Funding, Collateralization and T2S

Funding, Collateralization and T2S Threat or Opportunity? targit GmbH 2014 targit. All rights reserved. 1

Content (1) What are the drivers for the next years? (2) How does T2S fit in? (3) T2S integrated collateralized funding - benefits to the market Presentation elaborated by Peter Schönberger, with contributions by Torsten Wieczorek, Torben Hartig, Frank Weber, Christian Marchart and Klaus Lagler 2014 targit. All rights reserved. 2

What are the drivers for the next years? TARGET2-Securities (T2S) The new Eurosystem single technical platform, enabling central securities depositories (CSDs) and national central banks to provide core, borderless and neutral securities settlement services (DvP) in central bank money (target2) in Europe. T2S is a nonmandatory project and aims to separate the infrastructure from the service. First T2S projects have started at EU banks more will come. Collateral Central Bank Management (CCBM2) (new, predecessor CCBM) A common platform for Eurosystemcollateral management, establishing efficient collateral mobilisation and management procedures for both domestic and cross-border collateral(project freeze currently as to better align it with T2S implementation) Financial & Monetary Integration Custody & Settlement Value Chain Set up of an European Payment System Euro Basel II & III target 2 SEPA CCBM & CCBM 2 T2S Custody (Global) (Local) Asset CSDs Custodians Custodians Managers T2S affected stakeholders / market actors Investors Creation of a single European Securities Market Cash Settlement (PSD, Payment Systems Directive) Securities Settlement (CSD Regulation proposal) Clearing (EMIR) Trading (MiFID & MiFID II) Settlement CSDs CCPs Trading Venues Brokers/ Dealers Investors 2014 targit. All rights reserved. 3

What are the drivers for the next years? ECB, Mrs. Gertrude Tumpel-Gugerell, 2011 We are seeing considerable growth in secured borrowing. Also the legislation on CCPs and OTC derivatives (EMIR) will require more margining. All regulatory initiatives point to the greater demands for more high-quality collateral. T2S will enable banks to make very significant savings in collateral when settling securities transactions. Accenture and Clearstream, 2011 Current way of managing collateral shows some inefficiencies both internal (i.e. related to the specific business model of each market actor) and external (i.e. determined by the fragmentation of markets and platforms): these inefficiencies are estimated at about 4 billion per year, of which about 10% originating from processes of over-collateralisation. SLTimes92, Jan 2014 Finally, repo remains the primary tool for the ECB to affect monetary policy. No other product or combination of products can fulfill all of these functions as efficiently and with lower market risk than repo. The financial market crisis and resulting regulations are changing the world of liquidity and collateral. The big trend is that funding, collateral and clearing is coming together [this will be] a centralised management of cash and non-cash collateral where all resources are pooled and optimised. (sources: ECB, PwC, Accenture, Clearstream, Newedge UK, BondLend, UniCredit, Finadium) 2014 targit. All rights reserved. 4

What are the drivers for the next years? «33bn can be saved with T2S» T2S s impact on Tier 1 capital needs of euro zone banks to comply with 2019 Basel Requirements Sources: PwC analysis based on Clearstream data OECD Journal: referring to EU capital exercises target (9% of RWA) 2014 targit. All rights reserved. 5

What are the drivers for the next years? Summary of the 18th Clearstream GSF Summit January 27 th 2014 in Luxembourg Surveyed ~ 850 international banks, corporates, infrastructure providers Top priority for 95% is sourcing the most appropriate collateral to cover global exposures Banks still have much work to undertake to establish a clear approach to their collateral management needs Only 13 % have already achieved readiness on collateral strategies The upcoming regulatory requirements will require financing to be more collateralised 85 % anticipated, triparty repo will become increasingly attractive to corporates as a replacement for cash deposits, e.g. using GC Pooling Select The convergence of such optimizations is visible - Funding, Collateral and Clearing is coming together Graph taken from: 4sight, Nov 2013 White Paper 2014 targit. All rights reserved. 6

How does T2S fit in? T2S will affect the complete custody and settlement space CSDs who will directly utilize the T2S infrastructure Can offer higher value-added functions (i.e. asset and collateral services) Can expand client spectrum from broker-dealers to the local custodians and asset managers Can refine and expand existing services only in favour of (bigger) Custodians Custodians who will adapt to T2S infrastructure Can rationalize the number of CSDs they work with Can outsource technical functions related to securities clearing, settlement - but preserve direct memberships Can expand the higher value-added functions (i.e. asset and collateral services) and trade relationships Can give up custody business at all (if too small as a subcustodian or as an only local custodian) 2014 targit. All rights reserved. 7

How does T2S fit in? T2S will affect the complete custody and settlement space For the Backoffices Management of custody network interaction will be simpler and cheaper due to homogenization and concentration Backoffices can concentrate more on offering services to their clients rather than managing multiple clearing and settlement instances (e.g. custody reconciliations) Funding, Treasury and Cash Management impacts of T2S are associated with The new ability to centralize cash management in a single set of accounts (T2S and target2 RTGS) More accurate and effective risk management due to central control of T2S cash and securities positions and exposures This concentration effects of T2S will result in synergetic benefits for FO and MO collateral management and funding processes as well as for CCPs quicker, standardized access, broader ISIN spectrum, more revenue potential IT departments will be fully impacted by T2S as these have to adapt processes and infrastructure (application systems, data, ICT) and provide solutions which are E2E integrated and tested this will expand from Front- to Mid- and Backoffice to Settlement and Accounting systems 2014 targit. All rights reserved. 8

Summary of drivers for the next years 1. Improvements in derivatives business as well as in funding activities will consistently require more high quality liquid assets (HQLA) as collateral 2. Regulations and Risk drive collateralization and centralisation activities internally and externally 3. Pan EU settlement standardization through T2S adds well to those trends and completes them downstreams 4. Optimizations in E2E processes and IT at banks, asset managers, CCPs, CSDs, Custodians will follow FX/MM Derivatives Funding and Collateralization Repo, SecLend Securities FO Capital Req. OTC Trade Clearing Funding, Clearing Collateral Settlement Custody Legacy Custody MIFID II CRD IV BIII (gen) EMIR BIII LCR, NSFR CCP CCBM(2) T2S AIFMD UCITS The E2E integration and automatization of Funding and Collateralization with T2S will generate benefits to those adapting quickly and with well thought services High synergy potential 2014 targit. All rights reserved. 9

T2S integrated collateralized funding offers benefits to the market Capital and Funding benefits Risk & Regulation benefits Business benefits Tier 1 capital savings for banks having regulations and T2S (access) implemented -Cheaper and quicker funding with E2E integrated funding and collateral management -T2S will allow institutions to pool cash, currently held in each EU market, into a single account, reducing liquidity usage by ~ 15% -Collateralization via CCP and Triparty supports Balance Sheet Netting according to IAS 32 -Collateralization lowers RWA and CVA cost Mitigation of liquidity and settlement risks through T2S EMIR and MiFID II compliantbanks will benefit from such regulatorydriven Trading, Collateral Management and Clearing improvements Basel III compliance (LCR, NSFR) can easier be met by banks with improved liquidity management T2S custodians can attract more buy side clients because spectrumand services can be extended morechances to offer invidual attractive services first T2S drives market standard harmonization, e.g. Corporate Action handling, t+2 settlement to be standard, all across > 24 pan EUCSDs Developed RepoLending andcollateral trading units can access,utilizecollateral pools and T2S benefits and so can provide improved funding Buy Side will benefit from T2S integrated collateralized funding as they can turn to banks and custodians offering those new enhancements/services early Sell Side will benefit from T2S integrated collateralized funding as they can lower cost, attract and bind clients and offer more efficient and attractive funding 2014 targit. All rights reserved. 10

What are banks tasks around T2S integrated collateralized funding? External Internal Example 1 of 2 RTGS, non FX/MM, RSL FO BO CCP 1 CCP settl. OTC Deriv F2B FI,EQ FO BO CSD 1 CCP 2 CSD 2 Coll Coll CCP n CSD n OTCD business does collateralization with cash collateral, primarily conducted in FXMM systems Alternative: OTCD business does collateralization with non cash collateral conducted in FI/EQ System FI,EQ must provide ISIN firm positions for defined utilization as collateral positions RSL can optimize ISINs quality through upgrades, swaps RSL can provide external cash cheaper by repo ing out temporary idle assets RSL can provide all funding cheaper and safer compared to choice of unsecured funding FX/MM can help optimizations in multi currency collateralization through basis trading or FX Swaps Collateral Management must collect business related movements from all silo systems, manage, valuate and process both inventory and movements centrally in a Collateral Management system OTCD business is CCP cleared, both exposure and collateralization is managed/cleared there Other CCPs for other clearing relevant businesses exist too Still some non-ccp business exist too CCPs settle non cash collateral via different CSDs or settles it direct through own settlement/csd capabilities Today: fragmentation of internal and external E2E landscape non EU non T2S MD, SD, LD, RD: Market Data, Static Data, Legal Data, Reference Data Abbreviations: DMP: Default Management Process (at CCPs) CSA: Credit Support Annex ( Collateral Agreement ) GMRA: Global Master Repo Agreement ATS: Alternate Trading System RSL: Repo & Securities Lending HQLA: High Quality Liquid Assets OTCD: Over the Counter Derivatives FI, EQ: Fixed Income, Equities MMG: Management EDM: Enterprise Data Management FO, MO, BO: Frontoffice, Midoffice, Backoffice 2014 targit. All rights reserved. 11

What are banks tasks around T2S integrated collateralized funding? Example 2 of 2 FX/MM, RSL OTC Deriv FI,EQ External Internal FO BO F2B Collateralization CCP CCP FO BO Collateralization FO consolidation in progress Collateral consumers vs. Collateral providers defined Collateralization better developped, e.g. as cross function, middleware styled CCP landscape optimized T2S single paneu cross border settlement = one collateral pool Achievements: Less fragmentation of internal and external E2E landscape Consolidations in FO, Coll.Mmg., CCP areas as well as through T2S benefits Holistic approach to E2E processes including workflows and data RTGS T2S, non non EU CSD non T2S CSDCSDCSD 2014 targit. All rights reserved. 12

Expected activities and where targit and BE can guide and support their clients Work type E2E and Collateral Management Risk and Regulatory CCPs T2S PreStudies / Concepts Business and IT Specifications Systems selections Implementations -IncreaseIT workflow alignment and convergence -DetermineE2E and Collateral IT strategies -Pre Post Trade Workflows -MD, SD, LD alignment -RSL, Triparty solutions -New Collateral Solutions -3rd party trading venues -E2E Funding and Coll via RSL etc. -Alignproduct related E2E and collateralization workflows (proposal: implement a Coll MMG layer as a middleware) -Transform market, static and ref. data into centralized steering data SW Developments Reconciliations, interfacing CCP and T2S connectivity Application product Developments Intelligent workflow, reconciliation, inventory management and valuation solutions -Align fundingand other businesses to regulation (e.g. Fundamental Review, EMIR, Basel III, MiFiD, Intraday LiqMon.) -Settlement, Credit and Liquidity Risk issues - Valuations and Curves (e.g.ois) -Align workflowsto risk, regulatory and T2S enhanced legal agreements (CSA, GMRA ) - Valuations and Curves (e.g.ois) Reconciliations, interfacing -CCPs benefit from T2S and subsequent alignments -Some CCPs to expand from domestic to international scope -Interaction of CCPs with ATS and FO as well as downstream workflows and interfacing -CCP Risk MMG (DMP, segr.) -CCP provider and model selection -Valuation, recon solutions CCP and T2S implementations,incl. multi curr. settl., ICP/DCP, SWIFT web based platform MyStandards, routines for AutoCollateralisation Reconciliations, interfacing CCP and T2S connectivity -Meta solutions for T2S/CCPintegrated FO and Collateral Management -Developinterface solutions from BO or E2E systems (Calypso, Sophis, KTP) to CCPs T2Sparticipation, provider selection, model definition, services and business case evaluations -Integrationof T2S settlement processes with inhouse MO/BO systems and workflows -Custody process consolidation T2S ICT standards, tools Adapt MO and BO systems to T2S standards T2S ICT Reconciliations, interfacing CCP and T2S connectivity -Develop solutions around standard formats (Swift MT, ISO, XML, EBICS ) -Developinterface solutions from BO or E2E systems (Calypso, Sophis, KTP) to T2S (eg. via Merva) 2014 targit. All rights reserved. 13

Threat or Opportunity? Conclusion 1. Banks should serve the economy, work orderly and fertile and they are not here to just fulfill regulations or standards 2. Spending should therefore be smart, selected and pinpointed and should ideally generate multiple benefits 3. The fragmented EU settlement landscape will soon be changed by the T2S project and this will impact the business models of financial institutions 4. Each financial institution must clarify how to utilize T2S renewals and benefits - with own adapted services or indirectly leveraging of advanced 3rd parties? 5. We will not see unsecured business anymore, all funding and trading activities will require collateral and margining in whatever form and settlements of cash and securities will flow organically in Europe within a couple of years 6. As collateral will be the new cash for the next years, financial institutions must strengthen their units, processes and infrastructure to support that and to optimize their specific cost-income ratio 7. The value proposition of funding, collateral and T2S is obvious now the organizational and implementation efforts have to follow the decided strategy of each financial institution 8. The synergies of Collateralized Funding and T2S are one of the best opportunities in recent years to generate value for money a wise investment in optimized business models, processes and technology 9. targit and BE are experienced with all the issues arising from the evaluation and projecting of such activities 10. We can support your funding, collateral and T2S effort with business and technical expertise as well as all delivery and implementation capabilities 2014 targit. All rights reserved. 14

Contact Peter Schönberger Principal Capital Markets targit GmbH München * Frankfurt * Wien * Zürich Ridlerstraße 31b D-80339 München tel ++ 49.89.517397-24 fax ++ 49.89.517397-77 mobil ++ 49.171.3520020 mailto: peter.schoenberger@targit.de http://www.targit.de 2014 targit. All rights reserved. 15

targit mission statement targit is a highly specialized consulting and IT services company in financial markets located in Munich, Frankfurt, Zurich and Vienna - with about 60 highly skilled and experienced people targit supports banks, exchanges, brokers, investment companies, asset managers, custodians and industrial companies targit provides guiding and support in all financial market related tasks and the implementation of systems from front office to back office targits business activities range from strategic and functional consulting over development and implementation of solutions to their test, support and maintenance targit business solutions are an asset for our customers based on our threefold expertise - business, application and IT targits strategic competitive advantage originates from its independence as well as from project and product oriented partnerships targit - large enough to deliver. Small enough to care. 2014 targit. All rights reserved.

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Your success is our goal targit GmbH targit GmbH targit GmbH targit GmbH Ridlerstraße 31 b Berliner Straße 44 Walfischgasse 8 Rüdigerstraße 17 D-80339 München D-60311 Frankfurt am Main A-1010 Wien CH-8045 Zürich Telefon:+49 89 517397-0 Telefon:+49 69 269140-0 Telefon:+43 1 8901198-0 Telefon:+41 43 344407-0 Telefax:+49 89 517397-77 Telefax:+49 69 269140-11 Telefax :+43 1 8901198-77 Telefax:+41 43 344407-77 info@targit.de www.targit.de info@targit.de www.targit.de info@targit.at www.targit.at info@targit.ch www.targit.ch 2014 targit. All rights reserved.

Glossary Clearing. Generally, clearing refers to the process of comparing trades before settlement date or the determination of the net obligations of the broker participants (for both securities and cash). In certain publications, clearing may be used synonymously with settlement. Settlement. The settlement process refers to the exchange of cash and securities on the contractual settlement date. The settlement date can be agreed upon at trade execution or can be prescribed by local trading conventions. Settlement may be processed on a provisional or a final basis. Settlement finality. The exchange of cash and securities is final when a settlement can no longer be unwound. Finality eliminates the main legal risks of payment and settlement systems, reduces systemic risk and ensures the smooth operation of a system. Provisional settlement. Provisional settlement allows for onward delivery of securities which were not received on a final and irrevocable basis. Systemic risk is introduced in the system if the unwinding of a specific settlement has a cascading effect on other previously settled transactions. Gross settlement. Gross settlement systems settle transactions on an instruction by instruction and real-time (RTGS) basis throughout the day. RTGS systems are costly due to the need for collateral or available cash balances to cover payment obligations during theday or for securities lending programmes to cover short securities positions. RTGS systems,however, typically reduce systemic risk. Net settlement. In net settlement systems, obligations are settled at the end of the business day on a net basis. The net process is subject to potential systemic risk, due to the contagion effect where incoming funds are relied upon to make onward payments when a participant cannot meet his obligations. As there is no requirement to post collateral or keep cash balances readily available during the day, net systems tend to be less costly. Central securities depository (CSD) and International central securities depository (ICSD). A CSD is either the physical entity or the system that facilitates the settlement and safekeeping of securities and ensures the reconciliation of participant accounts. Securities can be safe kept in immobilised or dematerialised form. Settlement generally occurs in book entry form. An ICSD is a depository settling trades in international and various domestic securities, usually through direct and indirect links with agents in the domestic markets. The best known ICSDs are Euroclear Bank and Clearstream International. The eurobond market developed in part in response to operational and regulatory inefficiencies in domestic bond markets. Central counterparty (CCP). A CCP acts as counterparty to every buy and sell trade, a process known as novation. This process concentrates counterparty risk and provides multilateral netting. Vertical and horizontal integration. Vertical integration refers to the merger of institutions providing different services in the value chain (eg trading, clearing, CSD). Horizontal integration refers to the merger of institutions providing similar services (eg clearing services for equities, derivatives and fixed income instruments). Both integrations offers advantages of scale. Continuous Linked Settlement (CLS ). CLS is a unique process that enables cross-border currency transactions to be settled intraday. CLS enables settlement to be final withpayout from central bank funds. As it is a real-time, global settlement system, it will significantly reduce the settlement risk caused by delays arising from differences in time zones, legal jurisdictions and operating procedures. Delivery versus payment. Delivery versus payment (DVP) is the simultaneous, final, irrevocable and immediately available exchange of securities and cash on a continuous basis throughout the day. Straight through processing. Straight through processing (STP) is defined in many different ways by different segments in the financial industry. In general, it is considered to be a process that improves the efficiency of the securities industry by eliminating trade and settlement failures, reducing manual processing, decreasing settlement time, etc. Collateral & Liquidity Management Collateral & Liquidity Management is defined as the optimal management of credit, collateral, capital and all related execution, pricing, operational, documentation and risk management of a portfolio across all products, all business units and all locations (ICMA definition) Abbreviations: MD, SD, LD, RD: Market Data, Static Data, Legal Data, Reference Data DMP: Default Management Process (at CCPs) CSA, GMRA: Credit Support Annex ( Collateral Agreement ), Global Master Repo Agreement ATS: Alternate Trading System RSL: Repo & Securities Lending HQLA: High Quality Liquid Assets OTCD: Over the Counter Derivatives FI, EQ: Fixed Income, Equities MMG: Management EDM: Enterprise Data Management FO, MO, BO: Frontoffice, Midoffice, Backoffice 2014 targit. 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