Panel Session: OTC derivatives clearing arrangements Joint Bank of England / ECB Conference on ‘Payments and monetary and financial stability’ 12-13 November 2007 Panel Session: OTC derivatives clearing arrangements Simon Grensted Managing Director, Business Development LCH.Clearnet www.lchclearnet.com ©LCH.Clearnet Group Limited

Derivative Market Size & Growth Some clues to where new clearing products are likely to emerge However, clearing is only feasible if the multilateral risks can be managed Key factors: Size Growth Liquidity Vanilla Multilateral adoption STP Messaging Price sources Potential to backload Ability to auction a defaulter’s portfolio

SwapClear notionals Notionals have grown in line with the market; we were told it would be too complex, not feasible, it is not, others will follow… Size (October 07): $103trillion Circa $3trillion per month STP : ~89% in T+0 or T+1

STP is a key benefit SwapClear is an STP only system, manual intervention is for exceptions only; we got there through rigorous multilateral implementation and testing.

What makes OTC clearing worth doing but difficult? Benefits Clearing offers a highly scalable processing environment, everyone is bound to a consistent model Multilateral netting brings improvements over bilateral netting Collateral and guarantee arrangements save Credit Capital and Basle II regulatory capital Strong business case for user adoption and clearing houses to build services. Its not that easy Many OTC services are really about clearing off exchange trades (particularly energy and equities derivatives). Pricing illiquid trades eg out of the money options The real OTC world is divided into many shapes and sizes Real OTC trades can be very complex. Clearing works for the volume/vanilla trades Now imagine a portfolio of complex trades. Some illiquidity Price dislocations Concentration risks LTCM and other defaults have moved the industry forward in learning about defaults and how to manage them Pricing trades, then portfolios is vital to risk management. Multilateral risk introduces new problems to solve LCH.Clearnet has taken a conservative (services are not open to all) and industry partnership approach to default management

Clearing Membership Structures General Clearing Members are vital to LCH.Clearnet’s credit risk intermediation. The model is more complex when you look at the GCM structures and organisations GCM GCM GCM GCM

Clearing Membership Structures GCMs carry the risk of their client defaulting. LCH.Clearnet has different structures across markets TYPE A TYPE D BANK TRADING BANK SUB CLIENT TRADER CLIENT TRADER GCM SUB CLIENT TRADER BANK SUB RELATED BANK SUBS ACCESSING CLEARING DIRECTLY BANK SUB OFFERING GCM SERVICES Futures OTC BANK TYPE B TYPE C GCM & TRADER GCM & TRADER SUB CLIENT TRADER CLIENT TRADER TRADING OWN BOOK AND OFFERING SERVICES TO SUBS CLIENT TRADER GCM OFFERING GLOBAL CLEARING FACILITIES

IRS Notional distributions It is a highly concentrated market, 86% of the total in 38 banks with portfolios of more than $1trillion 65% of total notional in top 10

What next? Standards in post trade infrastructure Convergence with the DTCC warehouse More work to be planned out between our working groups Ultimately we would like to see consistent layered models where processes are consistent and services can be implemented consistently across abroad range of derivatives First step Deriv/SERV interface for IRS trades into SwapClear

LCH.Clearnet Contacts Amsterdam London Brussels Paris Porto Simon Grensted Managing Director, Business Development + 44 (0)20 7426 7066 simon.grensted@lchclearnet.com