Going back ten years or more, Collateral Management was in many firms seen as an adjunct to their Operations or Credit risk teams. Given the easy profits from trading, little attention was made to the flow of margin assets or their cost, as these were a side-line in the overall profits of a firm. The first step change for a CM team was the arrival of SwapClear in 1999, and the take up of clearing by a core group of banks in 2000 with the drive to automate the clearing process. SwapClear requires Initial Margin which was a new idea for OTC products. Most Credit Support Annexes at the time required net mark-to-market (or Variation Margin as most call it now), and no additional amounts (other than some customised CSAs for FX or Prime Brokerage). Initial Margin became a new cost to the CM team, and forged a new relationship with the Repo / Treasury desks – as someone had to bear the funding cost of the IM, and it couldn’t be the CM team itself who have no profit to spend. This became the genesis of an evolving relationship between the front office and the CM teams – and also the Risk Management team to understand why the IM at SwapClear is driven higher or lower, and therefore increasing or decreasing costs.

1. The Economics of Collateral and
Making a Profit
June 2016
Final

2. Please wait
© 2016The OTC Space Limited2
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3. Introduction
Bill Hodgson
© 2016The OTC Space Limited3

4. Background
© 2016The OTC Space Limited4
} Going back ten years or more, Collateral Management was in many firms seen as
an adjunct to their Operations or Credit risk teams. Given the easy profits from
trading, little attention was made to the flow of margin assets or their cost, as
these were a side-line in the overall profits of a firm.
} The first step change for a CM team was the arrival of SwapClear in 1999,and the
take up of clearing by a core group of banks in 2000 with the drive to automate
the clearing process. SwapClear requires Initial Margin which was a new idea for
OTC products. Most Credit SupportAnnexes at the time required net mark-to-
market (or Variation Margin as most call it now), and no additional amounts (other
than some customised CSAs for FX or Prime Brokerage).
} Initial Margin became a new cost to the CM team, and forged a new relationship
with the Repo /Treasury desks – as someone had to bear the funding cost of the
IM, and it couldn’t be the CM team itself who have no profit to spend.This
became the genesis of an evolving relationship between the front office and the
CM teams – and also the Risk Management team to understand why the IM at
SwapClear is driven higher or lower, and therefore increasing or decreasing costs.

5. Speakers
© 2016The OTC Space Limited5
TedAllen has specialised in collateral management for nearly 20 years and is currently Director of
Business Development for ApexCollateral at FIS.Apex Collateral is FIS's strategic solution for
Enterprise Collateral Management.It provides a unique value propositionto manage,trade and
optimise collateral assets on a single platform.The Apex Collateral community of clients spans
the buy side and sell side in NorthAmerica,EMEA andAPAC.Apex Collateral delivers a
compelling solution to the challenges of collateral market reform and the global regulatory
environment.
John has worked in capital markets for 15 years+ (10 at Accenture and 5+ as independent
consultant).He has extensive experience in derivatives and collateral management having worked
both with the sell-side (clearing members) and buy-side (asset managers) and currently focuses
on regulatory driven business change.He has previously worked with HSBC,Barclays,Morgan
Stanley andAccenture.
Eric specialises in collateral optimisation/trading,funding,liquidity,OTC clearing and client
clearing.He currently works on front office collateral optimisation,repo and tri-party repo,
liquidity management and short term funding at Commerzbank,and has previously worked with
Capco,Goldman Sachs,and Citi Group.

6. Main Points
© 2016The OTC Space Limited6
} Is cash still king? 80%+ of margin calls are met with
cash but in this low interest rate environment, is this
still appropriate?
} What are the platform and infrastructure choices to
meet the March 2017 non-cleared OTC collateral
regulations?
} How can funds utilise their assets to cover margin
calls without reducing their return on investment?
} What you really need from an optimisation approach
} What new innovations are happening in collateral
management?

7. Regulations and Market Initiatives
Ted Allen, John Lund,Eric Bystrom
© 2016The OTC Space Limited7

8. Regulatory and market initiatives
EMIR / DFA etc
• CENTRAL CLEARING
• TRADE REPORTING
• MANDATORY
RECONCILIATIONS
BCBS IOSCO
• FINAL PILLAR OF OTC
MARKETS REFORM
• GLOBAL STANDARDS
FOR MARGINING OF
NON-CLEARED OTC
DERIVATIVES
• PROJECT BLAZER
BASEL III
• EXPOSURE
CALCULATIONS AND
DISPUTES
• LIQUIDITY RATIOS AND
RISK MANAGEMENT
AND OTHERS….
• SFTR
• ASSET ENCUMBRANCE
• UCITS, 1940 ACT
• ISDA / ICMA / ISLA BEST
PRACTICES
• ….
Challenges
• Operational complexity
• Regulatory compliance
• Increased volumes
• Market infrastructure changes
• Increased cost of collateral
• Optimisation and Transfer Pricing
• Liquidity impacts
• Higher capital charges

9. 9
Extra
collateral
required
$800b
Increase in
margin calls
5x
Increase in
substitutions
10x
Impact of non-cleared margin rules

10. JXL Consulting Ltd
Bilateral book fragmentation: derivatives fission
28/06/2016 10
1
2
3
4
5
1. Legacy Bilateral
2. New Bilateral
3. Cleared (Mandated)
4. Cleared (Elective)
5. New Products e.g. Listed
hybrids
Market changes will significantly change the composition of a typical derivatives
portfolio over the next few years | a theoretical evolution of categories

11. Un-cleared Bilateral Margin Rules
11
• Possible Delay to the Implementation of the Rules
– EU rules still not final, being reviewed as we speak
– “Our objective is to deliver the standard before the end of the year [2016] and
for firms covered by the first wave of the rules to be required to comply
before the middle of next year [2017],” said a Commission spokesperson.
– Bloomberg: http://bit.ly/BBGUMRDelay
– IFR: http://bit.ly/ifrumrdelay
• European Commission may delay implementation for six months
– From September2016 to March 2017for IM & VM for tier 1 firms
– From March 2017 to September2017 for all firms subjectto VM
• No change to US rules timing – leading to a US disadvantage?
• Brexit effect?

12. Poll 1
Familiarity with the Uncleared Margin Rules
© 2016The OTC Space Limited12

13. 13
How familiar are you with the upcoming
BCBS IOSCO regulations for margining of
non-cleared OTC derivatives:
1. Deeply and intimately familiar
2. Pretty familiar
3. A bit worried I should know more
4. I don’t understand the question

14. Poll Results
How well do the audience know the rules?
© 2016The OTC Space Limited14

15. Preparations at Commerzbank
Eric Bystrom
© 2016The OTC Space Limited15

16. Poll 2
Challenges in preparing
© 2016The OTC Space Limited16

17. 17
What is your biggest problem in preparing for
BCBS IOSCO rules for margining of non-
cleared OTC derivatives:
1. Negotiation of new regulatory CSAs
2. Preparing operations processes
3. Technology and infrastructure
4. Managing the cost of collateral
5. Something else

18. Poll Results
Which areas are causing problems?
© 2016The OTC Space Limited18

19. Trends
John Lund
© 2016The OTC Space Limited19

20. JXL Consulting Ltd
Collateral Trends
28/06/2016 20
Cash Drivers
• Dealer preference for cash only CSAs
• Cleared VM required in cash
• Cash operationally easier
• Current investment environment
favours cash
Non cash Drivers
• Fully invested funds prefer non cash
• Some CMs favour non cash for cleared IM
• Increasing cleared IM materiality
• Extension of CCP eligible asset types
• Cash negative rates favour non cash
There is likely to be a gradual shift in favour of non cash

21. The Economics of Collateral
Eric Bystrom, John & Ted
© 2016The OTC Space Limited21

22. Managing the Cost of Collateral
•Funding
•Returns
•Opportunity Cost
•xVA & Pricing
•Cheapest to deliver Bonds versus Operational capabilities

23. JXL Consulting Ltd
How can funds utilise assets?
28/06/2016 23
• One size does not fit all in the fund universe.
• Whilst some funds can easily post additional collateral from existing inventory,
others (esp pension funds) will struggle to avoid impacting fund returns.
• Any mitigation strategy should be twofold:
-Razor focus on reducing “demand” [root cause]
-Deploy multiple strategies to make best use of available asset sources
• Asset source optimisation could include:
-Change in use of derivatives
-Collateral transformation by CMs
-Collateral transformation by CCPs
-Securities lending
-Peer to peer repo
-Use of alternative products (e.g. swap futures)

24. Centralized profit center to unlock the potential of collateral
management – Sell Side View?
24
Market trend
Centralcollateral/liquidity management andtradingunit
Collateral management
(Cross product
collateralization)
Liquidity management
(Repo / reverse repo)
Enterprise collateral inventory
Cross-asset, real-time
Securities lending /
collateral trading
Collateral optimisation /
collateral
transfer pricing
Central view of inventory
Operational efficiency
Enable collateral trading and improve ratio management

25. Poll 3
Centralised Collateral Management
© 2016The OTC Space Limited25

26. 26
Has your firm established a program to
centralise collateral management?
1. Yes, it has been centralised
2. Yes, it is an ongoing initiative
3. No – but it’s in our plans
4. No – we will never do this
5. Something else

27. Poll 3 Discussion
What appetite is there for centralisation?
© 2016The OTC Space Limited27

28. Future building blocks
John Lund
© 2016The OTC Space Limited28

29. JXL Consulting Ltd
Infrastructure Building Blocks
28/06/2016 29
A 5 year strategy is essential to deliver the right infrastructure at the right time
2016 2017 2018 2019
IM
Sim
Cat 2 IRS
Clearing
Cat 2 CDS
Clearing,
PRIIPs
Uncleared
VM
Pension
Exemption,
MiFID2
Uncleared
IM
Pre-TradePostTrade
CCP
Collateral
Mgt
Capacity
Limit
Monitoring
Venue
Selection
Costof
Collateral
Collateral
Transform
Fee
Simulations
Fee
oversight
Tier
assessment
Clearing
Eligibility
Treasury
Mgt
Intra-day
margining
Cross
Margining
Concentr.
Limits
Uncleared
IM
Direct
Clearing
Fund
Accounting

30. Poll 4
Collateral Optimisation
© 2016The OTC Space Limited30

31. 31
What is the state of collateral optimisation at
your firm?
1. No need for optimisation
2. We are studying the business case
3. We are investing in a program
4. We have an established collateral optimisation
process
5. Something else

32. Poll Discussion
How optimised are attendees?
© 2016The OTC Space Limited32

33. The Collateral Value Chain
John,Ted & Eric
© 2016The OTC Space Limited33

34. JXL Consulting Ltd28/06/2016 34
Post trade
Collateral
Optimisation
Pre-trade
Collateral
Determination
•Cross
margining
•Cleared IM
optimisation
•Bilateral IM
•Accurate cash
inventory
•Accurate non
cash inventory
•Availability of
unsecured
financing
•Cost of
collateral
methodology
•Algorithm to
attribute cost
over multiple
fund managers
in one
margining pot
•Daily review of
collateral
•Substitution
over events
•Accurate cost
attribution
Optimisation Value Chain
Capture
Constraints
Evaluate
Supply
Minimise
Demand
•Haircuts and
eligibility
•Concentration
restrictions
•Investment
restrictions
•Holding costs
(e.g. LDR)
Collateral Transformation
“Optimisation”is in reality a number of distinct components

35. Global Inventory
Availability ladder of positions
Requirements
• cOTC / ETD
• Bilateral
• Funding
• … Requirement1 Requirement2 RequirementN
Constraints
• Substitution & Concentration limits
• Eligibility & haircuts
• Corporate actions
• Settlement cut-offs
• …
Eligibility 1 Eligibility 2 Eligibility N
Position1 Position 2 Position n
Complexity:How to achieve a holistic allocation thatmeets all constraints and minimises cost
Scale:automate the allocationprocess – automatic collateral tradecreation
Holistic Numerical Optimization
OptimalAllocations:
- Minimize costs
- Maximize liquidity
Holistic Post-Trade Collateral Optimization

36. One last thing
What / how / when is the Asset Shortfall?
© 2016The OTC Space Limited36

37. Final Question
© 2016The OTC Space Limited37
} What is the“assets shortfall?”
} Why might this happen?
} When might this happen?
} What are the consequences?
} Is there any evidence for this?
} Does the audience have any views?
} Let us know using the Questions panel

38. Next steps
What should you be doing?
© 2016The OTC Space Limited38

39. Next Steps
© 2016The OTC Space Limited39
} What should your firm be doing?
} Review the current economic effect of your
collateral management activities
} Review your operational and technical platforms
} Look cross-business (OTC,Repo, Exchanges,
Stock Loan)
} Establish an Owner / Sponsor for your Strategy
(if you don’t already have one)

40. Contact Details
© 2016The OTC Space Limited40
} Ted Allen
} Email: ted.allen@fisglobal.com
} Phone:+44 20 8081 3065

41. Thank you
We will publish this webinar in video, audio and transcript format
soon
© 2016The OTC Space Limited41