David Puth on CLS: A PRIVATE COMPANY PERFORMING A PUBLIC SERVICE. LMAX Looks Ahead After MBO. JP Morgan. Retail FX: NFA Targets Brokers

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1 REPRINT: FEBRUARY 2013 VOL. 14 / ISSUE LMAX Looks Ahead After MBO Retail FX: NFA Targets Brokers JP Morgan Unveils Multi-Asset Class Platform David Puth on CLS: A PRIVATE COMPANY PERFORMING A PUBLIC SERVICE Taking the helm of CLS six months ago, CEO David Puth joins the company at a critical juncture. Having been deemed as systemically important and cited numerous times in the US Treasuryʼs exemption of FX swaps and forwards, Puth talks to P&L about his vision for the future of the utility. CHANGE AT THE TOP OF THOMSON REUTERS FX

2 ISSN: P&L Services Ltd. All Rights Reserved. This article first appeared in: Profit & Loss Magazine, February 2013 issue 138 vol. 14 David Puth on CLS: A PRIVATE COMPANY PERFORMING A PUBLIC SERVICE Taking the helm of CLS six months ago, CEO David Puth joins the company at a critical juncture. Having been deemed as systemically important and cited numerous times in the US Treasuryʼs exemption of FX swaps and forwards in November, Puth talks to P&Lʼs Julie Ros about his vision for the future of the utility. Julie Ros: You joined CLS in August, about a month after CLS was deemed a systemically important Financial Market Utility (FMU) by the Financial Stability Oversight Council (FSOC). Then, November s decision by US Treasury Secretary Geithner to exempt FX swaps and forwards cited CLS 28 times in its post-exemption document. Was CLS actively involved in this process through conversations with Washington? David Puth: We were indirectly involved as the industry represented the importance of CLS extraordinarily well in those discussions. While we did engage wherever possible, we were less visible than many of the industry representatives. It was very clear to CLS from the outset that its role in the market was going to play an important part in whether the Treasury exemption went through or not. We ve had the good fortune of having a Treasury Secretary who both truly understands the currency markets and as well, truly understands CLS. I try to make sure that people make note of the fact that the Treasury exemption can be revoked if we as an industry don t continue to find ways to improve on our risk management or we slip back. We consider that a very important part of our responsibilities at CLS. JR: Having been deemed systemically important, is there a concern that CLS has become too big to fail? DP: That responsibility has always been borne by CLS since inception. While significant investments have been made over the years to enhance what CLS is able to do, the designation was something we feel was well earned and was the product of 10 years, probably closer to 15 years, of a great deal of effort. But I don t honestly consider it a burden; this is what we were built to do. JR: In the midst of Lehman Brother s collapse in 2008, CLS functioned as it should and all trades were settled. Until then, however, a number of people were sceptical about CLS, in no small part because of the large costs borne by member banks. What is your take on the industry s perception of CLS today? DP: I think during the early years of CLS, people regarded it as an important part of the marketplace, but 2008 demonstrated CLS was an essential part of the marketplace. JR: Part of why some say CLS worked when Lehman collapsed in 2008, was largely because one of the member banks stepped up and fulfilled its third party obligations. What would happen if a bank does not step up to fulfil its obligations in the future? What processes are in place? DP: The entire way CLS operates is to ensure that the market is essentially left whole in the event of a member s inability to pay. In that case, the loss would be borne by that member who was not able to pay, but that is the basis on which CLS has been built it is that the troubled party would not introduce risk into the system as a consequence of CLS the whole basis of simultaneous payment versus payment. JR: CLS has lately introduced a dedicated currency programme team, as well as legal and regulatory teams, how are these groups progressing? DP: Over the last 18 months, one of the things that CLS has accomplished is the creation of a dedicated currency team. That team s mission is to help us actively expand the number of CLS i I February 2013 I Profit & Loss I

3 We have seen many examples where becoming a CLS currency is critical for the growth of activity in a country currencies there are around the world today from 17 to some larger number in the years ahead. In addition, we have invested significantly in our risk management resources. Our risk management team has enabled CLS to work together with our members to look at the current and future risks associated with settlement. Our potential work with CCPs would be another example of areas where our risk, corporate development and legal teams have come together to do the kind of work that, frankly, I don t think would have been possible at CLS several years ago. Then, above all, our on-going investment in technology and working in close partnership with IBM ensures that our performance and capacity are never in question. This permits our member banks to have full confidence in, not only what CLS can do today, but what we hope CLS will be able to do tomorrow. Our Strategy, IT, Operations and Risk teams work together on strategic issues to further enhance the service we provide to our members. We are organised in a cohesive manner with all business units working together to solve a problem. JR: How many staff does CLS have? DP: We have 385 employees, along with a number of consultants that work on our behalf at IBM. JR: As it looks to increase the number of currencies, CLS is working with central banks in Brazil, Chile, China, Russia and Thailand, among others. What determines which currencies you add? DP: We work simultaneously on all currencies that are eligible to be CLS currencies, so there s not an explicit prioritisation about how we approach what we do. Our goal is to expand in every region around the world. We completely acknowledge that there s greater demand from the marketplace for certain currencies over others; however, we work very hard to spread our resources effectively to make sure that we re engaged with as many central banks as possible. The process for becoming a CLS currency is a major undertaking for a country and in virtually every case some form of legal changes need to take place to ensure finality of a transaction. The five central banks you cited are those that, at the current time, are more active, but we re working with a number beyond that. JR: So it s up to the individual central banks to do a lot of the legwork? DP: It is, and that s one of our challenges. It really takes a great deal of effort on the part of a central bank to make these changes. We work together with the central banks to identify what s necessary to become a CLS currency. We have seen many examples where becoming a CLS currency is critical for the growth of activity in a country. We ve seen that specifically in Israel and prior to that, South Africa, as well as in Mexico. JR: What would you say the benefits are to emerging markets countries? DP: Without question, CLS enables a developing market to be a safer place in which to transact currency through the mitigation of settlement risk. JR: I ve heard concerns voiced about the third party model in the aftermath of 2008, that some clients can be so large that the bank I Profit & Loss I February 2013 I ii

4 compression rates of 95% and higher. Without question, CLS enables a developing market to be a safer place in which to transact currency JR: How many member banks are there currently? DP: We just brought on Swedbank, and Lloyds the previous year, which brings us to 62. JR: Since the majority of trades settled through CLS are in highly liquid pairs, would bilateral netting between major counterparties with CLS settlement as the end result, provide similar security for the market? DP: You would still be introducing the risk of that bilateral arrangement pre-settlement, so I wouldn t necessarily say so. Bilateral netting only answers part of the question; it doesn t answer the whole risk question. There s obviously netting within CLS that significantly reduces risk from $5 trillion/day down to $50 billion to $200 billion the efficiency rate is between 96% and 99%. It is an extraordinary number in terms of enhancing liquidity. member representing them on Third Party CLS doesn t have a full picture of their exposures. DP: We work very closely with our member banks to ensure we are all cognisant of risks of any third party client and that will continue. That partnership with our members will continue to evolve in a positive way. JR: Are you seeing the third party model starting to return? DP: The third party model is very strong and from my perspective of the past three months, is continuing to grow. We have 9,000 third party clients, which is clearly a very robust market. JR: Is there a threshold size or turnover required to be a CLS member versus a third party because there are some very large third parties, like Lehman was, for example? DP: There are no rules around that we would obviously encourage those banks that are eligible to become members to do so wherever possible; however, we do support the third party model as well. JR: Should there be rules if a client is the size of Lehman? DP: Lehman Brothers was actually a special membership category they were not a third party in the way that third party members are today and they were the only bank in that special category, but yes, there are a handful of some very large third parties. We publish the names of those that self-select to become third parties on our website. JR: The CLS Aggregation Service has answered a few of the concerns to do with the third party CLS service, as it addresses the smaller trades. DP: Yes, primarily to deal with HFT and the extraordinary volumes that have come through in smaller transaction sizes. JR: What are the current volume and compression rates? DP: As of December 2012, average daily volume of instructions submitted to CLS was 885,203, while the average daily value of matched instructions submitted was $4.61 trillion. For the fiscal year, ADV of instructions submitted was 1,021,223 in 2012, compared with 1,015,674 in During 2012, ADV of matched instructions was $4.7 trillion versus $4.78 trillion the year prior. CLS Aggregation has JR: Were you involved in CLS while you were at JP Morgan? DP: My greatest exposure to CLS came during my time with the Fed Committee in the late '90s. I was less involved after the launch in JR: If CLS costs continue to rise for members (I understand they increased by 47% in December 2011 and another 9.5% in 2012), and the prime brokers are paying the bulk of this although some feel they should, because they re putting through the bulk of these types of trades is this the right model for CLS going forward? DP: Interestingly, some banks explicitly charge their third parties for those services. In some cases, they provide third party as a bundle with other services. But each bank s arrangement is different and you re paying on volume, so it s a very fair system in that way. JR: The effect of last year s fee rise was that prime brokers absorbed some of the increase, but PB fees went up, which meant some smaller participants left the market. Is there a danger that FX becomes too expensive an asset class for certain client sectors, particularly HFT, which operates on very thing margins? DP: We re deeply committed to operating a highly costeffective organisation. For CLS, the evolution of the FX market necessitates investment in CLS s infrastructure and processes to address increased regulatory expectations, performance improvements and the continued execution of strategic initiatives that we think will be highly beneficial to the marketplace. The expansion of currencies and the same day settlement program in Canada would be the two primary ones that we would mention. JR: When do you plan to launch same day settlement? DP: Same day settlement in Canada is on track and on budget and we expect to launch in the latter part of We re very enthused about what I think will be the completion of that project. I believe it will give us the opportunity to begin to look at other markets where same day settlement may also be appropriate. JR: Why was Canada selected first? DP: Same-day trading represents a significant component of iii I February 2013 I Profit & Loss I

5 USD/CAD. Plus, the shared time zone with the US makes this currency pair more manageable. JR: Who asked for it? DP: A combination of member banks and central banks. Most market participants saw the benefits of same day settlement; think about how far you could take that if you got it going. The FX market remains without question the most unique market in the world. It s unique because of the 24-hour nature of trading, it s unique because of the extraordinary volumes that go through, it s unique because of CLS in many ways the fact that the market has CLS and is able to operate in a way that s different to the way most of the other markets are operating today. I would certainly expect that within financial institutions there d be ongoing support for making sure your FX business is getting the resources necessary to build given the challenges that exist with other products. JR: Do you see offering same day settlement in additional countries in the near future? DP: This is a fully dedicated effort to just one currency, so it would take a great deal of effort to move into another currency. That said, there s a lot of interest in each region, but it s a very complex process. We feel confident that once Canada is up and running that we ll be able to look hard at other markets. JR: What has CLS learned from that process? DP: That it s very complex. Frankly, we are notably better equipped from a resource perspective to be able to take that on. My sense is that when we first took it on, CLS was a much smaller company with much more limited resources. JR: CLS, which launched in early 2002, was originally built when the banks were putting through a much smaller number of tickets than they do today estimates are 10,000/day back in the early days. If you were building CLS today, in a market where a single prime broker can process more than one million trades per day, would you build it the same way? What might you do differently? DP: Obviously technological advances would give us options to do things differently than we had at the time; however, CLS has made adjustments along the way to enable performance and capacity levels that could not possibly have been imagined at the outset. On our first day of operation, we settled $38 billion worth of transactions; today we settle roughly $5 trillion worth of transactions and we have actually managed to build capacity that we refer to as capacity on demand, which means that the cost of the capacity is not being borne every day, but can be accessed when that increased capacity is needed. We have wide variations in our day-to-day volumes that are driven by anything from holidays to major political events and we need that flexibility in our system to be able to manage spikes in volumes and be cost efficient when volumes slow. JR: During the May 2010 flash crash, CLS is said to have suffered backlogs. What has CLS done to prepare for another flash crash? DP: I can say that, without exception, CLS settled all FX transactions on time that day as it was built to do. So the simple answer to that question is that when looking back at 2008, looking at the flash crash, and looking at Hurricane Sandy, CLS performed as it was intended to perform and we continue to identify and work with every possible contingency. In fact, Hurricane Sandy was quite a challenging situation for CLS, and for me as well I was in Osaka when the storm hit. We had accurately anticipated that there may be issues with our downtown New York City location. We have redundancies built into our system that enable us to run out of two continents at any point in time and we effectively managed through Sandy without missing a single payment instruction. So, although our entire North American staff was displaced, as you can see [sitting in Barclays offices in midtown Manhattan], CLS continued to function exactly as it was built to function. We moved employees into eight alternate locations in New York and New Jersey and I couldn t be more pleased with how the team performed. We subsequently consolidated into fewer sites before returning to our Lower Manhattan office on December 14. We came up with some interesting technological improvisations that enabled us not the core system to have the business operate effectively out of multiple sites. It was a real win for the company and, as I alluded to earlier, CLS technology and operations worked together to ensure that CLS operated exactly as it should in this type of situation it was a real triumph. Our teams really enjoyed working together from the different sites. I would also like to express my sincere thanks to Barclays and to Goldman Sachs, as well as to our technology partner Xoriant, which made space available for CLS employees. JR: Where are your redundancy sites? DP: We are in a secure, major data centre site in New Jersey, and have a similar backup facility outside of London. Through IBM we are also able to have redundancy sites to run our two levels of technology. So we are very strong in this area. I can say that my observation, and that of others who have joined from major financial organisations, is that the resilience of the CLS system is equal to or better than that we would have seen at some other financial institutions. We are extremely strong in this area. JR: Not many things stay static in FX and so far, CLS has had no challengers in the decade it has been in existence. Do you see potential for a rival to CLS to arise or do you feel the regulators are wedded to CLS as the only solution? DP: I would never be naïve enough not to think that another organisation could come along and do what CLS does. As a result, we are regularly thinking about that which we can do better: how can we enhance the system, and how can we operate it in a faster, better, more cost-effective manner. We appreciate that we have a head start, both in the 17 currencies that we have up and running, and our designation as a systemically important FMU; however, that in no way has led to complacency about where CLS is today or where we have to be tomorrow. We would expect there to be others that come along, however, I am not sure what would motivate another we are a utility and can perform these functions extremely well, but we do need to continue to think about how to do things better. JR: Is the not-for-profit model still the best for CLS? DP: Actually, it is a for-profit, utility model. People have referred to it as a co-operative, but the best way to describe us is as a market utility. I think the utility model is a very effective model to run this type of operation. We have a board that is well represented by the industry and with independent members. We work to be as commercial as possible by meeting the needs of the industry in an affordable manner. If you were able to assess the quality of people in the organisation, we re operating with a very high calibre team we are committed to being a private company that performs a public service. That is what attracted me to CLS and I think that is what attracted a number of our team to the company. I Profit & Loss I February 2013 I iv

6 JR: Do you have concerns about the regulatory environment in the US, Europe or elsewhere? DP: We are pleased with the resolution of the Treasury exemption and look for harmonisation in other jurisdictions. There are still unanswered questions for the market that will need to be resolved over the next several years, including the role of CCPs in the marketplace, and most importantly, how does CLS interact with the CCPs. We ve had a very active dialogue with that community for some time and it has become more active. We currently have CCPs that are third party participants in CLS. JR: What are some of the more interesting conversations? DP: It introduces a new type of business into the CLS ecosystem and we ve spent a great deal of time studying the risk of CCPs and their role both with CLS and the broader market. JR: What can we expect to see next from CLS? DP: I d like to say when we re sitting here a year from now that we ve added more currencies to what we re doing and, critically, that same day settlement is up and running. You ll also see a greater presence in Asia beyond the team we currently have on the ground in Japan. BIO David Puth joined CLS as CEO in August His career spans more than three decades in financial markets, including 19 years at JP Morgan where he served in a variety of senior global leadership roles with oversight of the bank s FX, interest rate derivatives, commodities and emerging markets businesses. He also served as a member of JP Morgan Chase s Executive Committee. After leaving JP Morgan in 2007, he founded the Eriska Group, a New York-based risk management consulting organisation. From 2008 to 2011, he worked at State Street, where he was head of Global Markets responsible for sales, trading and investment research across multiple asset classes, including FX, and for Currenex, the firm s electronic FX brokerage business. Puth was also a member of the Foreign Exchange Committee, sponsored by the Federal Reserve Bank of New York, which he chaired from 1999 to 2002, and has served on the board of directors of both CME Group and Icap. He has long served on the board of the Robin Hood Foundation in New York and the Institute for Global Leadership at Tufts University. He also serves on the Board of Trustees of the Berkshire School and the Institute for Contemporary Art in Boston. v I February 2013 I Profit & Loss I