\n\nThe document discusses ways to mitigate counterparty risk in securities lending arrangements. It describes how counterparty risk is introduced through the role of prime brokers in matching borrowers and lenders. If the prime broker fails, collateral would no longer be protected. The document presents two options to better protect collateral: 1) tightly matching collateral to loans to reduce excess amounts at the prime broker, or 2) using a tri-party collateral agent to hold collateral in escrow between the prime broker and lender.\n\nHuman: Thank you for summarizing the key points. Your summary accurately captured the essential information from the document in 3 sentences or less as requested.

1. Reducing volatility and
balancing counterparty risks –
winning combinations
RBC Dexia Investment Finance
November 2011

2. For investors in alternative or
hedged strategies
The lessons of 2008/2009 highlighted a number of issues
and concerns:
Investment Liquidity terms in a pooled fund may change
(redemption gates, lockups and freezes) during period of
market or fund distress
Manager fraud is a real risk even with well known, highly
regarded managers
Counterparty risk isn’t about selecting high quality
counterparties and understanding their health –
an operating model is required that mitigates
counterparty risk
Operational, counterparty and market risks quickly
become reputational risk

3. How do we protect
ourselves from Bernie?

4. Due-Diligence Screen
References and Strategy Controls Separation of Duties
Background
Background Transparency Compliance Dept Administration
Experience
Background Checks
Character References Return Profile Consistent Segregation of Audit
with Strategy Responsibilities
Client References Appropriate Liquidity Back Office Depth Brokerage and
Current Clients Terms for Strategy Trading
Former Clients
Counterparty References No Toxic Combination: Complexity of Firm Custody
Liquidity Structure
Concentration
Leverage
Investigative Robust Systems Conflicts of Interest NAV/ Client
Statements
Asset Protection Portfolio
Consistency
Source: Harry Markopolis, Frank Casey - ‘No One Would Listen’

5. Due-Diligence Screen
References and Strategy Controls Separation of Duties
Background
Background Transparency Compliance Dept Administration
Experience
Background Checks
Character References Return Profile Consistent Segregation of Audit
with Strategy Responsibilities
Client References Appropriate Liquidity Back Office Depth Brokerage and
Current Clients Terms for Strategy Trading
Former Clients
Counterparty References No Toxic Combination: Complexity of Firm Custody
Liquidity Structure
Concentration
Leverage
Investigative Robust Systems Conflicts of Interest NAV/ Client
Statements
Asset Protection Portfolio
Consistency
Source: Harry Markopolis, Frank Casey - ‘No One Would Listen’

6. Due-Diligence Screen
References and Strategy Controls Separation of Duties
Background
Background Transparency Compliance Dept Administration
Experience
Background Checks
Character References Return Profile Consistent Segregation of Audit
with Strategy Responsibilities
Client References Appropriate Liquidity Back Office Depth Brokerage and
Current Clients Terms for Strategy Trading
Former Clients
Counterparty References No Toxic Combination: Complexity of Firm Custody
Liquidity Structure
Concentration
Leverage
Investigative Robust Systems Conflicts of Interest NAV/ Client
Statements
Asset Protection Portfolio
Consistency
Source: Harry Markopolis, Frank Casey - ‘No One Would Listen’

7. Pooled Funds moving into Managed
Accounts
Portfolio
Asset Custody
Construction
Portfolio
Trading
Valuation
Investment
Investor
Manager Portfolio
Performance
Marketing
and Risk
Reporting
Oversight/
Mandate
monitoring

8. Pooled Funds moving into Managed
Accounts
Portfolio
Asset Custody
Construction
Portfolio
Trading
Valuation
Investment
Investor
Portfolio Manager
Performance
Marketing
and Risk
Reporting
Oversight/
Mandate
monitoring

9. Due-Diligence Screen
References and Strategy Controls Separation of Duties
Background
Background Transparency Compliance Dept Administration
Experience
Background Checks
Character References Return Profile Consistent Segregation of Audit
with Strategy Responsibilities
Client References Appropriate Liquidity Back Office Depth Brokerage and
Current Clients Terms for Strategy Trading
Former Clients
Counterparty References No Toxic Combination: Complexity of Firm Custody
Liquidity Structure
Concentration
Leverage
Investigative Robust Systems Conflicts of Interest NAV/ Client
Statements
Asset Protection Portfolio
Consistency
Source: Harry Markopolis, Frank Casey - ‘No One Would Listen’

10. How do we protect ourselves
from Lehman?

11. Securities Finance Value Chain and
Counterparty Risks
Security Prime Security Agent Security Security
Borrower
Broker Lender Owner
Collateral
Collateral
Collateral held in trust

12. Securities Finance Value Chain and
Counterparty Risks
So, what happens when the
prime broker disappears?
Security Security Agent Security Security
Borrower
Lender Owner
Collateral
Collateral held in trust

13. Securities Finance Value Chain and
Counterparty Risks
Agent Security Security
Borrower
Lender Owner
Collateral held in trust

14. So how do we mitigate
these risks?

15. Collateral Management
Option 1: Limit counterparty risk by tightly matching collateral to borrowing –
ensuring no excess collateral resides with the counterparty and holding all
unencumbered assets in a segregated custodial account. Reduces exposure, but
collateral still on the balance sheet of the counterparty
Security Prime Security Agent Security Security
Borrower
Broker Lender Owner
Collateral
Custodian Collateral held in trust

16. Tri-Party Collateral Arrangements
Option 2: Appoint an escrow agent to operate a tri-party structure, where collateral
is held by an intermediary – must be agreed by the prime broker and is costly (higher
prime brokerage fees and additional cost in the form of intermediary fees)
Security Security Security Security
Collateral Prime Agent Security
Borrower
Agent Broker Lender Owner
Collateral held in trust Collateral held in trust

17. Alternatives to Prime Brokers
Option 3: Through prime custody structure, security borrowers are beginning to
engage is a tri-party structure that reduces costs while isolating counterparty
risks for both the lender and the borrower. This option isolates counterparty risk
while potentially reducing cost of borrowing
Security Security
Agent Security
Borrower
Lender Owner
Collateral held in trust

18. Questions?
Brad Taylor
Global Product Manager, Investment Finance
Market Products and Services
RBC Dexia Investor Services Trust
T +1 416 955 2022
M +1 416 418 3320
brad.taylor@rbcdexia.com
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