MarkitSERV presentations 2Feb10

Frankfurt, 2 February 2010

OTC Cash and Derivative Markets in 2010

2 February 2010

OTC Derivatives RegulationMarcus Schüler

3

Objectives of OTC derivatives regulation

Risk–

Reduce systemic–

Operational

Increase transparency–

To the public and to regulators –

On transactions and on positions

Secure market integrity

Improve market functioning

The ideal solution should –

Encompass also products that are not suitable for central clearing or electronic trading –

Use proven infrastructure to secure delivery in a timely and cost effective fashion –

Maximize interoperability, foster competition and avoid the creation of vertical silos–

Provide useful, high quality information in the right format, not just more data

4

What has been achieved so far?

Risk reduction–

Electronic trade confirmation–

Novation protocol–

Credit Event settlement–

Trade compression–

Launch of CCPs for CDS

Transparency–

Creation of Trade Repositories for CDS, Interest Rate and Equity

derivatives

5

Agenda for 2010 and beyond*

Reduction of systemic risk–

Central ClearingGreater use of CCPsInteroperability of CCPsEnd user exemption

–

Further improve the efficiency of collateral management and trade compression

Transparency–

Mandatory reporting of OTC derivatives transactions to Trade Repositories–

Public dissemination of price and volume informationEstablish a TRACE-like trade reporting system (US)Extension of MiFID to non-equity markets (Europe)

Market functioning–

Increased use of exchanges and electronic trading platforms for execution –

Attract new liquidity providers and reduce bid/offer spreads

*See New York Federal Reserve Bank Staff Report “Policy Perspectives on OTC Derivatives Market Infrastructure”, January 2010 for details

6

OTC derivatives legislation –

the current status

US Legislative proposals–

US Administration OTC Derivatives Bill–

August 11, 2009–

Reed Bill –

Senate Banking Committee, September 22–

House Bill–

Passed December, 2009 –

Senate Banking Committee–

Dodd Bill, November 10, 2009–

Senate Agricultural Committee–

Draft bill expected in February

Europe–

European Commission communication on OTC derivatives

–

October 20, 2009–

Discussion paper “Legislation on Market Infrastructures”

–

January 2010

Asia−

Japanese FSA −

Blue Print, December 2009

7

Relevant parties and their responsibilities

Alternative Swap Execution Facilities (ASEF) and regulated exchanges–

Execution of swap trades–

Timely dissemination of trade information (post-trade transparency)–

Emergency powers of regulators and position limits

Central Counterparty (CCP)–

Assume, consolidate and manage counterparty risk from bilateral trades–

Capture data and make it available to regulators and the public

Swaps Repository (SR)–

Capture details of all OTC derivative trades–

Might perform life cycle management–

Make transaction and position information available to regulators and the public

Major swap market participants–

Report customized trades to a SR or the Commission–

Store the complete audit trail and make it available to regulators–

Aggregate positions in security-based products across formats and asset classes

8

Critical issues to be addressed

Clearing requirement–

Which OTC derivatives have to be centrally cleared? How to deal with moral hazard issues?

–

Proposed approachesStandardized vs customized productsRegulators to decide on clearabilityCCPs to apply to the Commission In addition grant the Commission the right to declare products as clearableRestrict dealer ownership of CCPs (Lynch amendment)

Trading requirement–

Which products have to be traded on regulated exchanges or ASEFs?–

Proposed approachedStandardised vs customised productsNo requirement to trade electronically as long as the trade is reported All cleared products need to be traded electronically Voice brokerage permitted if trades are processed through ASEFs Require electronic trading also for non-cleared products

9

OTC market practices

Report to

Submitto

Swaps Repositories

Majority of trades

submitted to

Negotiated OTC

Transaction

Electronically Traded OTC Transaction

ECN or ECM or any other Electronic Execution or Negotiation Facility

Telephone, IM, Voice Broker, or Other ECN Means

Clearing Houses

Electronic Trade Processing

Facility

10

Legislative proposals

Swaps Repositories

Negotiated OTC

Transaction

Electronically Traded OTC Transaction

Alternative Swap Execution Facility "ASEF"

Data Fragmentation

Problem

Clearing Houses

Rep

ort

to

Public / Market Participants / Regulators

Public TradeReporting

Public

Regulator

Audit Trail

Submit Trade to Clearing House

Submit Trade to Repository

Telephone, IM, Voice Broker, or Other ECN Means

2 February 2010

Role of Trade Processing in the OTC Derivative Markets

Jeff Gooch

12

Agenda

Current environment

About MarkitSERV

Future plans

13

Current environment

Market faces unprecedented challenges from both regulators and participants

New derivative regulations being drafted in both Europe and the US

Industry commitments to clearing:−

Interbank and client clearing−

Multiple clearers

Volumes have generally held steady despite industry challenges

14

Current credit volumes

15

Rates volumes

16

Equity volumes

17

What is MarkitSERV

DTCC’s

Deriv/SERV Post-Trade Confirmation and Matching

Services

+ Markit’s Trade Processing Services

Integrated multi-asset class solution for OTC derivatives market

18

Key facts

Go-live on 1st September

50:50 owned by DTCC and Markit

Industry governed with seven customers on its board

A management committee that consists of 14 executives, whose combined operations, technology, management and commercial experience averages 18 years

300+ staff

Over 8 million confirmations per year

The largest OTC processing network that has over 80 banks connected, more than 50 interdealer brokers and over 1,600 buy-side firms

19

Combined product set

Legacy Product MarkitSERV Product

Deriv/SERV Confirmation and Matching Service MarkitSERV DSMatch

Deriv/SERV MCA-Xpress MarkitSERV MCA-Xpress

Deriv/SERV Novation Consent MarkitSERV Credit Novation Consent

Markit Trade Manager MarkitSERV Trade Manager

Markit Wire MarkitSERV MarkitWire

Markit PBWire MarkitSERV PBWire

Markit PortRec MarkitSERV PortRec

Markit Tie-Outs MarkitSERV Tie-Outs

20

Proposed architecture –

dealer to client flow

Buy-side

SP 1

SP 2

Portal

Prime Brokers

Clearingmembers

BrokerDealer A

CCPOther service providers

MarkitSERV

Novation consent

Affirmation

AllocationConfirmation

TIW Gateway

CLS

DTCC TIW

E-TradingVoice IDB

BackloadingLife Cycle Event

New Trades

BrokerDealer B

Portfolio Compression

PC 1 PC 2 PC 3

Portfolio Reconciliation

PR 1 PR 2 PR 3

21

Industry benefits

Increase industry efficiency and decrease operational risk by joining the two largest derivatives confirmation platforms, spanning the entire post-trade life cycle

Connect multiple market participants, execution venues and clearing providers through a single, secure gateway

Reduce/eliminate the dependencies on manual-based processes

Improve accuracy and security of OTC derivative transactions globally

Lead and assist the industry in meeting the challenging regulatory demands in a very dynamic environment

22

Implementation approach

Phased implementation with early deliverables (e.g. development of a cross-product client portal)

Minimise impact on existing customers

Maximise attractiveness to new users to adopt electronic solutions by improving functionality, reducing uncertainty and linking platforms together to increase industry take up across asset classes

Support for different workflow and business models:–

Affirmation and matching models–

Prime brokerage relationships–

Links to clearing houses–

Outsourcing to fund administrators

23

Implementation approach (continued)

Meet user requirements for processing in a holistic front to bank environment – from block affirmations to settlement and portfolio maintenance

Develop key middleware to support full trade lifecycles

Support DTCC Trade Information Warehouse and any other repositories or clearers selected by the industry

24

Delivery plan

Integrated Portal -

Rates

LIVE

TBD

Rates

Client Clearing

Data Migration

Novation Consent solution

Interoperability

Allocations solution

LIVE

April 2010

March 2010

April 2010

TBD

Credit

Front Office affirmation model

Clearing designation on T

Expansion to buy-side clearing

Block/allocation and give-up

Novation Consent solution

LIVE Interbank

Developed

Developed

TBD

Q2 2010

Integrated Portal -

Credit TBD

Integrated Portal -

Equities Phased-in, Q3/4 2010+

CommonPortal

Single Sign On

25

Delivery plan (continued)

Collateral /Portfolio

Reconciliation

Tri-party reconciliation for TIW

Direct links to DS Match and MarkitWire

Continued integration with Valuations Manager

Q1 2010

Q1 2010

ongoing

Commodities

Extend Physical Power and Gas Coverage to North America

Buy-side firms

Turn on 2 way link with MTM

Allocations

Emissions, Physical Coal, Return Swaps on Commodity Indices

Q1 2010

Q1 2010

Q1 2010

Q1 2010

2010

Equities

Increased eligibility and take-up

Meet all mandates (options, swaps) and implement industry-agreed corporate actions processing solution

Field Harmonisation, Convergence, Single Platform

ongoing

ongoing

Phased-in, 2010+

Equity Trade Reporting Repository July 2010

26

Common portal –

web view

Trade Manager

MarkitSERVTrade Manager (MTM) reduces operational risk and manual intervention by allowing participants to manage their risk and various processes in a timely manner electronically on one platform

–

Automates Front to Back Processing, with real-time connectivity to MarkitWire

and DSMatch platforms, as well as web-based workflows for electronically-ineligible product types

Proven cross-asset class solution–

MTM has a broad existing user client base, covering investment managers, hedge funds, and fund administrators

–

MTM encompasses all products –

Credit, Equities, Rates, Commodities, FX and all structured products

MTM’s flexibility allows participants to implement any or all of the components available on the platform depending on their need and business model

Suite of management reports for aging, counterparty scorecards and internal productivity

PortRec

MarkitSERV PortRec helps buy-side firms and fund administrators identify and address challenges associated with position and valuation differences within their derivative portfolios

Automatic reconciliation & reconciliation review process–

Highly flexible rules engine for optimal reconciliation rates (target by counterparty, product, date & value ranges)

Identification of critical economic breaks & online dispute resolution–

Drill down to underlying trade details & confirmation status to uncover the root cause of discrepancies via MarkitSERVTrade

Manager, DSMatch and MarkitWire

confirmation services

Side by side valuation comparisons –

Quickly locate significant valuation differences–

Incorporate independent mark via Markit Portfolio Valuation Service

Cross-asset management reporting–

Instant production of management reports–

Targeted dashboards for top issues, trends and aging

29

Improving the customer experience

New combined customer service help lines:–

UK/Europe/Asia: + 44 (0)84 4994 7378

US and Canada: + 1 877 765 8737

–

[email protected]

Dedicated multiproduct account management teams (including Italian, German and French speakers)

Steamlined signup and legal documentation process for buy-side customers

New integrated case management system

2 February 2010

Central Clearing and its Impact on the

Derivative MarketsTom Price

31

Agenda

What is Central Clearing?−

Bilateral Clearing (legacy) vs. Central Clearing−

Structure and obligations of participants−

Hierarchy of loss protection in default of a clearing member

Scope of Central Clearing−

OTC Derivatives market overview−

Addressing systemic risk−

Systemic risk vs. liquidity (CDS single name example)

Prerequisites for centrally clearing CDS

Current state of the CDS clearing market−

Current state−

Obstacles to a robust central clearing market in CDS

Expected ultimate impact of CCPs in OTC Derivatives

32

What is Central Clearing? Bilateral Clearing (legacy) vs. Central Clearing

New entrant in the market

Buyer for every seller a and a seller for every buyer

33

What is Central Clearing? Structure and obligations of participants

Obligations of various participants to ensure stability for CCP Structure:

Central Clearing Party–

Contribution of First Loss Capital

Clearing member–

Contribution to guaranty/reserve fund–

Initial and variation margin–

Contingent claims

Non-clearing members–

Initial and variation margin

Example: CCP Membership Criteria:Minimum capitalizationMinimum net worthRatings criteria Operational complianceLegal complianceMonitoring as ongoing entity

34

What is Central Clearing? Hierarchy of loss protection in default of a clearing member

Source: Duffie, Li, Lubke

1.

Initial margin of defaulting member

2.

Defaulting member’s contribution to guaranty/reserve fund

3.

Central clearing house’s first loss capital

4.

Guaranty/reserve fund

5.

Central clearing house has ability to raise additional funds from surviving participants

35

Scope: Size of the OTC Derivatives market

Source: BIS

OTC derivatives have become systemically importantCurrent focus is on expanding CDS clearing

36

Addressing systemic risk

Central Clearing

Trade repositories

Public transparency

Trading on electronic platforms or alternative swap execution facilities

Operational metrics

Trade compression

T+0 settlement

37

Scope: systemic risk vs. liquidity (CDS single name example)

There are over 3,000 single name reference entities in the CDS marketThe majority of these are not expected to centrally clearTop 1,000 reference entities above, represent over 95% of the Gross Notional80% of the Gross Notional is covered by the top 476 entities

Source: DTCC, Markit

38

Pre-requisites for centrally clearing CDS

Increased standardisation−

CDS Big Bang−

Determination committees−

Full coupon and IMM dates−

Standard protection period−

Hardwiring auction−

ISDA CDS Standard Model−

Developed and supported in collaboration with Markit

Improved pricing accuracy

39

Improved quality of clearing prices in CDS market

CDS pricing services historically suffered from some or all of these issues:

Submission window–

Quotes come in throughout the day. More often in morning.–

Books are closed at different timesSubmission obligation

–

There is no obligation to provide Quotes–

Quotes dry up during volatility (“Call desk”) or near holidaysSubmission size

–

Books of Record prices are not of a standard size–

The size of a Quote is often not statedIDs

–

Quotes do not have RED IDs. Educated guessing on instrument pricedQuality incentives

–

Insufficient incentives and therefore focus on pricing qualityCoverage

–

Quotes often only address the 5 year point on curve.

Other points modeled

40

Current state of the CDS clearing market

Large number of potential and active CCPs

Higher costs

Increased collateral/margin means less leverage

More reporting requirements

Buy-side on sidelines

$1 billion revenue in 2012 for OTC clearing in CCPs ($323 million in CDS) as estimated by Morgan Stanley

Dealers have made commitments to regulators to centrally clear, increase transparency and continue operational efficiency

41

Obstacles to a robust Central Clearing market in CDS

Scope of products:−

No bespokes, SN sovereigns and CPP member entities

Multiple CCPs−

Cost: Less netting and higher transaction costs

Lack of cross asset margining within CCPs

Regional legal structures−

Laws are generally national rather than global [e.g. bankruptcy]

Interoperability of CCPs−

Standardisation risk and valuation metrics−

Accessibility of dealers to all CCPs

42

Expected ultimate impact of CCPs in OTC Derivatives

Reduced systemic risk

Higher standardisation of OTC product

Improved pricing accuracy

Increased scope coverage of cleared instruments

Changed liquidity profile of market (cleared vs. non-cleared)

Greater transparency through more reporting requirements

One dominant CCP per asset class per region

Increased margin/lower leverage

Buy-side and sell-side involvement

Greater regulatory involvement

2 February 2010

Clearing

The Way For Electronic Loan Processing

Joe Widner

44

Current state of the loan market

Globally the largest inefficient financial market

Key areas of concern–

Faxes as primary communication method–

Secondary settlement times range from weeks to months–

Independent processes for loan transfer and cash settlement–

Decentralised data coupled with privacy requirements–

Operational costs and errors

The loan asset class will see limited growth or advancement past historical levels without changing the environment

45

Critical requirements

Basic building blocks are necessary to lay foundation for change–

Counterparty identification–

Loan identification–

Standardised communication protocols–

Availability and access to agency data–

Common and published practises (e.g. Know-Your-Customer process)

With these the next layer of efficiency can be built–

Reconciliation–

Trade settlement workflow–

Cash settlement integration (DVP)

46

Markit’s

objective and ability

Markit is uniquely position to provide the platform and leadership required to execute changes for the loan industry

Leverage parallel experience in derivatives markets

Unique relationship with both the buy-side and sell-side

Approaching 400 loan specific associates worldwide (25% of Markit)

Leading global provider of loan products and services–

Valuations (Loan Pricing)–

Portfolio management (Wall Street Office -

WSO)–

Loan reference data and distribution (WSOData)–

Operations outsourcing (WSOWeb)–

Trade Processing (ClearPar)

Loan Board created in 2009 consisting of 10 global sell-side banks, 3 global buy-side firms, DTCC and Markit

47

Accomplished to-date

Acquisition of Wall Street Office (WSO) in 2008–

8mm faxes processed centrally–

5004 facilities available for electronic STP processing–

3mm faxes eliminated

Acquisition of ClearPar in 2009–

100,000+ trades processed per year–

New European enhancements and online agent signing–

New distressed enhancements to manage inventory and PSA integration

New loan offerings–

Over 20,000 Markit Entity Identifiers (MEIs) issued–

Major agent/broker banks setup on Market Document Exchange for KYC–

Launching of new cash loan indices

48

Required components

Loan Identifiers

Loan Data

FpMLEntity Identifiers

Counterparty Data Electronic Messaging

Trade Matching

STP ProcessingAgent Validation

KYC Automation

Centralized Data:

Foundation:

Basic integration:

Advanced: Trade Collateral

Reconciliation

Future: DVP STP Settlement Repos

Launched in final or interim state In design / development

Launched in interim state Under consideration

49

Appendix

50

Focus transitions from returns to risk

For most of 2009, secondary loan prices have been posting a strong recovery. However, memories and perhaps wounds from the financial crisis are still fresh. Before the crisis, loans were considered to be a relatively stable asset class with low price volatility. This perception began to change in July 2007, the start of the crisis. With the

fall of Lehman Brothers in September 2008, volatility skyrocketed. The credit crisis has led investors to re-examine the way they think about investing in the loans asset class, namely a shift in focus from returns to risk. Because the credit crisis threatened the health of the overall financial system, this new focus on risk goes beyond just investment risk but includes systemic and operational risks as well.

51

Initiatives in progress

52

Integration efforts to decrease settlement times

TradeMatched

TradesSubmitted

WSO WSOData

Check /EnrichData

FundingMemo

CAChecks

InventoryCheck

Allocations DVP

TradeCaptureAPI

MEIs

WSOData

WSO AgentsDTCC

WSOData

MDE

Consent &Minimums

MDEDTCC

CheckAffiliations /Holdings

SettlementInstructions

DTCC

WiringDetails

LEGAL & PROCESS REFORM

PLATFORM

KYC

MDE

Agent

CheckStatus

SendPacket

53

Question & Answer session

54

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