically-traded and centrally-

(1,930)

(1,332)

(638) (801)

(1,000)

(500)

Sum of changes = $(3.42) trillion

Furthermore, the growth in the third

quarter of 2010 signals the marketsperception of some regulatorycertainty following the passage of theDodd-Frank Act in the US, the EUs

US

$c eare env ronmen .

Growth in 2010:Q3 signals themarkets perception of someregulatory certainty following theassa e of the Dodd-Frank Act in the


(2,000)

(1,500)

Source: DTCC

proposed framework, and progressby US regulators in the rule writingprocess.

US, the EUs proposed framework,and progress by US regulators in therule-writing process.

The number of new contracts created quarterly has grown, while averagetrade size has remained consistent


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60

80

ousands Average Weekly CDS Trades

By Quarter The writing of new CDS trades hasbegun to accelerate after stagnatingthrough the credit crisis.

Total New Contracts - Quarterly

20

40Th

The launch of ICE Clear US in 2009coupled with a move towardsstandardization of contracts and creditevent management has driven growth.

-

Avera e Weekl CDS Trades

Net contract volume has experiencedperiodic quarterly declines although thiscan be attributed to trade compression.

Total New Contracts - Weekly

30

40

50

80

100

120

Millions

ousands

and Average Trade Size

By Week

The weekly view shows considerablymore volatility in contract creation andaverage trade size throughout the period.

Credit events and macroeconomic datasuch as the Euro ean debt crisis in the

-

10

20

-

20

40 UST

h

spring of 2010) have had measurable

impacts on the CDS market.

Recently, average trade size is trendingslightly below the 2009-2010 average of


Source: DTCCNew Trade Avg Trade Size Linear (Avg Trade Size)

m on per con rac , u averagetrade size has remained remarkablyconsistent over the past 18-22 months.

Detailed Analysis:Other Major Asset Classes


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The limits of the ETD structure is illustrated by strong demand for OTC equityderivatives


75/80

14.015.0

Equity Derivatives ComparisonNotional Outstanding / Open Interest

Drivers for OTC equity derivatives

Despite the fact that the cash market isexchange-traded and that most global marketshave vibrant equity ETD markets, there is still

1.3

12.5

significant usage of OTC equity derivatives,globally.

In some markets, such as London, the drivers forthe use of OTCD instruments are related to taxconsiderations.

1.1

7.5

10.0

$Trillions Equity swaps are also widely used to access

emerging markets, where owning the underlyingshares can be restricted and / or come withsignificant post-trade clearing and settlement

headaches.

4.1

5.3

0.6

5.0

U In the US, many institutional investors choose to

trade look-a-like contracts that have all the sameparameters as an ETD option, but are tradedand cleared on a bilateral basis. TABB Groupbelieves that these contracts will become

4.4 8.5 7.0-

2.5

2004 2005 2006 2007 2008 2009 2010e

centrally-cleared under the new regulations.

Exchanges have tried to launch many features ofthe OTC options market with such products asbinaries, knockouts and barriers, with limited


OTCD ETD Ratio OTCD / ETD


. ,strategies anonymous and dealer efforts toprovide attractive product sets have limited theirappeal to investors.

OTCDs and ETDs for equities exhibit the most similar behavior relative allother asset classes


76/80

277ETD - EquityDrivers of Turnover Frequency in Equity Markets

A substantial portion of the equity OTCD market is similar in structure to the ETDmarket. As a result, the skew caused by short-term expirations is not as prevalent hereas in other OTCD asset classes, particularly interest rate derivatives.

Drivers of Turnover Frequency in Equity Markets

Contracts-for-Differences and Total Return Swaps have higher turnover levels sincethey are used as a substitute for cash instruments. These products are designed to be

liquid and cost-effective for investors.

41

OTCD - Equity

, ,turnover ratios than other equity OTCDs. These types of instruments provide cost-effective strategies to reduce risk, particularly against specific Black Swan events.

109

24

2185

66ions

ot ona utstan ng pen nterestNotional Turnover / VolumeTurnover Frequency

1458 7

10 10 9

US$

Trill


2004 2005 2006 2007 2008 2009 2010e2004 2005 2006 2007 2008 2009 2010e


The FX market has traditionally been dominated by OTCDs, though adoptionof ETDs has been rising in recent years


77/80

23%1,200

1,400

s

OTCD FX Notional Turnover(includes Spot transactions)

1,079

1,274

Drivers of FX Derivatives

The FX market is dominated by non-US entities looking to hedgeexposure to US dollar-denominated

54%

58% 57%23%

23%

Documents

Developpments in OTC Markets