Stephen Thompson CFAManager of Derivatives and Quantitative EvaluationProvince of Nova ScotiaLiability Management and Treasury Services

Occupational Hazard

Allied Irish Bank ($700 million) Amaranth ($6 billion) Barings ($1 billion) Daiwa ($1 billion) Enron Counterparties (Several over $1

billion) Kidder Peabody ($350 million) LTCM ($4 billion) Midland Bank ($500 million) Société Générale ($7 billion) Subprime Mortgages & Lehman (up to $40

billion)

“The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts. In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

Warren Buffett 2002

All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate,

And cleared through central counterparties by end-2012 at the latest.

OTC derivative contracts should be reported to trade repositories.

Non-centrally cleared contracts should be subject to higher capital requirements.

Increase transparencyImprove market efficiencyReduce systemic risk

No Reforms for Exchange Traded Derivatives

Over the Counter trades seem the sole focus of International Scrutiny

Push is to limit, or eliminate Bilateral Trading

Any discussion about OTC derivatives is now necessarily a discussion about Legislation and Regulations

Driven by; Optics, we must be seen doing something Politics, both global and domestic (be ahead

of the US or be subject to their rules)

Federal Reserve Act of 1913: 32 pages

Glass-Steagall act: 37 pages Sarbanes Oxley: 66 pages Dodd-Frank: 848 pages

Franken Dodd, Dodd Frankenstein…

Canada's G20 commitment of clearing over-the-counter (OTC) derivatives by December 31st, 2012 Canada is moving faster than most to enact both

G20 commitments and Basel III Requirements.

Canadian OTC Working Group Recommendations provide clues to framework. Look for Canadian CCP’s, SDR proposals No National Securities Regulator but Expanded

Federal Roles in Derivatives Markets

CCP SEF SDR or TDR SEC CFTC EMIR MiFid LCH BCBS IOSCO

CVA DVA Basel III ISDA CSA CSA OTCDWG CMIC CPSS OMG, LOL, WT…

CFTC (or SEC), CCP and SEF determine which swaps must trade exclusively on a Swap Execution Facility (“SEF”)

Must be executed on a SEF if; transaction falls with the “swap” definition in the

Act; and the swap type is mandated by the CFTC (or SEC)

to be cleared on a CCP; and the client is not exempt from the requirement to

clear Block trades: CFTC vs SEC rules Block trade definition

Clearing and electronic trading will be mandated for many products and users

Multilateral trading most likely prominent Increased capital charges for uncleared

trades and possibly minimum margin requirements

Liquidity will be affected by the changes in style of trading, margin requirements, reporting requirements, costs

Collateral requirements will increase for most whether cleared or not

Counterparty risks may be reduced

Asset-Liability matchingAsset Allocation

Diversification Leverage

LDI StrategiesAlternative Investments Innovation and Risk Management

Prepare for new cost structures Increased Capital Costs for Non-cleared trades Increased transaction costs for cleared trades

Prepare for Collateral Management either in-house or through intermediaries

Prepare for increased legal costs ISDA / CSA

Prepare for increased transaction Reporting and associated costs

Look back to cash market mandates Is cash more effective than swaps +

Collateral?

Sit down with Managers whose mandates have derivative heavy strategies. Strategies should already be in place Operational costs may become a pressure

Will increased complexity push Buy-side investors from bilateral markets?

▪ Maybe, but these are the testing ground for innovation

Is this the end for the OTC Market?▪ Remains to be seen. Likely be a smaller club

with more agency relationships. Bilateral trading will become highly scrutinized

Does any of this satisfy the G20 goals?▪ Not on its own but stay tuned