EU Regulatory Changes and Its Impact on Korea March 2014

DEUTSCHE BANK GROUP

Deutsche Bank

Contents

1

1. Executive Summary

2. Status of Cross-Border Trades

3. Why is equivalence so important?

4. Status of CCPs in Korea

5. Recommendations for CCPs in Korea

Deutsche Bank

Contents

2

1. Executive Summary

2. Status of Cross-Border Trades

3. Why is equivalence so important?

4. Status of CCPs in Korea

5. Recommendations for CCPs in Korea

1. Executive Summary

3

Global Snapshot of Derivatives Reform Most rules finalised Most rules proposed Very early stage

We have focused our analysis on 8 key jurisdictions: U.S., EU, Canada, Brazil, Japan, Hong Kong, Singapore and Australia

4 Deutsche Bank

Summary Timing Overview

2012

2013

2014

Proposals on most rule making areas

Over 90% of rules finalised by CFTC

Implementation of most requirements

July 1: New ISDA protocol deadline

Final rules on margin for uncleared

swaps

EMIR entered into force

Issuance of several technical standards

Implementation of several technical

standards (e.g. risk mitigation tech-

niques)

Consultation on EU-margin proposal in

Q1 2014, final adoption by Q1 2015

Implementation of reporting and clearing

requirements

Consultation papers addressing most

rulemaking areas issued

Detailed proposals on reporting adopted

in Ontario, Québec and Manitoba

CSA proposals on model clearing rules

Start of reporting requirements in

Ontario, Québec and Manitoba

Provincial clearing rules to be adopted

Legislation on reporting adopted Regulation on pension eligibility for OTC

trading expected

Continued compliance with pre-existing

regulation

Implementation of central clearing rules

Financial instruments and Exchange Act

amended

Post trade reporting implemented

Consultation and conclusion papers on

broad derivatives reform introduced

Legislation proposed which includes

clearing and reporting

Further consultation on regulations

expected 4Q 2013

New legislation expected to take effect in

2Q 2014

Consultation and legislation on central

clearing and post-trade reporting

obligations introduced

Further consultation on reporting and

clearing

Licensing requirements for CCPs and

TRs effective

Clearing requirements to become

effective in H1 2014

Commencement of trade reporting

Legislation adopted

Finalised post-trade reporting

requirements

Review of whether to introduce

mandatory clearing for certain products

led to recommendation of mandatory

clearing for interest rate derivatives

denominated in GBP, EUR, JPY & USD

Further OTC derivatives market

assessment early 2014 to determine

whether additional requirements for

clearing should be recommended

Phasing in of reporting requirements

5 Source: FSB: Sixth progress report on implementation of OTC derivatives market reforms (September 2013)

Summary Rules Overview

Central

Clearing

Exchange

Trading

Post-Trade

Reporting

(to the market)

Post-Trade

Reporting

(to the regulator) Margin

(for centrally cleared

contracts)

(final details TBD)

(for centrally cleared

contracts)

(final details TBD)

Global regulators

monitored progress by

the BCBS-IOSCO

Working Group on

Margining

Requirements;

(guidance on margin

rules published by

BCBS-IOSCO 2

September13)

(early stage)

Voluntary for most products

“” Indicates general scope of regulatory reform

6 Deutsche Bank Source: FSB: Sixth progress report on implementation of OTC derivatives market reforms (September 2013)

Infrastructure Status Update – Clearing Houses

Clearing House Status

Interest

Rate Credit FX Commodities Equities

CME Group Operational Expected

ICE Credit Clear Operational

LCH Clearnet Operational

Options Clearing Corp. TBC Expected

CME Clearing Europe Operational Expected Expected

Eurex Clearing Operational Expected

European Commodity Clearing Operational

ICE Clear Operational

LCH Clearnet Operational

CDCC Operational Expected Expected

JSCC Operational

HKEX Operational Expected 4Q

2013

Expected

4Q 2013

SGX-DC Operational

BM&F Bovespa Operational

ASX Operational

7 Deutsche Bank Source: FSB: Sixth progress report on implementation of OTC derivatives market reforms (September 2013)

Infrastructure Status Update – Trade Repositories

Source: Unconfirmed public sources/internet

Reporting Repositories Status

Interest

Rate Credit FX Commodities Equities

Listed

derivatives

CME Group Operational Not

DTCC-DDR Operational applicable

ICE Trade Vault Operational for US

DTCC-GTR Europe tbc

Regis-TR tbc

ICE Trade Vault tbc tbc

CME Group tbc tbc

KDPW tbc tbc tbc tbc

UnaVista tbc

Capital Track tbc tbc tbc tbc tbc tbc tbc

8 Deutsche Bank

Infrastructure Status Update – Trade Repositories

Source: FSB: Sixth progress report on implementation of OTC derivatives market reforms (September 2013)

Note: Registration of European trade repositories due to open in February 2013

Mexico,

Canada

Reporting Repositories Status

Interest

Rate Credit FX Commodities Equities

DTCC Data Repository Japan Operational

HKMA Expected 4Q 2013

DTCC Singapore Expected 1Q 2014 Expected Expected Expected Expected Expected

BM&F Bovespa Operational

CETIP Operational

DTCC Australia Expected 1Q 2014

9 Deutsche Bank

Deutsche Bank

Contents

10

1. Executive Summary

2. Status of Cross-Border Trades

3. Why is equivalence so important?

4. Status of CCPs in Korea

5. Recommendations for CCPs in Korea

2. Status of Cross-Border Trades

10

Deutsche Bank

3/20/2014

Source: Financial Stability Board OTC Derivatives Market Reforms Fifth Progress Report on Implementation, April 2013 12

OTC derivatives Jurisdictions are making progress on implementation of derivatives reforms

Changes needed to implement the G20 OTC derivatives commitments are

underway across all FSB jurisdictions

As rules take effect, uncertainty about the treatment of cross-border activity will

become a more pressing concern

“Regulators should continue to cooperate in the cross-border application of regulations, to

enable them to defer to each other where these achieve similar outcomes….

Detailed work, and a timeline for action, is thus needed to address the challenges in

translating the encouraging recent cross-border regulatory understandings into practice”

~ Financial Stability Board, September 2013

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OTC derivatives Key risks of divergence

Scope of

counterparties covered

Scope of counterparties covered in each jurisdiction differs and some rules have extra-

territorial effect – e.g. some aspects of EU legislation apply to non-EU counterparties,

though not clear if non-financial counterparties are in scope

Issue Risks

Margin requirements

for non cleared

derivatives

For cross-border trades, margin models need to be agreed by counterparties and must

be approved in each jurisdiction.

CCP memberships

Under Article 25 of EMIR, for EU banks to continue to be members non-EU CCPs they

must apply for recognition by ESMA and receive an equivalence determination from the

EC within a fixed time period.

Conflicting clearing

obligations

For cross border trades, CCPs must be recognised by both jurisdictions, to satisfy

clearing obligations. If regulators define conflicting criteria, it will be difficult for

CCPs/cross border trades to satisfy both rules

Intragroup transactions Approval from clearing and margining for cross border intragroup transaction

exemptions depends on equivalence determinations and approval from both regulators

Reporting requirements Trade repositories and swap execution venues need to be able to meet criteria for

recognition in both jurisdictions for cross-border trades. Reporting requirements are not

the same between the EU/US

Overlapping rules The proposed definition of US persons will result in many entities captured by

transaction level rules (margin/clearing). E.g. an EU branch of a US bank will be

subject to these rules when dealing with a US counterparty, in addition to EU rules

Platform bifurcation

Derivatives platforms based anywhere may be bound by US rules if they trade with a US

counterparty. Could result in fragmented liquidity if platforms split their offerings into US

and non-US trading pools

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OTC derivatives Approaches to equivalence assessments

14

Other

Jurisdictions

European

Union

United

States

Substituted compliance

The CFTC evaluates whether foreign regulatory requirements are

comparable and comprehensive

Granted on a firm-by-firm and requirement-by-requirement basis (rather than

an analysis of a foreign jurisdiction’s regulatory regime)

Temporary relief for certain transactions and entities to allow for timing

differences between US and other rules

Equivalence assessment

The European Commission can adopt rules determining that the legal,

supervisory and enforcement arrangements of a third country are equivalent

to the EMIR rules in relation to clearing, reporting and requirements for non-

cleared derivatives

Most APAC jurisdictions have included some form of recognition provision in

their framework for clearing and reporting, although as yet there is little detail

on the process and how they will determine whether to rely on home

regulators

At a global level regulators are working together to identify ways to manage rules on a cross-

border basis:

Deutsche Bank

An international approach Understandings to resolving cross border issues?

15

On 30 August 2013, representatives of Australia, Brazil, the EU, Hong Kong, Japan,

Ontario, Quebec, Singapore, Switzerland and the US agreed to:

Consult and communicate when equivalence or substituted compliance assessments are

being undertaken

Take a flexible, outcomes-based approach to assessments

Take a stricter-rule applies approach to gaps in trading or clearing requirements

Consult ahead of determining mandatory clearing determinations

Remove barriers to reporting to trade repositories by market participants and to access

to trade repository data by authorities

Provide for appropriate transitional measures and a reasonable but limited transition

period for foreign entities

However, the process for implementing these understandings remains to be developed

“The Principals agree to deal pragmatically through the ODRG, other multilateral groups,

and/or on bilateral bases, as needed, with a view to ensuring that the G20 goals are met

while also aiming to minimise disruption and legal uncertainty.”

~ OTC Derivatives Regulators Group (ODRG), August 2013

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Contents

16

1. Executive Summary

2. Status of Cross-Border Trades

3. Why is equivalence so important?

4. Status of CCPs in Korea

5. Recommendations for CCPs in Korea

Deutsche Bank

Equivalence is the mechanism by which an authority in one jurisdiction considers the

extent to which it can rely on another jurisdiction’s regulations

How can equivalence be assessed?

Equivalence judgments – one country reviews legislation and rules in another to

assess the extent to which they are the same and may then adjust local

requirements accordingly

Substituted compliance – a regulated firm from one country is allowed to comply

with foreign regulations if those rules are deemed to be equivalent, with decisions

made on a case-by-case basis

Mutual recognition – bilateral or multilateral agreement to recognise regimes and

allow direct access to markets

With the trend towards increased globalisation and the large number of global regulatory

reforms, getting equivalence right is becoming increasingly important

Why is equivalence so important? What is equivalence?

17

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If implemented appropriately, equivalence can:

Support consistency and convergence of practices, and cross border passporting

Reduce duplicating, conflicting or complex requirements arising from

extraterritoriality

Support cross-border activities of financial institutions, corporates and consumers,

which will improve:

– access to funding and capital

– risk and liquidity management

– access to services and products

Ensure fair, transparent and efficient markets and investor protection

Why is equivalence so important? Equivalence is essential to cross border trade and capital flows

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“We are committed to take action …. to raise standards together so that our national

authorities implement global standards consistently in a way that ensures a level playing

field and avoids fragmentation of markets, protectionism, and regulatory arbitrage”

~ G20 Communiqué, Pittsburgh 2009

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Why is equivalence so important? Benefits from equivalence require common approaches on cross-border basis

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However, whether these benefits can be realised will depend on how equivalence

is implemented. Challenges include:

Judgments being made against different standards (e.g. local rules versus global

standards)

Timetables not taking into account implementation status in other jurisdictions

Insufficient adaptation to local context (e.g. legal frameworks, market development)

“Differences in approaches are emerging in some areas that could weaken the effectiveness

of reforms in these markets, create potential opportunities for regulatory arbitrage, or

subject market participants and infrastructures to conflicting regulatory requirements.” ~ Financial Stability Board (FSB), April 2011

“We will not seek to apply our rules (unreasonably) in the other jurisdiction, but will rely on

the application and enforcement of the rules by the other jurisdiction.”

~ US Commodity Futures Trading Commission (CFTC) and EU joint announcement on cross-border

derivatives, July 2013

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Risks of fragmentation Benefits from equivalence require common cross border approaches

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1. Disruption of cross border activity – lack of a proportionate approach to

equivalence may disrupt the risk management activities of multinational companies,

reduce liquidity in certain jurisdictions and create legal uncertainty

2. Competitive distortions – lower standards in one jurisdiction create competitive

advantages, unnecessarily restrictive standards damage competitiveness

3. Trapped capital – rules which ring fence capital within borders can undermine global

flows of capital and potentially increase financial stability risks

4. Regulatory arbitrage – fragmented rules create damaging opportunities for

arbitrage

5. Undermining cross border resolution – if national resolution regimes are not

recognised on a cross border basis the resolution of cross border banks will be

difficult, creating financial stability risks

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Increased quantum of regulation

~14,200

2012

~17,800

2011 2010

~12,200

2009

~10,100

2008

~8,700

US Europe Asia

Structural reform

(Vickers, Volcker, Liikanen)

Financial Transaction Tax

Recovery and resolution

regime

Bank levies

Compensation reform

Foreign banks capital

requirements

Some softening of

some proposals

Significant additional regulation

Aim for open but well-regulated markets

Number of document changes, announcements and

enforcements by regulatory agencies

Fragmentation of regulation

Source: Thomson Reuters Accelus

Examples

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Risks of fragmentation The risks of fragmentation have increased

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United States

2012

APAC

2013

The Fed laid out plans for future US bank reforms that go beyond an international agreement

~FoxBusiness, 2 July 2013

Japan delays cross-border

rules amid US and

European uncertainty

~AsiaRisk, 22 May 2013

― Prudential rules / Basel 3

― Volcker / Swaps push out

― No likelihood of “functional”

reforms

Regulators committed to

implement global reforms,

but in a way that supports

market development and

often only once there is

clarity on EU and US regime

EU

Additional recent proposals

affecting European banks:

― Bank structure reform

― Financial transaction tax

― CRD 4 incl. comp reform

European banks warned to

expect tougher scrutiny

~Financial Times, 16 May 2013

US has increased pace

and tightened regulations:

Risks of fragmentation International coordination in a fragmented environment is challenging

However, through the G20/FSB and international standards setting bodies like IOSCO

and the BCBS, we have a framework through which these challenges can be resolved

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G20 endorsement of equivalence principles must be unequivocal by the entire membership

Agreements intended to support consistency should not be undermined by national implementation

Political reality and policy-making processes may still result in local variations in practices, but should expect

shared objectives and alignment with global agreements

Primary legislation and regulations should reflect or reference global standards

Outcomes-focused approaches will allow for differences between jurisdictions

Prescriptive approaches will inevitably result in fragmentation - undermining coordination and consistency

needed for stability and growth and to support cross-border activity

Equivalence should not equate to the exporting of detailed rules to another jurisdiction or ultra vires regulation

Impact studies should consider implications for other jurisdictions

Recommendations Guiding principles for assessment approaches

23

National implementation should take into account the global dimension

The G20 standard must be the standard

Extraterritorial impacts should be avoided

Deutsche Bank

Contents

24

1. Executive Summary

2. Status of Cross-Border Trades

3. Why is equivalence so important?

4. Status of CCPs in Korea

5. Recommendations for CCPs in Korea

Deutsche Bank

STATUS OF CCPs in KOREA Legal Framework

25

Legal Framework

Financial Investment Products under the FSCMA in Korea

Exchange–traded

derivatives

OTC derivatives

Securities Derivatives

KRX

KRX

- Existing CCP for

exchange – traded

derivatives

- New CCP for OTC

derivatives (KRW IRS)

- Mandatory clearing

starts June 2014

Deutsche Bank

STATUS OF CCPs in KOREA Timeline

26

Current Status

1. The Amendment to the FSCMA mandating the CCP clearing for OTC derivatives has become effective as of

6 July 2013.

2. The Amendment to the Enforcement Decree of the FSCMA has become effective as of 9 July 2013.

3. FSC issued an amendment to the Detailed Rules of FSCMA on 9 July 2013 in which the effective date for

such mandatory clearing is set for 30 June 2014.

4. FSC endorsed a CCP license to the KRX in September 2013.

5. KRX has applied for the EMIR recognition before 15 Sept 2013 deadline.

6. Mandatory CCP clearing for the KRW IRS transactions has been set for 30 June 2014 by the FSC.

7. ESMA has issued a final report on “Technical advice on third country regulatory equivalence under EMIR –

South Korea” on 1 Oct 2013.

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Contents

27

1. Executive Summary

2. Status of Cross-Border Trades

3. Why is equivalence so important?

4. Status of CCPs in Korea

5. Recommendations for CCPs in Korea

Deutsche Bank

Clearing rules indicate a clear relationship between the CCP, its members and clients of the member.

Clear client protection. Clear segregation and portability requirements.

FSC, FSS and KRX’s willingness to cooperate with foreign regulators.

Inevitable that national laws will not match perfectly

(i) legal framework – laws & regulations, clearing rules

(ii) regulatory bodies – FSC, FSS and BOK

Extraterritoriality issues – FSCMA, “Real Name Act”, etc.

Principles for Financial Market Infrastructure (PFMI)

The FSB has identified six priority areas where consistent and comprehensive implementation of reforms is

critical for global financial stability: Basel Framework, OTC Derivatives Market Reform, Compensation

Practices, G-SIFIs, Resolution Frameworks and Shadow Banking

Effective recovery and resolution processes

Recommendations for CCPs in Korea

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Challenges - Compliance with global standards

Positive features of Korea Exchange as a CCP

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Resolution Frameworks FSB Key Attributes for Resolution Regimes in early stage of implementation

Recovery &

resolution plan Bail-in of creditors

Resolution

financing Resolution tools

Approach to bank

structure

FSB Key

Attributes

USA Dodd-

Frank Act

EU Recovery

& Resolution

Directive1

APAC

jurisdictions2

Group level plans

for global

systemically

important banks (G-

SIBs)

Power to write-

down/ convert

creditor claims

Either ex-ante

resolution funds or

ex-post funding

mechanism

Powers to sell,

separate assets,

create bridge bank

Powers to make

structural changes

to ensure

resolvability

Group level for

largest US banks

US plans for largest

foreign banks

Transfer powers

have similar effect

Due to propose

layer of loss-

absorbing debt

Temporary loan to

FDIC recouped

through ex-post

levies

FDIC can take over

operating entities of

banks in a trust

Same as FSB for

US banks

Largest foreign

banks to create

holding company

Individual institution

and group level

plans

Statutory regime to

bail-in broad scope

of bank liabilities

Resolution funds

ex-ante funded to

1% of covered

deposits

Powers to sell,

separate assets,

create bridge bank

and apply bail-in

Same as FSB

under proposed

legislation

Possible

requirement for

separation

Australia & Japan

require RRPs for

systemic local

banks

China considering

RRPs

Transfer powers

have similar effect

Japan considering

contractual bail-in

No dedicated funds

Japan & Australia

propose to use

deposit insurance

funds

Resolution regime

for banks in

Australia,

Indonesia, Japan,

Korea, Singapore

Indonesia, Korea

and Singapore

have powers to

require changes

1RRD not yet finalised, based on European Commission proposal, June 2012 2 Source: Asian bank resolution regimes, Clifford Chance, May 2013

Deutsche Bank 30

Resolution Frameworks What are the consequences of a lack of international coordination?

Single Group Recovery and Resolution Plan

Works with the grain of consolidated

supervision and group-wide bank management

Most appropriate for centrally structured banks

using “Single Point of Entry” (SPE) strategy

Multiple Local Recovery and Resolution Plans

Reassures host authority that operations of

foreign banks can be safely resolved

More suitable for banks with many subsidiaries

to take “Multiple Point of Entry” (MPE) approach

Multiple

recovery and

resolution

plans

Multiple RRPs may lead to multiple resolution strategies and lack of clarity in a resolution event

Group-wide approach to loss absorbency

Minimum bail-in requirements should be set at

the most appropriate level for resolution plan

For SPE, this will be at group level while solo

level requirements are appropriate for MPE

Fragmented approach to local requirements

Duplication of bail-in minima at group and solo

level will require significant debt issuance

Financial stability implications of wholesale

funding with no clear business purpose

Multiple

levels of

resources

for bail-in

Multiple requirements for bail-in may distort bank funding markets and individual bank structures

Cooperation and coordination

Firm-specific cooperation agreements identify

barriers to coordination ahead of a crisis

National regime recognises foreign action and

minimises impact on overseas financial stability

Effective or actual national ring-fencing

“Plan B” assumption of no cooperation becomes

default option in a crisis when trust is low

Incentivises national requirements to hold capital

onshore or subsidiarise, trapping capital flows

Incentives

for national

ring-fencing

Without confidence in coordinated action, countries may require national subsidiarisation

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