COUNTERPARTY RISK MANAGEMENT IN AN EVOLVING MARKETPLACE Gerry Dorkin, Executive Director, J.P. Morgan November 2009

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Agenda How does J.P. Morgan manage counterparty risk? Group sessions How do you manage counterparty risk? What are your priorities? What are your biggest challenges? What is the right model? Review of findings Run through the topics and questions at the end

How does J.P. Morgan manage Counterparty Risk? Understanding the financial strength of banks… Two-pronged approach: Analysis of the Fundamentals (Quantitative) Overlay the Qualitative

How does J.P. Morgan manage Counterparty Risk? Analysis of the Fundamentals (Quantitative) Capital Assets Management Equity Liabilities and Liquidity So obviously we’ve discussed rate volatility through the crisis but the issue here is that it continues. Interbank liquidity continues to be tight. Perception is everything. Northern Rock example. Who would have considered a household name UK Bank would have to be nationalised in the 21st century? Perception that the bank was in trouble drove investors to withdraw their cash in droves. Flight to Quality….ie not everyone takes the same view. The consistent theme across our clients is that there is no consistency…. Flight to Transparency….exponential growth in liquidity funds as proactively addressed the need to provide transparency.

How does J.P. Morgan manage Counterparty Risk? Overlay the Qualitative: Diversity of earning streams Track record External Ratings Market Perception

How does J.P. Morgan manage Counterparty Risk? An evolving marketplace… Temporary support programmes rolling off: TARP TAGP Liquidity Fund Guarantees Government Ownership Increased regulatory oversight FSA liquidity requirements for banks Does your risk management strategy still make sense?

Sustaining liquidity management through the cycle How does J.P. Morgan manage Counterparty Risk? Sustaining liquidity management through the cycle

The layers of credit risk: How does J.P. Morgan manage Counterparty Risk? The layers of credit risk: Counterparty concentration Regular assessment of counterparty risk profiles and comparison against risk preferences Opportunities to optimise cash held, classify appropriately, or invest and diversify to mitigate concentration risk Core financial services provider choice; credit profile; core provider risk etc. Relationship strength; depth of understanding your business Understand & Manage Risk Instrument choice and legal behaviour Instrument type; fit to liquidity needs Changes to structure, risk profile or return profile Transparency of holdings Review assets against risk criteria: Cash accounts and time deposits money market mutual funds reverse repos direct securities investments Review other criteria e.g. jurisdiction Understand & Manage Risk Investment quality - support and service quality Holdings and collateral; next level analysis Support, experience, track record and access Clear and complete investment policy ongoing inspection type, level and frequency of disclosure triggers for escalation or review Understand & Manage Risk

How does J.P. Morgan manage Counterparty Risk? Operating model: Effective and sustainable liquidity management requires a balance between: Capital Preservation Liquidity / Availability of Funds Convenience & Cost Return / Performance In addition, the balance must be achieved in compliance with the investment risk and currency risk management policies Management oversight and reporting are additional over-heads which must be organised to be efficient if practice is to be maintained long term Liquidity Management is not a ‘fair-weather activity’ or a ‘knee-jerk reaction’. It is a fundamental part of business

How does J.P. Morgan manage Counterparty Risk? In practice… COUNTERPARTY X

Group Session Market turmoil continues and the effect of Government intervention has yet to fully play out. Markets are no longer waiting for return to “normal” but to a new paradigm. Availability and cost of liquidity remains difficult. Volatility has enforced behaviour change; Investment guidelines. Diversification. Transparency and due diligence. Operational risk, not just counterparty/instrument risk. Increasing regulation brings extra requirements, but also opportunities.

Review of Findings