1. 12 February 2002 Basel and the Impact on Securities Houses/Investment Firms Securities Institute Risk Forum Steve Teather Merrill Lynch Europe PLC Steve Teather Merrill Lynch Europe PLC

2. The New Basel Accord The Three Pillars Pillar 1 Minimum Capital Requirements Pillar 2 Supervisory Review Pillar 3 Market Discipline Timetable Quantitative Impact Study (‘QIS) - March 2002 (Investment firms?) CP3 - Summer 2002 Implementation - 2006 (?) The New Accord was not drafted with Investment firms in mind Capital Adequacy Directive is the important one The Three Pillars Pillar 1 Minimum Capital Requirements Pillar 2 Supervisory Review Pillar 3 Market Discipline Timetable Quantitative Impact Study (‘QIS) - March 2002 (Investment firms?) CP3 - Summer 2002 Implementation - 2006 (?) The New Accord was not drafted with Investment firms in mind Capital Adequacy Directive is the important one

3. Why all the fuss? Trying to develop a risk sensitive regime In effect trying to bring regulatory capital closer to economic capital No revision of market risk Aims to maintain overall level of capital (in the Banking industry) Significant proposals Credit risk - external v internal ratings based approach Operational risk - a new charge Disclosure (Pillar 3) - extensive disclosure of potentially sensitive information

4. The impact on Investment firms 1 Trading book v banking book Proposals designed and calibrated based on the banking book General assumption of carry-across confirmed by Basel More clarity needed Operational risk Calibration of minimum charge based on a typical international bank Investment firms have different business profiles to the typical bank Result = significantly higher operational risk charge compared to banks Compensating reduction in credit risk charge?

5. The impact on Investment firms 2 Credit risk mitigation Initially proposed the “w-factor” though this has been moved Use of collateral haircuts Significant impact on repos and securities lending Concerns with documentation - collateral and credit derivatives Large exposures Increases in exposures could have significant large exposure implications

6. The impact on Investment firms 3 Securitisation Proposals treat securitised products as more risky than similar non-securitised products Treatment of synthetic securitisation likely to be penal Treatment of unrated tranches Minimum capital Will economic capital be greater than regulatory minimum for investment firms? Pillar 2 will lead to an upwards review of capital only

7. Further food for thought Integrated Prudential Sourcebook Counterparty risk Material holdings Liquidity Outsourcing Systems and controls Financial Conglomerates Directive Material holdings Group structure Investment Services Directive Commodities Prospectuses Directive, IAS 39 etc etc