CLS Bank International

CLS Bank International Assessment of Compliance with the Core Principles for Systemically Important Payment Systems December 2011 2011 CLS Bank International

TABLE OF CONTENTS EXECUTIVE SUMMARY... 1 0 GENERAL BACKGROUND... 4 1 CORE PRINCIPLE I:... 19 2 CORE PRINCIPLE II:... 27 3 CORE PRINCIPLE III:... 36 4 CORE PRINCIPLE IV:... 46 5 CORE PRINCIPLE V:... 48 6 CORE PRINCIPLE VI:... 49 7 CORE PRINCIPLE VII:... 51 8 CORE PRINCIPLE VIII:... 57 9 CORE PRINCIPLE IX:... 60 10 CORE PRINCIPLE X:... 63 APPENDIX A:... 70

EXECUTIVE SUMMARY Safe and efficient financial systems depend on safe and efficient payment systems. A wellmanaged payment system efficiently reduces the effects of economic disturbances that could otherwise unsettle or disrupt the smooth functioning of domestic and international financial markets. As part of the international financial community s efforts to strengthen global financial infrastructure, the Bank for International Settlements ( BIS ) Committee on Payment and Settlement Systems ( CPSS ) published the Core Principles for Systemically Important Payment Systems ( Core Principles ) in January 2001. 1 The Core Principles serve as a set of guidelines for the design and operation of safe and efficient systemically important payment systems by providing a detailed framework for the key characteristics of such systems. In March 2011, CPSS and the Technical Committee of the International Organization of Securities Commissions ( IOSCO ) issued Principles for Financial Market Infrastructures as a consultative report, comprising twenty-four principles intended to replace the ten Core Principles. 2 These Principles have not yet become effective. CLS Bank submitted comments to the Principles on July 29, 2011. The Board of Governors of the Federal Reserve System ( Board of Governors ) issued its Policy on Payments System Risk in 2007, whereby the Board established an expectation that systemically important systems must publicly disclose self-assessments of compliance with the Core Principles. 3 The Board believes that self-assessments can assist users of the system and other interested persons in identifying, evaluating and managing the risks and costs of using the system s services while furthering global financial stability. CLS Bank International ( CLS Bank ) was established by the private sector in cooperation with a number of central banks as a payment versus payment ( PvP ) system, to reduce the settlement risk arising from foreign exchange ( FX ) transactions, which involve separate payment instructions in two different currencies. CLS Bank began settling FX transactions in 7 currencies in September 2002, and now does so in 17 currencies. In 2007, CLS Bank expanded its service to include single-currency payment instructions relating to non-deliverable forward ( NDF ) transactions and over-the-counter ( OTC ) credit derivative transactions. It should be noted, however, that FX transactions continue to make up a large majority of the transactions settled by CLS Bank. Extensions of the settlement service offered by CLS Bank ( Settlement Service ) to any new type of payment instruction and/or any new currency are subject to regulatory review and approval. The Settlement Service is a systemically important system for settling payment instructions relating to certain types of underlying financial transactions (i.e., FX contracts, NDF contracts and OTC credit derivative contracts) in specifically authorized currencies. Accordingly, the CLS system must meet or exceed the current international standards for such systems. In addition, CLS must comply with applicable policies of individual central banks whose currencies are settled by CLS Bank. Overall, the CLS system observes each of the applicable Core Principles. As a system that settles payment instructions in reliance on central bank funds, the CLS system meets the standards for finality of settlement and funding. The laws in each of the relevant jurisdictions provide a well-established legal foundation for settlement and funding finality. Access to the CLS system is determined by objective, publicly disclosed criteria. CLS believes that the CLS system s rules and procedures are clear, permit its users to understand the 1 2 3 www.bis.org/publ/cpss43.htm www.bis.org/publ/cpss94.htm 72 FR 2518; January 19, 2007. 1

financial risks associated with participation in CLS Bank, and provide incentives to participants to manage risk. The CLS system operates effectively and efficiently, providing secure, reliable and practical services to its users. Finally, while CLS believes that there is room for improvement in its governance framework, and is currently in the process of assessing ways to improve its governance process, CLS believes that its governance arrangements are reasonably effective, accountable and transparent. CLS Bank also complies with applicable policies of individual central banks whose currencies are settled by CLS Bank. Apart from the Settlement Service, CLS Group Holdings AG ( CLS Group Holdings ) provides an aggregation service through CLS Aggregation Services LLC ( CLSAS ) and the In/Out Swap Program through CLS Services Ltd. ( CLS Services ), an affiliate of CLS Bank located in London. These services are not assessed for compliance with the Core Principles, but are discussed herein where deemed relevant. Summary Findings Core Principle Observed Broadly Observed Partly Observed Not Observed I. Legal Basis II. Understanding Financial Risks III. Management of Financial Risks IV. Prompt Final Settlement V. Multilateral Netting VI. Settlement Assets VII. Security and Operational Reliability VIII. Efficiency IX. Access Criteria X. Governance Over the course of several months, CLS evaluated its compliance with each of the Core Principles. In doing so it considered a number of factors, including its self-assessment against the key considerations and explanatory text as well as a consideration of other factors. In 2

summary, CLS believes that it observes Core Principles I through IX and broadly observes Core Principle X (Governance). The summary conclusion against each of the Core Principles is set forth in the preceding table. CLS used the following guidelines for determining the relative level of observance of each of the Core Principles. Summary Assessment Definition Observed All key issues have to be fulfilled. Broadly Observed Some minor problems may be present which do not, however, have a significant impact on the fulfilment of the key issues and, thus, the safety and/or efficiency of the system. Partly Observed Significant issues/risks exist with a significant impact on the fulfilment of the key issues and, thus the safety and/or efficiency of the system, but these issues/risks will be addressed by the system owner/operator with a reasonable time frame. Not Observed Significant issues/risks exist with a significant impact on the fulfilment of the key issues and, thus the safety and/or efficiency of the system, and the owner/operator has not planned to address these issues/risks within a reasonable time frame. CLS has determined with regard to Core Principle X, that several areas of its governance should be strengthened and improved. While CLS believes that these issues do not give rise to presenting significant risks to the safety or efficiency of the CLS System, it has taken steps to address these issues and considers these matters to be important. In particular, CLS has determined that governance would be improved by having additional subject matter expertise and the inclusion of independent directors on the CLS Holdings Board. CLS also has determined that repositioning the Risk Management Committee to become a committee at the CLS Group Holdings Board level and adding a standing committee to focus on strategy would help CLS better manage these important functions. CLS believes that these measures combine with amending the charters of the existing CLS Group Holdings Board committees to take into account greater concern and focus on technology and financial matters, expanding the membership of the CLS Bank Board and meeting monthly will better position CLS to meet is obligations. CLS recognizes, however, that good governance requires thoughtful diligence, continued self-assessment and a commitment to improve its capabilities and performance. CLS appreciates its important role in the financial markets and the obligations that accompany the privileged position that it occupies. CLS is committed to continue to work to find ways to strengthen its governance to better ensure its ability to meet those obligations successfully on an on-going basis. Further detail regarding these issues and actions and others is set forth in Section 10 below. 3

0 GENERAL BACKGROUND OF THE CLS SYSTEM The Settlement Service enables the members of CLS Bank ( Members ) to have payment instructions relating to certain types of underlying transactions directly processed for settlement with finality, in reliance on central bank funds. A Member or an affiliate thereof must be a shareholder of CLS Group Holdings, unless the Member is a central bank, which pays a fee in lieu of becoming a shareholder of CLS Group Holdings. 4 CLS Group Holdings is a Swiss company that owns CLS UK Intermediate Holdings, Ltd., which in turn owns CLS Bank and CLS Services. The CLS Settlement System consists of hardware and software that process FX payment instructions for settlement, subject to the satisfaction of certain risk management tests, and provides real-time information to the Members on the status of their respective payment instructions. All information is exchanged and authenticated between the CLS Settlement System and the Members and central banks (and/or their Real Time Gross Settlement ( RTGS ) systems), using highly secure, resilient and available network connections, and strong encryption. Under a Services Agreement between IBM and CLS Bank (the IBM Agreement ), IBM provides operational services for the CLS Settlement System, and service management and support functions. 0.1 Brief History Beginning in the mid-1990s, central banks became increasingly concerned that the high level of settlement risk in existing practices, coupled with an unexpected event or failure, could trigger a serious disruption of the global FX markets and financial system liquidity. Settlement risk in the context of the FX market is the risk of paying out sold currency without receiving the purchased currency in return; having such exposure for even a short time can be significant, because comparatively large transaction values and gross value settlement may combine to represent a large portion of a party s capital. The CPSS report issued in 1996, Settlement Risk in Foreign Exchange Transactions (known as the Allsopp Report), recommended that industry groups develop a risk-reducing, multi-currency FX settlement service to protect against the loss of principal. 5 A group of major financial institutions, the Group of Twenty ( Group 20 ), joined forces (beginning in 1994) to consider how the private sector might develop such a solution. The Group 20 conducted a one-year study of alternative approaches, which resulted in the continuous linked settlement concept. Continuous linked settlement, an arrangement designed to eliminate settlement risk, is a simultaneous, PvP exchange of each of the two legs of an FX transaction. In June 1997, the Group 20 formed CLS Services Ltd. (later renamed CLS UK Holdings Ltd. and then subsequently named CLS UK Intermediate Holdings, Ltd. ( CLS UK Holdings )) to develop and build a new, multi-currency, simultaneous settlement service. The development of the CLS Group was given further support in September 2000, when CPSS s chairman emphasized the importance of such private sector initiatives. 4 5 A central bank which issues or (if applicable) otherwise circulates a currency settled in CLS Bank may apply for membership. The Reserve Bank of New Zealand is currently the sole central bank Member of CLS Bank. See also Progress in reducing foreign exchange settlement risk, CPSS (May 2008). 4

CLS UK Holdings acquired both the Exchange Clearing House ( ECHO ) and Multinet International Bank ( Multinet ) in 1997, to consolidate the providers of FX processing services. 6 In the Spring of 1998, certain non-group 20 financial institutions were asked to join CLS UK Holdings, which resulted in CLS UK Holdings having 61 shareholders by the end of 1998. CLS Bank, located in New York, was established as an Edge Act corporation under Section 25A of the Federal Reserve Act in November 1999, following approval by the Board of Governors of the Federal Reserve System. The CLS Group reorganized in April 2000. CLS Group Holdings was established as a for profit, shareholder owned company under Swiss law, with CLS UK Holdings as its wholly-owned subsidiary. CLS UK Holdings in turn has two wholly-owned subsidiaries, CLS Bank and CLS Services. CLS Services is located in London and provides support and technology related services to CLS Bank (including services in connection with the IBM Agreement as further discussed below in the response to Core Principle VII). CLS Bank went live with its Settlement Service in September 2002 with 39 Settlement Members and seven (7) currencies, and has added ten (10) currencies since going live: Go-Live Currencies (2002) Australian dollar Canadian dollar Euro Japanese yen Swiss franc UK pound sterling US dollar Abbreviation AUD CAD EUR JPY CHF GBP USD 2003 Currencies 2004 Currencies 2008 Currencies Danish krone DKK Hong Kong dollar HKD Israeli shekel ILS Norwegian krone NOK South Korean won KRW Mexican peso MXN Singapore dollar SGD New Zealand dollar NZD Swedish krona SEK South African rand ZAR CLS Bank extended the Settlement Service to single-currency payment instructions for NDF and OTC credit derivative transactions in 2007. It is important to note, however, that FX transactions continue to make up a large majority of the transactions settled by CLS Bank notwithstanding the introduction of these new products. CLS Bank has also launched a new currency program in 2011, which involves active and focused engagement with multiple prospective new jurisdictions. Extensions of the Settlement Service offered by CLS Bank to new types of payment instructions or new currencies are subject to regulatory review and approval. In 2010, CLS Aggregation Services LLC was created as a majority owned subsidiary (51%) to provide a specialized service to Members and their affiliates. The minority owner (49%) of CLSAS is Traiana Inc., which is in turn majority owned by ICAP, an interdealer broker. CLSAS offers an aggregation service, in which spot market FX transactions involving the same pair of trade counterparties (which may be Settlement Members or affiliates of Settlement Members referred to as Aggregation Parties ) and the same currencies are aggregated together to comprise a cumulative amount of buy currency against a cumulative amount of sell currency. Following this aggregation process, the relevant Settlement Members each submit a single payment instruction for settlement to CLS Bank one Settlement Member submitting an instruction to CLS Bank for the total amount of buy currency and the other Settlement Member 6 ECHO and Multinet were developed by the private sector in Europe and North America, respectively, to address pre-settlement risk by multilaterally netting FX transactions for settlement through a central counterparty. 5

submitting an instruction to CLS Bank for the total amount of sell currency. In this manner, CLSAS compresses multiple transactions into one transaction, which is then submitted for settlement to CLS Bank. This aggregation service provides economic benefits to users and reduces demands on the Settlement System. CLSAS does not net or settle trades, or provide any other services apart from the aggregation service. 0.2 Regulation and Oversight On November 1, 1999, the Board of Governors of the Federal Reserve System approved the formation of CLS Bank as an Edge Act corporation, under Section 25A of the Federal Reserve Act. The provisions of Section 25A were added to the Federal Reserve Act by the Edge Act, which Congress passed in 1919 to facilitate international banking transactions. As an Edge Act corporation, CLS Bank is regulated and supervised by the Federal Reserve. CLS is also subject to comprehensive regulation by the Bank of England under Part 5 of the Banking Act 2009. CLS became subject to such regulation when HM Treasury specified CLS as a recognized payment system pursuant to Section 184(1) of the Banking Act 2009, by order dated January 5, 2010. In addition, should CLS Bank be designated as a designated financial market utility by the U.S. Financial Stability Oversight Council, it will be subject to the provisions of Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and any regulations promulgated thereunder. The central banks whose currencies are settled in CLS Bank have established the CLS Oversight Committee, organized and administered by the Federal Reserve, as a mechanism to carry out their individual responsibilities for the safety and efficiency of payment and settlement systems, and the stability of the financial system. In jurisdictions outside the U.S. and U.K., some of these central banks and other regulatory bodies have granted CLS Bank exemptions from regulatory requirements, based on exercise of oversight by the CLS Oversight Committee and the participation in the Committee by the jurisdiction s central bank. The CLS Oversight Committee operates in accordance with the Protocol for Cooperative Oversight of CLS. 7 The Protocol was adopted by the Oversight Committee to minimize duplication of effort by the central banks, foster consistent, transparent communications between the central banks and CLS Bank, and enhance transparency regarding applicable regulatory policies in the CLS Bank jurisdictions. 0.2.1 Eligible Transactions and Currencies As stated above, FX transactions involving payment instructions in two different currencies, settled on a PvP basis, are the most common transactions settled by CLS Bank in the Settlement Service. In addition to settling FX transactions, the Settlement Service settles singlecurrency payment instructions relating to underlying NDF and credit derivative transactions. As noted above, extensions of the Settlement Service to new types of payment instructions or currencies are subject to regulatory review and approval. 8 The FX transactions settled by CLS Bank include spot market transactions, and forward contracts and exchange-traded futures contracts, wherein a Member exchanges a sell currency for a buy currency. In a spot market transaction, the exchanging Members will typically specify 7 8 The Protocol is available at: www.federalreserve.gov/paymentsystems/cls_protocol.htm. See also Central Bank Oversight of Payment and Settlement Systems, issued by CPSS in May 2005. Approval was previously obtained for settling payments of option premiums, but CLS Bank does not at present intend to include option premiums in the Settlement Service. 6

a T+2 (i.e., the second business day following submission of instructions) or earlier settlement date, whereas forward contracts will generally have a settlement date of T + >2. CLS Bank also settles the exercise of FX option contracts; however, it should be noted that the instructions submitted by Members following any such exercise are indistinguishable from instructions for spot market and forward transactions as described above. FX swaps constitute a second general category of instruments settled by CLS Bank. The FX swaps settled by CLS Bank include: swap-forward swaps consisting of a first leg which is a spot market transaction followed by a second leg which is functionally a forward contract; overnight swaps, where CLS Bank settles the second leg which has a tomorrow settlement date; and tomorrow-next day swaps consisting of a first leg with a tomorrow settlement date and a second leg with a settlement date of the next day. CLS Bank does not guarantee the settlement of any payment instruction submitted for settlement, or become a counterparty to any underlying transaction, but the PvP process ensures that the principal amount involved in an FX transaction is protected. For FX payment instructions, CLS Bank simultaneously settles the two payments, thereby eliminating the risk that one payment is made without the corresponding payment being made (a risk which arises when the two legs of an FX transaction are settled separately). For an NDF or an OTC credit derivative (as distinct from the FX transactions described above) CLS Bank settles a single payment representing the amount due. In the case of OTC credit derivatives, CLS Bank settles a single amount due under one or more types of transactions maintained in the Trade Information Warehouse (the Warehouse ) of DTCC Deriv/SERV LLC ( Deriv/SERV ), a wholly-owned subsidiary of The Depository Trust & Clearing Corporation. 9 Deriv/SERV centrally calculates the payments for OTC credit derivative transactions for which the Warehouse maintains the official legal record, or matches and affirms payments for OTC credit derivative transactions for which the Warehouse maintains basic economic information. Payment instructions for such transactions may then be submitted to CLS Bank for settlement, either through Deriv/SERV or an affiliate thereof approved by CLS Bank. (The Warehouse does not support all of the 17 currencies settled by CLS Bank, so CLS Bank only settles credit derivative transactions in some of these currencies.) As discussed above, CLS Bank settles payment instructions in the following 17 currencies: AUD, CAD, EUR, JPY, CHF, GBP, USD, DKK, NOK, SGD, SEK, HKD, KRW, NZD, ZAR, ILS and MXN. The central banks of these currencies have contributed to the effectiveness of the CLS system by maintaining central bank accounts for CLS Bank, and by creating a window period during which all of the central banks RTGS systems are open at the same time, to accommodate the funding necessary for the settlement of payment instructions. The benefits of participation in a PvP system such as CLS Bank are maximized, and the liquidity implications of such participation are mitigated, by funding in central bank money using this window period of overlapping RTGS opening hours. 9 The Warehouse is intended to provide a comprehensive, centralized trade database with the most upto-date record of each OTC credit derivative transaction, as well as a central processing capability to standardize and automate downstream processing of payments and other post-confirmation processes. 7

0.2.2 Participating Institutions; Access to the CLS System The CLS Bank Rules provide for two types of Members: Settlement Members and User Members. Qualifying shareholders of CLS Group Holdings (or affiliates of such shareholders) are eligible to become Settlement Members or User Members. In addition, a central bank which issues or (if applicable) otherwise circulates a currency that is settled in CLS Bank is eligible to become a Settlement Member. As of September 30, 2011, CLS Group Holdings has 73 shareholders, and CLS Bank has 63 Members. 10 Each Settlement Member maintains a single multi-currency account at CLS Bank (an Account ). A User Member must be sponsored by a Settlement Member. This sponsorship takes place when a Settlement Member agrees to be responsible for all funding obligations arising from an identified User Member s payment instructions, and to have these instructions processed for Settlement through the Settlement Member s Account. User Members do not maintain Accounts. Each Settlement Member is responsible as principal, and not as agent or trustee, for the funding obligations arising from payment instructions that are settled through its Account, regardless of whether the instruction is: (i) submitted by the Settlement Member for itself; (ii) submitted by the Settlement Member on behalf of its customers; or (iii) submitted by a User Member and authorized by the Settlement Member. As illustrated in Diagram 1 below, institutions that are not Members (commonly referred to as third parties ) may have indirect access to the CLS system through Members which, on behalf of such third parties, agree to be responsible for those payment instructions in CLS Bank. Third parties do not have any contractual relationship with CLS Bank, and all funding takes place between CLS Bank and Members. The terms on which a Member agrees to provide these services to third parties are governed through private, bilateral, contractual arrangements between Members and third-parties, or other intermediaries. 11 CLS Bank has no involvement in matters arising out of any such contractual relationships, including payments that may be due from the Member to the third party or vice versa. Apart from the requirement that each third-party must be a corporation or other legal entity rather than a natural person, CLS Bank does not prescribe requirements as to: (i) the types of companies and financial institutions for which Members may provide third-party services; (ii) other characteristics of these companies and financial institutions; (iii) contractual terms governing relationships between Members and third-parties; or (iv) compliance by a thirdparty with any legal requirement (with limited OFAC-related exceptions as discussed below in Section 1.3.4). The prescription and enforcement of these types of requirements pertaining to third-parties is appropriate for the relevant Settlement Member s prudential supervisor, as each Settlement Member must be a financial institution subject to prudential supervision by an authority acceptable to CLS Bank. These supervisory authorities are better positioned than CLS Bank to enforce such requirements for third-parties. Moreover, prescribing and assessing compliance against such requirements would compromise the practicality and efficiency required by Core Principle VIII and the commitment to open access required by Core Principle IX (each of these Core Principles is discussed below). 10 There are more shareholders than Members because a shareholder may be, or be an affiliate of, an institution which has not yet become a Member. In limited cases, shareholders are (or are affiliates of) institutions which have ceased to be Members, or which have ceased to be prospective Members. 11 It is also possible for non-member institutions to contract directly with intermediary third-parties that in turn have entered into private arrangements with Members for settlement services. 8

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Diagram 1 Each Member connects to the CLS system through a CLS gateway, using a CLS-specific Graphical User Interface ( GUI ) and, if applicable, a Member s in-house application through the use of the CLS Member Application Programming Interface ( API ). For NDF Instructions only, connectivity is achieved through a CLS browser-based application or Transaction Delivery Agent ( TDA ) application, which is a SWIFT Alliance Gateway option that exchanges messages between dedicated IBM WebSphere MQ queues in two or more financial institutions. (SWIFT Alliance Gateway is a SWIFT connectivity product that allows a single SWIFT network connection to be used for secure access by multiple clients to multiple remote services such as CLS.) In each case, information is exchanged between CLS Bank and the Member over SWIFTNet InterAct. Payment instructions for FX and NDF transactions are submitted to the CLS system by Members using SWIFTNet InterAct and/or the SWIFT FIN service. These are the methods for submitting all FX payment instructions to the CLS system, including FX transactions resulting from aggregation by CLSAS. While CLSAS provides an aggregation service to its users, there is no straight-through processing of aggregated instructions from CLSAS into the CLS Settlement Service. Credit derivative payment instructions may only be submitted to the CLS system indirectly through Deriv/SERV, which is responsible for identifying the paying and receiving Members within the CLS system. As indicated above, Deriv/SERV connects to the CLS system through a Transaction Delivery Agent (TDA) service, and information is exchanged between CLS Bank and Deriv/SERV over SWIFTNet InterAct. Once these payment instructions are received from Deriv/SERV, the CLS system provides the Members with information regarding these payment instructions directly (i.e., separate from any information that Deriv/SERV may provide to the Members as users of the Warehouse). 10

Diagram 2 below provides an illustration of the interaction between Members and the CLS system. Diagram 2 11

0.2.3 Operational Timeline The CLS system operates on Central European Time ( CET ), except from the last Sunday in March to the last Sunday in October, during which it operates on Central European Summer Time ( CEST ). CLS Bank settles payment instructions for each business day on which the RTGS systems for at least two settlement currencies is open. Members may, however, submit payment instructions to the CLS system at any time, with the exception of those relating to credit derivatives. For any credit derivative, the CLS system must receive the relevant instruction from Deriv/SERV before 20:45 CET on the business day preceding the settlement date. Diagram 3 below provides an illustration of the operational timeline for the settlement and funding processes in CLS Bank on each business day. 12

Diagram 3 13

0.3 Settlement and Funding in the CLS System Settlement and funding in the CLS system are separate processes, but they are linked and run in parallel operationally. Settlement takes place over a two-hour period (07:00 09:00 CET), while funding takes place over a five-hour period (07:00 12:00 CET). In contrast to settlement, funding requirements are calculated on a multilaterally netted basis, taking into consideration all the Settlement Members payment instructions scheduled for settlement on that settlement date. Both settlement and funding occur without regard to the type of underlying transaction. In other words, payment instructions are processed without regard to whether they are two-currency FX payment instructions or single-currency NDF or credit derivative payment instructions, and the types of underlying transactions also have no bearing on calculating funding requirements. 0.3.1 Overview of Settlement Upon receipt of any payment instruction, the CLS system authenticates and validates certain information included in the instruction. If the payment instruction is not successfully authenticated and validated, it will be rejected by the CLS system. Large value instructions (above a certain threshold specific to each currency) are split into several smaller instructions in order to process them more efficiently for settlement. Once the splitting of a large value instruction has taken place, CLS treats the instructions resulting from the split as separately submitted instructions. Any settlement of an authenticated, validated payment instruction, including a separate instruction resulting from the splitting of an instruction, is dependent on the satisfaction of specific risk management tests (see Section 0.3.3 Risk Management Tests below). In addition, the failure of a Settlement Member to satisfy its funding requirements to CLS Bank may result in a delay in settlement, or settlement of fewer than all of the payment instructions submitted by the Settlement Member (potentially including one or more matched pairs of instructions resulting from a split instruction settling while other pairs do not settle). If an instruction is authenticated and validated and satisfies the risk management tests as described below, CLS Bank settles each payment instruction on its settlement date by making the appropriate debit and credit across the Accounts of the relevant Settlement Members on the books of CLS Bank. In the case of FX instructions involving two-currency payments, CLS Bank settles each pair of matched FX instructions simultaneously and separately i.e., on a gross basis. Similarly, CLS Bank will settle each single-currency payment instruction pertaining to an NDF or credit derivative transaction separately (on a gross basis). 0.3.2 Overview of Funding Because each Settlement Member is solely responsible for all funding requirements arising from the settlement of its payment instructions, whether such instructions pertain to underlying transactions that are proprietary or pertain to third party customer transactions, all fund transfers in the CLS System are between CLS Bank on one hand and a Settlement Member (or its nostro agent) on the other hand. 12 12 A nostro account is a bank account in a foreign jurisdiction, denominated in the currency of the foreign jurisdiction. The nostro account in the foreign jurisdiction is typically established by a domestic bank. The foreign bank would be considered a nostro agent (or nostro) for the domestic bank, which would in this example be a correspondent bank. 14

Whereas payment instructions are settled across the books of CLS Bank on a gross basis as described above, funding between CLS Bank and its Settlement Members occurs on a multilateral net basis. Specifically, the funding requirements are based on a multilateral net calculation of the expected debits and credits in each applicable currency, taking into consideration all payment instructions submitted by Members scheduled for settlement on that settlement date (without regard to the type of transaction associated with the instructions). This is true for both Pay-Ins and Pay-Outs, as described below. Each Settlement Member funds its multi-currency Account at CLS Bank each business day by making payments to CLS Bank through the applicable RTGS systems ( Pay-Ins ), and CLS Bank makes payments to the Settlement Members from CLS Bank s central bank accounts through the applicable RTGS systems ( Pay-Outs ). The benefits of participation in a PvP system such as CLS Bank are maximized, and the liquidity implications of such participation are mitigated, by funding in central bank money during the window period when all of the central banks RTGS systems are open at the same time. All transfers of funds occur during a threehour period for Asia-Pacific currencies, which for this purpose includes the Israeli shekel (07:00 10:00 CET), and a five-hour period for all other currencies (07:00 12:00 CET). Upon receipt of the final Pay-In Schedule issued by CLS Bank, a Settlement Member instructs its designated payment department and/or the financial institution(s) that act as nostro agent for the Settlement Member in one or more currencies, to transfer funds to CLS Bank s central bank accounts as set out in the Pay-In Schedule. CLS Bank makes Pay-Outs from its central bank accounts to Settlement Members in accordance with a Pay-Out algorithm. The Pay-Outs are transferred from CLS Bank s central bank accounts, in accordance with directions previously provided by the Settlement Member to CLS Bank, either to the Settlement Member s or the nostro agent s account at the relevant central bank. Nostro agents do not have any contractual relationship with CLS Bank, and CLS Bank has no involvement in matters pertaining to a Member and its nostro agent, including payments that may be due from the Member to the nostro agent or vice versa. In normal circumstances where settlement of all payment instructions is completed, CLS Bank completes Pay-Outs of the long balances in its central bank accounts to Settlement Members before the close of each RTGS system. As a result, each Settlement Member will have a zero balance in its Account, and CLS Bank will have no funds in its central bank accounts, at the end of each business day. 0.3.3 Risk Management Tests In its efforts to mitigate the credit, market and liquidity risk associated with providing the Settlement Service, the CLS System automatically applies the following tests to each payment instruction, regardless of the type of underlying transaction involved: Positive Adjusted Account Balance (Applying -Specific Haircuts). At no time will CLS Bank settle a payment instruction if such settlement would cause the sum of all of the currency balances in a Settlement Member s Account ( Account Balance ), expressed as a USD equivalent, to be less than zero following the application of currency-specific haircuts. CLS Bank applies these haircuts to each currency balance in the Settlement Member s Account, which for purposes of this risk management test results in an increase to each of the Member s short positions and a decrease to each of the Member s long positions. Applying these haircuts is designed to ensure that no Member s adjusted Account Balance, expressed as a 15

USD equivalent, falls below zero even during periods of extreme FX market volatility. 13 Short Position Limits (-Specific). At no time may a Settlement Member s Account have a short position in any currency in excess of the short position limit established by CLS Bank for that currency. These short position limits are established for each currency, as determined periodically by CLS Bank, based on the amount of CLS Bank s available, committed liquidity facilities for that currency. These currency-specific short positions are the same for all Members. Because settlement of payment instructions occurs against value in a Settlement Member s Account, the extension of short positions (within these pre-set limits) may permit settlement of an instruction submitted by the Settlement Member even if CLS Bank has not yet received a Pay-In from such Settlement Member in the specified currency. Because the short position limit for a currency at any time and the amount of the liquidity facilities available at such time are tied in with each other, events such as a drawdown on a liquidity facility would trigger a re-evaluation of such short position limit. Subsequent to a drawdown, CLS Bank is obligated under the liquidity agreements to re-deliver the acquired currency to the liquidity provider, which would thereby restore the liquidity facility to the original amount. Any such redelivery would also likely result in a re-evaluation of the relevant short position limit. Aggregate Short Position Limit (Member-Specific). At no time may the Settlement Member s Account Balance exceed the Aggregate Short Position Limit established by CLS Bank for that Settlement Member. This limit represents the maximum amount of all short positions in the Account taken together (expressed as a USD equivalent). The Aggregate Short Position Limit does not restrict the volume or value of payment instructions that a Member may submit for settlement. This limit only controls to the extent to which payment instructions can be successfully settled across the Settlement Member s Account as Pay-Ins are made during the settlement period. The Aggregate Short Position Limit is specific to each Member, and determined from time to time by CLS Bank for each Member based on specific criteria relating to the Member. At any time, CLS Bank has discretion to reduce any Member s Aggregate Short Position Limit based on several different factors, including reductions in the Member s stand-alone credit rating or the applicable country rating, material adverse changes to the Member s tier one capital, and/or a failure to satisfy Pay-Ins. Noninvestment grade Settlement Members are assigned a zero Aggregate Short Position Limit. If CLS Bank is unable to settle a pair of matched payment instructions by the relevant currency close deadline because the applicable risk management tests have not been satisfied (either for one submitting Settlement Member or both of them), these payment instructions will be rejected by the CLS system. In the case of a rejection of instructions caused by a Settlement Member failing to satisfy one or more risk management tests because it has failed to make a Pay-In, another Member may 13 A Settlement Member is not required to fund its Account in an additional amount to cover these haircuts. Haircuts affect a Settlement Member by causing CLS Bank to withhold value in the Member s Account through reduced Pay-Outs until the Settlement Member covers the entire amount of its short positions through its Pay-Ins to CLS Bank. 16

receive a Pay-In Call as a result of such failure. The Settlement Member which has failed to satisfy risk management tests, giving rise to such rejection of instructions, will be liable for the other Member s funding costs in connection with such Pay-In Call. Any such liability, however, must be enforced by such other Member rather than CLS Bank. 0.3.4 Liquidity Facilities; Withholding of Pay-Outs The continued failure of a Settlement Member to satisfy its funding obligations to CLS Bank potentially creates a situation where CLS Bank has sufficient funds to satisfy its Pay-Out obligations to other Settlement Members relating to payment instructions that have settled, but not necessarily in the currency or currencies that the other Settlement Members are expecting to receive. Any such unexpected and continued extension of short positions in the Account of the Settlement Member which has failed to satisfy its funding obligations must be offset by sufficient long positions in the Account. Without these offsetting long positions, the Settlement Member would not be able to have short positions in the first place. CLS Bank would then withhold Pay- Outs of long positions to that Settlement Member until the Settlement Member has satisfied its Pay-In obligations to CLS Bank. If this failure to fund by the Settlement Member continues, CLS Bank would access its committed liquidity facilities, so it can make Pay-Outs to other Settlement Members in the expected currency or currencies. CLS Bank maintains committed liquidity facilities in each currency for which the Settlement Service is provided. Under these liquidity facilities, CLS Bank may call upon its liquidity providers to enter into FX swaps or outright transactions intra-day. These transactions in turn allow CLS Bank to raise the liquidity in the currency it needs to pay out, in exchange for currency in which it has balances on its central bank accounts. These balances effectively represent the long positions in the failing Settlement Member s Account, funds which CLS Bank would otherwise have paid out to the Settlement Member in the absence of its failure to cover its short position(s). The currency haircuts applied to the currency balances in the Settlement Member Accounts, and the withholding of Pay-Outs to failing Settlement Members, together ensure that the value of these central bank balances will be significantly in excess of the value of the currency that is to be acquired through the liquidity facility. These liquidity facilities are used to facilitate the Settlement Service following a failure of a Settlement Member to pay in a particular currency, as opposed to providing liquidity to a Settlement Member to facilitate settlement of its payment instructions. 0.4 Use of the CLS System In the first three quarters of 2011, CLS Bank settled an average daily volume of 822,852 payment instructions, with a peak day of 1.96 million payment instructions on September 21, 2011 (this is also the all-time peak daily volume). 14 Average daily value during the first three quarters of 2011 was US$4.8 trillion equivalent, with a peak day of US$9.0 trillion equivalent (US$10.3 trillion equivalent on March 19, 2008 is the all-time peak daily value). 15 The multilaterally netted aspects of funding in CLS Bank yields a payment netting benefit of approximately 95.9%. 16 As a result of this netting and the application of the In/Out swap liquidity management tool described in Section 3.4.2 below, on average approximately 1.1% of the total 14 15 16 Each FX transaction involves two instructions, one for each side of the transaction. numbers set forth in this paragraph are for instructions and not transactions. The volume It is the convention in describing FX transactions to count the value of both sides of the transaction. For example an exchange of USD 1,000 for Euro 675 would be counted as USD 2,000 (counting each side as being equal to USD 1,000). This is the median of the daily payment netting benefit (represented by a percentage on each business day) during the first three quarters of 2011. 17

value of the payment instructions is currently required in funding from Settlement Members for CLS Bank to complete settlement on any given day. 18

1 CORE PRINCIPLE I: The system should have a well-founded legal basis under all relevant jurisdictions. 1.0 Assessment of Compliance CLS Bank observes Core Principle I. A comprehensive and well-established legal framework consisting of contractual provisions, statutes and regulations supports the CLS system. The contractual provisions clearly define the rights and obligations of each Member that participates in the CLS system, and the rights and obligations of CLS Bank and CLS Services. The statutes and regulations in each jurisdiction in which CLS Bank settles a currency or a Member s head or home office is located provide CLS Bank and its Members with a high degree of legal assurance for the finality of settlement and funding, and for the unity of account (including the enforceability of netting). This is true even in the case of the Member subsequently becoming subject to insolvency proceedings. 1.1 Governing Agreements 1.1.1 Contractual Provisions with Members The terms under which CLS Bank provides the Settlement Service are evidenced by the following documents (collectively, the CLS Bank Documents ): CLS Bank Rules. The CLS Bank Rules comprise the written record of the consensus, reached by the shareholders of CLS Group Holdings, the Members and the regulatory community, for the Settlement Service to comply with business, risk, regulatory, legal and system functionality requirements. Member Handbook. The Member Handbook provides additional details concerning various matters addressed in the CLS Bank Rules, and sets out the applicable procedural requirements for participating in the CLS system. Member Agreement. This agreement is executed by CLS Bank and CLS Services with each Member to create a legally binding relationship. Settlement Members 17 execute a Settlement Member Agreement, while any User Member 18 executes a User Member Agreement. The Settlement Member Agreements are substantively identical to one another and are not negotiated on a Member-by-Member basis (this is also true with respect to the User Member Agreements). Each Member agrees in its Member Agreement, among other things, to abide by the provisions of the CLS Bank Rules and the Member Handbook. The CLS Bank Rules and Member Handbook are governed by English law, while the Member Agreements are governed by New York law. (See Section 1.3.2 below for a description of the dual governing law structure of the CLS Bank Documents.) The Member Agreement contains software and trademark licensing requirements, and confidentiality provisions. Although the Members are obligated to keep the CLS Bank Rules and Member Handbook confidential, a Member is permitted to disclose information set forth in these documents to its third party customers, and institutions such as nostro agents which provide necessary services to the Member in connection with the Settlement Service. 17 18 Each Settlement Member has an Account with CLS Bank. User Members do not have Accounts with CLS Bank and settle through a Settlement Member. 19

1.1.2 Contractual Provisions with Central Banks and RTGS Systems Because all Pay-Ins are received, and Pay-Outs made, by CLS Bank using central bank funds, CLS Bank maintains a central bank account for each currency settled in the CLS system. CLS Bank has an agreement with each central bank (and in some cases the applicable RTGS system) that governs CLS Bank s central bank account. Each agreement with a central bank is governed by the laws of the central bank s jurisdiction. All funding to and from CLS Bank s central bank accounts is made through the applicable RTGS systems described below. CLS Bank participates in the RTGS system on a remote access basis via the SWIFT FIN network when direct access to an RTGS system is otherwise limited to institutions with offices in the relevant jurisdiction. (i) Australian dollar (AUD) Reserve Bank Information and Transfer System ( RITS ). CLS Bank is a member of and direct participant in RITS, the AUD RTGS system operated by the Reserve Bank of Australia. CLS Bank has an exchange settlement account with the Reserve Bank of Australia. CLS Bank is a member of the High Value Clearing System operated by the Australian Payments and Clearing Association, of which CLS Bank is also a member. (ii) Canadian dollar (CAD) Large Value Transfer System ( LVTS ). CLS Bank does not participate directly in LVTS, the CAD payment system operated by the Canadian Payments Association. CLS Bank uses the nostro services of the Bank of Canada (i.e., the Bank of Canada participates in LVTS on CLS Bank s behalf), with which it exchanges payment and reconciliation messages via the SWIFT FIN network. CLS Bank has a central bank account with the Bank of Canada. (iii) (iv) (v) (vi) (vii) Danish krone (DKK) KRONOS. CLS Bank is a member of and participant in KRONOS, the DKK RTGS system operated by Danmarks Nationalbank. CLS Bank has a central bank account with Danmarks Nationalbank. Euro (EUR) TARGET2-ECB. CLS Bank has access to the Trans European Automated Real-Time Gross Settlement Express Transfer system ( TARGET2 ), the RTGS system for the Euro. TARGET2 is characterized by a single technical platform called the Single Shared Platform and legally structured as a multiplicity of payment systems. The European Central Bank participates in TARGET2 though its component system, TARGET2-ECB. CLS Bank has a central bank account with the European Central Bank. Hong Kong dollar (HKD) Clearing House Automated Transfer System ( CHATS ). CLS Bank is a member of and participant in HKD CHATS, the RTGS system for Hong Kong dollar clearing operated by Hong Kong Interbank Clearing Limited. CLS Bank has a central bank account with the Hong Kong Monetary Authority. Israeli shekel (ILS) ZAHAV System. CLS Bank is a direct participant in the ZAHAV system, the ILS RTGS system operated by the Bank of Israel. CLS Bank has a central bank account with the Bank of Israel. Japanese yen (JPY) Foreign Exchange Yen Clearing System ( FXYCS ). CLS Bank has access to the Bank of Japan Network ( BOJ-NET ), the JPY RTGS system, through FEYCS operated by the Japanese Bankers Association, with which CLS Bank has a special relationship short of full membership. CLS Bank has a central bank account with the Bank of Japan. 20

(viii) (ix) (x) (xi) (xii) (xiii) (xiv) (xv) (xvi) (xvii) South Korean won (KRW) BOK-Wire+. CLS Bank is a member of and direct participant in BOK-Wire+, the KRW RTGS system operated by the Bank of Korea. CLS Bank has a central bank account with the Bank of Korea. Mexican peso (MXN) Sistema de Pagos Electrónicos Interbancarios ( SPEI ). CLS Bank participates in SPEI, the MXN RTGS system operated by Banco de México, on a remote access basis and exchanges payment and reconciliation message with SPEI. CLS Bank has a central bank account with Banco de México. New Zealand dollar (NZD) Exchange Settlement Account System ( ESAS ). CLS Bank is a member of and direct participant in ESAS, the NZD RTGS system operated by the Reserve Bank of New Zealand. CLS Bank has a central bank account with the Reserve Bank of New Zealand. Norwegian krone (NOK) Norwegian Interbank Clearing System ( NICS ) and NBO. CLS Bank is a member of and participant in NBO, the NOK RTGS system operated by Norges Bank. CLS Bank has a central bank account with Norges Bank. Singapore dollar (SGD) New MAS Electronic Payment and Book-Entry System ( MEPS+ ). CLS Bank is a member institution of MEPS+, the SGD RTGS system operated by the Monetary Authority of Singapore. CLS Bank has a central bank account with the Monetary Authority of Singapore. South African rand (ZAR) South African Multiple Option Settlement System ( SAMOS ). CLS Bank is a member of and direct participant in SAMOS, the ZAR RTGS system operated by the South African Reserve Bank. CLS Bank has a central bank account with the South African Reserve Bank. Swedish krona (SEK) RIX. CLS Bank is a member of and direct participant in RIX, the SEK RTGS system operated by Sveriges Riksbank. CLS Bank has a central bank account with Sveriges Riksbank. Swiss franc (CHF) Swiss Interbank Clearing ( SIC ). CLS Bank is a member of and direct participant in the SIC system, the CHF RTGS system operated by SIX Interbank Clearing on behalf of the Swiss National Bank. CLS Bank has a settlement account in SIC itself and a master account with the Swiss National Bank. The separation of the accounts is of a technical nature, from a legal point of view both accounts are considered as one the sight deposit account at the Swiss National Bank. UK Pound sterling (GBP) CHAPS. CLS Bank is a member of and participant in CHAPS, the GBP RTGS system operated by CHAPS Clearing Company Ltd. CLS Bank has a central bank account with the Bank of England. United States dollar (USD) Fedwire. CLS Bank is a member of and direct participant in Fedwire, the USD RTGS system operated by the Federal Reserve Banks. CLS Bank has a central bank account with the Federal Reserve Bank of New York. 1.1.3 Contractual Provisions with Liquidity Providers When CLS Bank needs liquidity in a particular currency it uses other currencies to obtain the desired funds. More specifically, in order to raise the liquidity in the currency it needs in 21

exchange for currency in which it has balances on its central bank accounts, CLS Bank maintains committed liquidity facilities with one or more liquidity providers in each of the 17 currencies for which transactions are settled by CLS Bank. Each liquidity facility is established pursuant to a Foreign Exchange Liquidity Agreement between CLS Bank and the relevant liquidity provider, which is governed by New York law and incorporates by reference the provisions of the 1997 International Foreign Exchange Master Agreement. The Foreign Exchange Liquidity Agreements are substantively identical, and the legal terms thereof are not separately negotiated with different liquidity providers. The liquidity facilities enable CLS Bank to enter into FX swaps or outright currency purchases on an intraday basis, with any funding in central bank money using the applicable RTGS systems described in Section 1.1.2 above. A liquidity provider may terminate its Foreign Exchange Liquidity Agreement with CLS Bank by providing at least 180 days notice. 1.1.4 Aggregation Service CLS Bank Settlement Members and their affiliates may participate in the Aggregation Service provided by CLSAS. The Aggregation Service is intended to address operational risk and capacity issues arising from high frequency, low value FX trades; for example, trades attributable to algorithmic trading, prime brokerage and retail aggregators. CLSAS does not net or settle trades, or provide any other services apart from the Aggregation Service. The Aggregation Service provides a calculation service which processes trade messages for underlying FX trades as follows: (i) (ii) (iii) The Aggregation Service authenticates and validates each trade message received. The Service then attempts to match each trade message with a corresponding trade message, based on the specified buy and sell amounts and currencies, the settlement date, and the identity of the two trade counterparties. A successful match of the trade message in the Aggregation Service constitutes a legal confirmation of the economic terms of the underlying FX trade. The Aggregation Service compresses into one or more aggregated transactions all of these matched FX trades between two specific trading parties that involve the same buy currency from one trading party, in exchange for the same sell currency from the other trading party (e.g., trade counterparty A buying USD from trading party B, in exchange for trade counterparty A selling euro to trading party B), and: (x) (y) for these matched FX trades, adding all of the buy sides in the currency (USD in this example); and for these matched FX trades, adding all of the sell sides in the currency for these matched FX trades (euro in this example). Members of CLS Bank agree to submit payment instructions for the resulting aggregated transaction to the Settlement Service, for themselves and their affiliates, if the aggregated transaction involves two currencies which are eligible for settlement in the CLS system. Aggregated transactions involving currencies ineligible for the Settlement Service cannot be submitted to CLS Bank for settlement. The Aggregation Service is supported by its own Aggregation Rules and Aggregation Participant Agreement, which are governed by New York law. These Rules and Agreements are separate and distinct from the documentation governing the Settlement Service. The Aggregation Participant Agreements are substantively identical to one another and are not separately negotiated. The Aggregation Service is further discussed below in Section 2.5, and in response to Core Principle VII. 22

1.1.5 In/Out Swap Program Settlement Members may participate in the In/Out swap service provided by CLS Services as a liquidity management tool for reducing a Settlement Member s funding obligations to CLS Bank. Like the Aggregation Service, the In/Out swap service offered by CLS Services is a distinct service from the Settlement Service offered by CLS Bank. Under its agreement with each Settlement Member which elects to participate in the In/Out swap service (each of which are substantively identical with one another), CLS Services agrees to act as calculation agent for the Settlement Member to identify potential swap transactions that would reduce the Settlement Member s funding obligation. The In/Out swap service is further discussed below in Section 3.4.2. 1.2 Finality of Settlement and Funding CLS Bank provides a Settlement Service in 17 currencies, including the Euro (EUR). CLS Bank has Members with head or home offices in 7 of the individual Eurozone jurisdictions. Each of the 23 CLS jurisdictions the 7 individual Eurozone jurisdictions plus the jurisdictions of the 16 other currencies 19 has a well-founded legal basis supporting the finality of settlement and funding in the CLS System, which CLS Bank confirms annually by obtaining discursive or reasoned legal opinions from external counsel as described below in Section 1.3 (with consultation throughout the year as necessary). 20 In the event that a large value instruction is split into separate instructions, one or more matched pairs of instructions may settle while other pairs do not settle. The splitting process does not affect the finality and irrevocability of the instructions that have settled. In 19 of these 23 jurisdictions, settlement and funding may only be final and irrevocable, and the unity of multi-currency accounts respected, if a payment system has been granted special statutory protections by the relevant governmental or regulatory authority (typically the central bank). CLS Bank benefits from this special protection by virtue of the following designations: European Union Member States (7 Eurozone Jurisdictions, Denmark, Sweden, and the United Kingdom) as a designated system under the EC Settlement Finality Directive Directive 98/26/EC of the European Parliament and of the Council of May 19, 1998 on settlement finality in payment and securities settlement systems, and the Financial Markets and Insolvency (Settlement Finality) Regulations 1999 that implement the Settlement Finality Directive in the United Kingdom (each as amended). Norway as a designated system under the Settlement Finality Directive and the UK-implementing regulations as described above. Although not an EU member state, Norway has applied the Settlement Finality Directive as a member of the European Economic Area Australia as a netting market under the Payment Systems and Netting Act 1998. Canada as a clearing and settlement system under the Payment Clearing and Settlement Act. 19 20 The 16 currencies are: AUD, CAD, JPY, CHF, GBP, USD, DKK, HKD, ILS, NOK, KRW, MXN, SGD, NZD, SEK, ZAR. The 7 individual Eurozone jurisdictions are Belgium, France, Germany, Italy, Luxembourg, the Netherlands and Spain. As the common currency of the Eurozone, the Euro is not subject to any individual Eurozone Jurisdiction. The concept of finality of settlement and funding may be expressed, in general terms, as protection from insolvency and other laws that might otherwise permit a post-settlement reversal of instructions, or a post-settlement clawback of settled amounts. 23

Hong Kong as a designated system under the Clearing and Settlement Systems Ordinance. Israel as a designated supervised system under the Payment Systems Law, 5798-2008. New Zealand as a designated settlement system under the Reserve Bank of New Zealand Act. Singapore as a designated system under the Payment and Settlement Systems (Finality and Netting) Act 2002. South Africa as a designated settlement system under the National Payment Amendment Act, 2004. South Korea as a designated payment and settlement system under the Debtor Rehabilitation and Bankruptcy Law. These 4 jurisdictions do not have similar laws that require any such special designation to support the finality of settlement or funding in the CLS system: Japan finality of settlement and funding is supported by applicable insolvency laws and case law. Mexico finality of settlement and funding is supported by applicable insolvency laws and case law. Switzerland finality of settlement and funding is supported by applicable insolvency laws, including the Swiss Federal Statute on Banks and Savings Banks of November 8, 1934, as amended, and the Swiss Federal Ordinance on the Bankruptcy of Banks and Securities Dealers of June 30, 2005, as amended. United States finality of settlement and funding is supported by applicable insolvency laws, case law and Article 4A of the Uniform Commercial Code. 1.3 Reasoned Legal Opinions 1.3.1 In General CLS Bank requires and receives reasoned legal opinions, which must be satisfactory to CLS Bank, each year from external counsel in the 24 jurisdictions where CLS Bank maintains a central bank account and/or where one or Members has its head or home office. Copies of the opinions are accessible by Members through a secured website and are also provided to the CLS Oversight Committee central banks. The annual opinion re-confirmation process occurs over the course of several months, during which time CLS Bank is often in frequent contact with external counsel; accordingly, CLS Bank expects to be advised of any potential effects of enacted or proposed changes in the law of these jurisdictions. In practice, the opinion re-confirmation process has resulted in local counsel providing CLS Bank with notifications as expected; however, CLS Bank has determined that this process can be improved by specifically requesting that counsel providing local law opinions to CLS Bank monitor all relevant laws and regulations for proposed changes and promptly communicate such proposed changes to CLS. CLS Bank has begun communicating this to local counsel in connection with the current round of opinion confirmations. The opinions primarily address the following issues: 24

Recognition of the choice of English law in the CLS Bank Rules and New York law in the Member Agreement. Finality of settlement of payment instructions submitted by Settlement Members across the books of CLS Bank, and finality of funding (Pay-Ins) from Settlement Members to CLS Bank s central bank accounts. CLS Bank requires favorable opinions to the effect that (in the absence of fraudulent or other inequitable conduct by CLS Bank) settlement and funding should be final and irrevocable, even if the Member is subsequently subject to an insolvency proceeding. 21 In addition, there should be no zero-hour or similar rule which would have the general effect of reversing settlement by CLS Bank of payment instructions or a Pay-In to CLS Bank in central bank funds if on the same day a Settlement Member subsequently becomes subject to an insolvency proceeding. Unity of Account CLS Bank should be able to treat the multi-currency Account of a Settlement Member as a single net balance (even if the Settlement Member becomes subject to insolvency proceedings). No adverse impact on finality of settlement or funding, or the unity of account, even if it were ever determined that there has been a violation of antitrust laws by CLS Bank. (For purposes of rendering an opinion on this issue, counsel is asked to consider a hypothetical violation of antitrust laws by CLS Bank.) Whether compliance with the CLS Bank Rules would cause a Member to violate any law in that jurisdiction. For the 2011 annual reconfirmation of the legal opinions, CLS Bank has asked external counsel to address laws applicable in their respective jurisdictions (if any) that give government authorities powers to take actions with respect to financial institutions experiencing financial difficulties (including laws applying before a financial institution becomes insolvent). These laws are sometimes characterized as special resolution regimes, which certain jurisdictions have enacted or will enact in the wake of the 2008 financial crisis. CLS Bank will work with external counsel to evaluate the possible ramifications (if any) of any such laws which counsel identifies. In addition to the jurisdictional opinion delivered by external counsel in all relevant jurisdictions, external counsel in England delivers an opinion on the enforceability of the CLS Bank Rules and Member Handbook (governed by English law) and external counsel in the U.S. delivers an opinion on the enforceability of the Settlement Member and User Member Agreements (governed by New York law). The dual governing law structure of the CLS Bank Documents is further described below in Section 1.3.2. Counsel to each liquidity provider delivers an opinion to CLS Bank on the enforceability of the applicable Foreign Exchange Liquidity Agreement (governed by New York law). CLS Bank requires these reasoned legal opinions because finality and irrevocability of settlement and Pay-Ins can be affected by the laws of the 24 jurisdictions where CLS Bank maintains a central bank account and/or where one or more Members has its head or home office. If CLS Bank were to determine that the legal opinion in a given jurisdiction is 21 Finality of settlement and funding should be irrespective of how the underlying transaction would be treated in the event of a dispute between the parties in other words, any such dispute would be resolved outside CLS Bank, without the possibility of any reversal of instructions submitted to CLS Bank or clawback of Pay-Ins made to CLS Bank. 25

unsatisfactory, such that CLS Bank or its Members were subject to undue risk, CLS would in the first instance work with local counsel to find a solution to mitigate such risk. If no satisfactory solution is found, CLS Bank would take the appropriate steps to prohibit the jurisdiction s currency and/or Members from participating in the Settlement Service. Diagram 4 1.3.2 Dual Governing Law Structure The CLS Bank Rules and Member Handbook are governed by English law, while the Member Agreements are governed by New York law. Before commencing the Settlement Service in 2002, CLS Bank determined that this type of dual governing law structure would afford maximum protection to the CLS system available under finality and netting legislation in the European Union and the U.S. Statutory finality and netting protection in the European Union under the Settlement Finality Directive is only available to payment systems which are governed by the laws of an EU member state. CLS Bank therefore determined that the CLS Bank Rules would be governed by English law, which is both the law of an EU member state and widely accepted in international financial transactions. In addition, the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) generally provides that notwithstanding any other provision of Federal law certain payments between two financial institutions shall be netted in accordance with the terms of the netting contract (12 U.S.C. 4403). Before amendments to FDICIA in 2005, only contracts governed by U.S. state or Federal law qualified as netting contracts, so CLS Bank specified New York law to govern the Member Agreements. 1.3.3 Suspension of Member in the Event of Insolvency CLS Bank takes a conservative approach where insolvency of a Member is concerned, and thus has a policy of suspending an insolvent Settlement Member as soon as CLS Bank has learned of and is reasonably able to confirm the insolvency event. If CLS Bank were to confirm an insolvency event during a settlement session, under this policy CLS Bank would immediately suspend the Settlement Member. Once a suspension is effective, any payment instructions in 26

the CLS system submitted by the Settlement Member will have a suspension flag and will therefore not be eligible for settlement in the CLS system. While CLS Bank will continue to take this conservative approach where insolvency of a Member is concerned, CLS Bank appreciates that any Member suspension will have repercussions within the financial system; accordingly, CLS Bank will not lightly make any decision to suspend. CLS has also initiated a review of its procedures for determining whether an insolvency event with respect to a Member has occurred, which includes an assessment of the appropriate time to contact the Member s primary regulator as permitted by the CLS Bank Rules. In addition, CLS Bank has asked external counsel to address special resolution regimes in the 2011 opinion reconfirmations, and will work with external counsel to evaluate possible ramifications of any such laws. CLS Bank will evaluate whether any such laws constitute insolvency events in a particular jurisdiction or, alternatively, how application of such laws may otherwise impact Members experiencing financial difficulties. 1.3.4 Anti-Money Laundering As a U.S. financial institution, CLS Bank must comply with all applicable U.S. anti-money laundering laws and regulations, including the record-keeping requirements of the Bank Secrecy Act, the USA PATRIOT Act, and regulations promulgated by the U.S. Department of the Treasury s Office of Foreign Assets Control ( OFAC ) involving specific countries, or specific companies and individuals known as Specially Designated Nationals. In certain circumstances, compliance with these laws and regulations could lead to the rejection of settlement instructions, or CLS Bank withholding funds instead of making Pay-Outs. As part of CLS Bank s compliance with OFAC regulations, CLS Bank scans each prospective third-party against OFAC s list of Specially Designated Nationals, prior to the third-party becoming eligible to have instructions settled on its behalf by the relevant Member. Additionally, CLS Bank scans each submitted instruction (which if submitted on behalf of a third-party will contain an identification number assigned to such third-party) against these lists prior to processing each instruction. 2 CORE PRINCIPLE II: The system s rules and procedures should enable participants to have a clear understanding of the system s impact on each of the financial risks they incur through participation in it. 2.0 Assessment of Compliance The CLS system observes Core Principle II. The rules and procedures of the CLS system fully define the rights and obligations of all involved parties and are available to all of the Members. These rules and procedures are clear and permit Members to understand the financial risks resulting from participation in the CLS system. 2.1 Disclosure of CLS Bank Rules and Member Handbook The rules and procedures of the CLS system, set forth in the CLS Bank Rules and Member Handbook, are available to all Members through a secured website. The CLS Bank Rules and Member Handbook are also provided to liquidity providers and to the central banks repesented by the CLS Oversight Committee. CLS believes that setting forth Member s obligations in these documents enables the Member to better assess the financial risks of participation in the CLS system. 2.1.1 Scope of CLS Bank Rules and Member Handbook The CLS Bank Rules specify: 27

Criteria for membership in CLS Bank. Criteria for the inclusion of a currency in the Settlement Service. Scope of liability of CLS Bank and CLS Services; indemnification obligations of Members. Responsibility of Members for payment instructions, and deadlines for amending and rescinding payment instructions. Procedures for handling events that may disrupt processing of payment instructions. Validation requirements and risk management tests applied to payment instructions. Obligations under Pay-In Schedules, and under Pay-In Calls issued to Settlement Members; consequences of failure to satisfy such obligations. Manner in which Pay-Outs are made by CLS Bank to Settlement Members. Circumstances under which CLS Bank may draw on its liquidity facilities; responsibilities of the failing Settlement Member(s) arising from such draw. Loss sharing arrangements. Reasons for which CLS Bank may take remedial action against or terminate a Member (including appeal process). The Member Handbook contains additional details concerning the matters addressed in CLS Bank Rules, including: Overview of the connectivity architecture of the CLS system. Methodology by which CLS Bank calculates currency-specific short position limits and Member-specific Aggregate Short Position Limits. Methodology for calculating volatility-based, currency-specific haircuts; and rates used to calculate USD base currency equivalents. Details as to how Members receive information regarding their respective payment instructions and Accounts. Approximate operational times for processes such as the issuance of initial and revised Pay-In Schedules, commencement of the settlement period, the settlement completion target time, the funding completion target time and currency close deadlines. Funding procedures; minimum Pay-In and Pay-Out requirements. Requirements necessary to be met by liquidity providers. Details of loss sharing arrangements. Form of the Testing and Trialing Agreement, under which prospective Members agree to conduct system and operational tests, and the form of Member Agreement and form of Liquidity Agreement (attached as exhibits). Current pricing policy, fees assessed for failure to fund, and applicable interest rates (attached as exhibits). 2.1.2 Amendments to the CLS Bank Rules and Member Handbook In order to ensure appropriate consultation among the Members and other stakeholders, the CLS Bank Rules and Member Handbook may only be amended as follows: 28

CLS Bank Rules. Amendments to or waivers from the Rules must be approved by the CLS Bank Board of Directors, and become effective 60 days following notice being provided to the Members and liquidity providers. 22 The Board of Directors or the President of CLS Bank may provide for an earlier effective date if he determines that exigent circumstances exist, and an earlier effective date is necessary to protect CLS Bank or its Members, or to comply with applicable legal or regulatory requirements. Member Handbook. Amendments must be approved by CLS Bank senior management, and become effective 30 days following notice being provided to the Members. CLS Bank may provide for an earlier effective date upon a determination that an earlier effective date is desirable for the protection of CLS Bank or its Members, or to comply with legal or regulatory requirements. In addition, when notice of any proposed amendment to the CLS Bank Rules or Member Handbook is provided to the Members, CLS Bank also provides the proposed amendment to the Oversight Committee central banks for review. 2.1.3 CLS Bank Protocols CLS Bank may specify Protocols in the Member Handbook, relating to best practices surrounding post-trade processes which have been developed and generally agreed upon within the industry. As noted in Section 1.1.1 above, each Member agrees to be bound by the Member Handbook (i.e., including these Protocols) in the Member Agreement that it delivers to CLS Bank. As of the date hereof, CLS Bank has specified the CLS Bank FX Protocol ( FX Protocol ) and the CLS Bank NDF Protocol ( NDF Protocol ) in the Member Handbook. The FX Protocol provides that notification that the CLS system has matched a pair of instructions is a confirmation of the FX transaction. For example, two Members may enter into an FX transaction pursuant to the 2002 ISDA Master Agreement, which provides that a Confirmation will be entered into as soon practicable (following the parties entering into the FX transaction). Under the FX Protocol, the notification from the CLS system constitutes the Confirmation, thereby obviating the need for either Member to send any further Confirmation documentation. The NDF Protocol functions similarly for NDF transactions. 23 Non-Members may also bind themselves under the Protocols, by delivering a letter to CLS Bank. For example, a non-member third-party may enter into an FX transaction pursuant to the 2002 ISDA Master Agreement (discussed above), with a Member submitting an instruction to CLS Bank to settle the FX transaction on the third-party s behalf. Under the FX Protocol, notification to such third-party that the CLS system has matched the instruction with the counterparty instruction constitutes the relevant Confirmation, making any further Confirmation documentation unnecessary. The FX Protocol and NDF Protocol also facilitate (but do not require) a non-member third-party s notification that it is bound by the Protocol, to each other person bound by the Protocol. 22 23 As part of CLS Bank s governance process, amendments to the CLS Bank Rules are first presented to the Risk Management Committee of CLS Group Holdings for endorsement. See Section 10.2.3 for additional information on this committee. The NDF Protocol also incorporates by reference the Multilateral Master Confirmation Agreement for Non-Deliverable Forward FX Transactions published by the Foreign Exchange Committee, EMTA, Inc. and the FX Joint Standing Committee as co-sponsors on October 31, 2007. 29

2.2 Financial Risks Addressed or Presented by the CLS System The Settlement Service was originally designed to eliminate the financial risk of loss associated with FX settlement by providing for the simultaneous, PvP settlement of the two payments associated with an underlying FX transaction. Although participation in a system, including the CLS system, inherently may present financial risks, the Settlement Service is structured to minimize these risks to the Members. The CLS Bank Rules and Member Handbook expressly outline the various processes involved in the CLS system, as well as the respective responsibilities and obligations of CLS Bank, CLS Services and each Member. 2.2.1 Settlement Risk Settlement risk the risk that a party makes a payment of one currency but does not receive the corresponding payment in the other currency exists when each currency leg of an FX transaction is being settled separately. Because the Settlement Service only settles the two payment instructions of an FX transaction simultaneously, it eliminates the financial risk of loss associated with FX settlement, specifically the risk of loss of principal. Although CLS Bank does not guarantee the settlement of any payment instruction, the PvP process ensures that the principal amount involved in the FX transaction is protected once payment instructions have been accepted for settlement. In contrast to two-currency payment instructions, settlement risk is not applicable to singlecurrency payment instructions that are eligible for processing in the CLS System. Settlement of payment instructions for credit derivative and NDF transactions occur in a single currency without a corresponding payment of any kind. Under the CLS Bank Rules, each Member agrees that, settlement of payment instructions for an underlying transaction with another Member automatically constitutes a discharge of the obligations due under the transaction. Because the CLS Bank Rules only apply to Members, a non-member trade party should document in its bilateral agreements with counterparties (including the Member providing it with third-party CLS services) how such obligations are discharged. 2.2.2 Operational Risk Operational risk in the CLS System is mitigated through the design and architecture of the CLS System to ensure system integrity, security and availability, and to ensure that it is operationally reliable and resilient; 24 by facilitating straight through processing; and by employing carefully tested system administered algorithms, such as the algorithms used for calculating Pay-In Schedules and Pay-Outs of long positions. These algorithms allow CLS Bank to limit nonroutine or manual transfers of funds that are most susceptible to error. In order to minimize the risk of error, such manual transfers may only be performed under dual operator control, to ensure that adequate checks and balances are undertaken prior to any manual transfers being performed. Additionally, controls are in place to clearly ensure that the correct authorization is established prior to any approval of manual funds transfer. Operational risk in the CLS system is managed in an appropriate and integrated manner across CLS. CLS Bank and CLS Services also have formal procedures describing the functions that each must perform in normal situations, along with failure management processes and procedures for disruptive situations. These procedures include those set out in detailed service manuals covering the operational services provided by IBM for the CLS System, including management of incidents with different levels of severity. Specific procedures with Deriv/SERV are also in place 24 See the response to Core Principle VII. 30

to assist in the management of both normal and disruptive situations. CLS operating procedures are reviewed periodically, primarily based on changes to the CLS System (i.e., system applications), and updated where appropriate. CLS continues to fortify and reinforce these procedures. In the event that an operational error in the CLS System results in a loss to a Member for which CLS Bank or CLS Services is liable under the CLS Bank Documents, CLS Bank is required to assess this loss to the Members through a mandatory loss sharing procedure. Members are aware of their full exposure to potential loss allocations, as these obligations are set forth in the CLS Bank Rules. In any such event, CLS will conduct a post-incident review to investigate the root causes, identify the issues encountered, and highlight any changes required to mitigate against a recurrence of these issues. CLS will then ensure that each required action is implemented. 2.2.3 Legal Risk As indicated in the response to Core Principle I, a comprehensive and well-established legal framework consisting of contractual provisions, statutes and regulations supports the CLS system. The risk that the obligations under the Member Agreement, the CLS Bank Rules and the Member Handbook are not enforceable against the Members is addressed by a requirement in the CLS Bank Rules that each executed Member Agreement must be accompanied by a legal opinion from the Member. This legal opinion addresses due execution and authorization of the Member Agreement by the Member, and its ability to perform its obligations under the Member Agreement, the CLS Bank Rules and the Member Handbook. The risk that laws and regulations could change in a manner that adversely impacts the conclusions contained in jurisdictional legal opinions is mitigated by CLS Bank s practice of obtaining updated jurisdictional legal opinions each year. This is particularly important with respect to finality of settlement and funding, and the unity of account (including the enforceability of netting). As described above in Section 1.3.1, this process occurs over the course of several months each year, with CLS Bank in contact with each jurisdictional counsel during such time. As a result, CLS Bank expects to be advised of any potential effects of enacted or proposed changes in the laws of these jurisdictions. CLS Bank also assesses with jurisdictional counsel the impact (if any) on these opinions of any proposed changes to the CLS Bank Documents. In many jurisdictions, statutory protections providing for finality of settlement and funding end a short time after the commencement of the insolvency proceeding. In addition, in certain jurisdictions, netting protections either terminate or are potentially restricted after the commencement of the insolvency proceeding. To mitigate this risk, if CLS Bank is reasonably able to confirm an insolvency event during a settlement session, CLS Bank s policy is to immediately suspend the insolvent Settlement Member. In addition, as discussed below in Section 3.1.1, CLS Bank monitors the overall financial condition of each Member (e.g., changes in its ratings or Tier 1 capital (or capital equivalent)). From time to time, certain Members will be subject to varying degrees of enhanced monitoring, depending on marketplace and other significant events. As indicated above in Section 0.3.1, for a large value instruction which is split into separate instructions, one or more matched pairs of instructions may settle while other pairs do not settle. The splitting process does not affect the finality and irrevocability of the instructions that have settled, but pairs of instructions that do not settle are subject to pre-settlement risk, and in certain jurisdictions the rights and obligations of the contracting parties with respect to such unsettled portion of the large value instruction may be unclear. To mitigate this risk, the CLS Bank Rules expressly provide that any such unsettled instructions shall be discharged only to the extent provided by agreement between the relevant Members. Moreover, the Rules make clear that 31

the obligations of the Members to CLS Bank with respect to the pair(s) of matched instructions which have settled shall be unaffected in these circumstances. 2.2.4 Market Risk; Application of Haircuts The extension of short positions to a Settlement Member exposes CLS Bank to possible FX rate fluctuations, if the Settlement Member does not timely satisfy its funding requirements and CLS Bank has settled payment instructions in reliance on the Settlement Member s Account being within the applicable short position and Aggregate Short Position Limits. This exposure is addressed by applying volatility haircuts to the currency balances in each Account, as part of the risk management tests performed before a payment instruction is settled or a Pay-Out of any long position is made (see Section 0.3.3 above). The application of haircuts provides a cushion against adverse FX rate movements (i.e., creates excess assets in CLS Bank s central bank accounts) to mitigate the risk of CLS Bank failing to have central bank balances with an aggregate value sufficient to complete Pay-Outs to eligible Settlement Members, whether by drawing on CLS Bank s liquidity facilities or by making a Pay- Out in an alternative currency. As of the date hereof, these haircut percentages range from 18-36% depending on the currency, as adjusted from time to time by CLS Bank. The haircut percentages are based upon a review of currency-specific historical volatility and include a cushion to reflect other currency-specific sovereign, geo-political or market factors. CLS Bank periodically assesses the extent to which the volatility protection afforded by the haircuts would have been sufficient to cover all previously observed FX market movements. The combined loss allocation and general loss allocation processes, described in Section 3.2.2 below, provide a further means of mitigating market risk if FX rates have moved such that the currency haircuts have not ensured that CLS has sufficient value in its central bank accounts to meet its Pay-Out obligations. Example Haircut percentages (hypothetical) of 25% for each of the EUR and USD. Instruction of Member to buy EUR 100,000,000 for USD 115,000,000. Assumption: Member s actual currency balances are EUR -50,000,000 and USD 85,000,000 (after the prior settlement of several other instructions submitted by the Member). A. The CLS system evaluates, as part of the settlement processing queue, the Member s instruction to buy EUR 100,000,000 and sell USD 115,000,000. B. In evaluating the instruction against the risk management tests, the CLS system simulates pro forma balances of EUR 50,000,000 and USD -30,000,000. C. The EUR balance of 50,000,000 is converted to the USD base currency equivalent. Assuming a EUR-USD exchange rate of 1.36 to 1, the CLS system simulates a USD base currency equivalent balance of 68,000,000: Simulated Balance Exchange Rate EUR 50,000,000 1.3600 68,000,000 USD -30,000,000 1.0000-30,000,000 Simulated Balance in Base Equivalent D. Application of Haircuts Applying the haircut percentages of 25% (hypothetical) for both the EUR and USD, the Member is treated as having a EUR balance of 51,000,000 (base currency equivalent) and a USD balance of -37,500,000, yielding an Adjusted Account Balance of 13,500,000 (base currency equivalent). 32

Simulated Balance in Base Equivalent 33 Haircut EUR 68,000,000 25% 51,000,000 USD -30,000,000 25% -37,500,000 Adjusted Account Balance (following application of haircuts) 13,500,000 Simulated Haircut- Adjusted Balance Because the overall account balance is 13,500,000 (i.e., positive) following the application of the haircuts, this instruction does settle. E. Failure to Make Pay-Ins If the Settlement Member then fails to cover its short position of 30 million USD and does not respond to a Pay-In Call for currency close, the short position is more than offset by the Member s long position in EUR. CLS Bank will access its committed USD liquidity facilities to acquire the 30 million USD it needs to complete its Pay-Out obligations to Members with long positions in USD. In accessing its liquidity facilities, CLS Bank would exchange currency in which CLS Bank has balances in its central bank accounts; in this example, part of the EUR long position in the failing Member s account. The haircuts are designed to ensure that CLS Bank does not suffer an FX market-related loss after it enters into a transaction under a liquidity facility, by creating excess assets in CLS Bank s central bank accounts without such excess assets created by the haircuts, the instruction would not have settled in the first place. After completing the first part of the FX swap with a Liquidity Provider (the today leg), the value of USD (i.e., the currency that CLS Bank is obligated to return to the Liquidity Provider) could rise in value against the Euro. In this example, there are potentially 38,000,000 (USD base currency equivalent) of excess assets in Euro central bank funds. Some of these funds may be paid out to Members with long positions in USD, in accordance with the Pay-Out algorithm. The remaining funds will provide a cushion against this type of rise in value of USD against EUR, in the event that CLS Bank has to purchase USD in the market based on the failing Member s continued failure to make the required Pay-In. 2.2.5 Credit Risk Set forth below is a description of credit risks associated with participation in the CLS system. The means by which these risks are mitigated by the design of the CLS system and/or are managed by the Members and CLS Bank are described below in the response to Core Principle III. CLS Bank does not guarantee the settlement of any payment instruction or become a counterparty to any transaction referenced in a payment instruction. However, the creditworthiness of the Members is important because of potential loss allocation assessments under the CLS Bank Rules, which may need to be collected from the Members. CLS is exposed to credit risk from each Settlement Member to the extent the Member incurs a short position in one or more currencies. Although the risk management tests in the Settlement Service require short positions to be covered/offset by a long position in one or more other currencies, if there is both a continued failure by the Settlement Member to satisfy its funding requirements and significant FX market movements in excess of the currency haircuts applied to the Account, an FX market loss would be incurred and affect the ability of CLS Bank to satisfy its Pay-Out

obligations to the non-failing Settlement Members. Because the CLS Bank Rules require a mandatory assessment of these FX market losses to the Settlement Members through a loss sharing procedure, the credit risk of the non-paying Settlement Member is ultimately borne by the Settlement Members. Each Settlement Member is exposed to the credit risk of CLS Bank with respect to the long positions in its Account. A Settlement Member that sponsors a User Member is also exposed to the credit risk of the User Member. Additionally, credit risk exists between a Member and any customer for which it provides third-party CLS-related services. 2.2.6 Liquidity Risk Set forth below is a description of liquidity risks associated with participation in the CLS system. The means by which these risks are mitigated by the design of the CLS System and/or managed by the Members and CLS Bank are described below in the response to Core Principle III. Each Settlement Member is responsible for managing the funding for its Account, either directly or indirectly through nostro arrangements. Although funding is calculated on a multilaterally netted basis, the nature of timed payments in the CLS system may increase the demands of liquidity management for the Settlement Members. This is particularly true for Pay-In Calls, because they are issued by CLS Bank as a first means of raising additional liquidity in response to a Settlement Member s failure to satisfy its Pay-In requirements, and are therefore unexpected. In addition, the potential for a Settlement Member to receive a Pay-Out from CLS Bank in a currency other than the currency it was expecting to receive could have a liquidity impact on the Settlement Member. As described above in Section 0.3.4, in the event of a continued failure on the part of a Settlement Member to satisfy its funding obligations to CLS Bank, CLS Bank will draw on its liquidity facilities to obtain the currency which the Settlement Member has failed to pay to CLS Bank, in order to make Pay-Outs to other Settlement Members in the expected currency. If, however, CLS Bank is unable to draw on its liquidity facilities, CLS Bank may make Pay-Outs to the other Settlement Members in an alternate currency. 2.3 Awareness of the Risks Addressed or Presented by the CLS System The Rules and Member Handbook indicate the above-mentioned financial risks resulting from participating in the CLS system. CLS Bank and CLS Services are in frequent and regular contact with the Members to discuss operational, risk and legal related topics. Settlement Members, nostro agents, liquidity providers and central banks have also undertaken a considerable amount of preparatory work to understand the liquidity and systemic risk issues related to the CLS system. CLS Bank discusses in its bilateral review with each Settlement Member the ability of the Member to manage the potential liquidity implications of a disruptive situation in the CLS System. In addition to the work performed before the go-live date in September 2002, relevant information regarding the results of liquidity simulations and analyses performed during the year (often but not solely in connection with the introduction of new products or currencies to the CLS system) is shared with the Oversight Committee central banks and Settlement Members. CLS participates in numerous forums where CLS-related issues are discussed, including: Treasurers Working Group; o Nostro Working Group which may be convened from time to time under auspices of Treasurers Working Group; Third Party Working Group; 34

Liquidity working groups formed in jurisdictions of new CLS currencies; Technology User Group; Workshops involving operations representatives of the RTGS systems of the currencies which are settled in CLS Bank; The New York Foreign Exchange Committee ( FXC ) and its Operations Managers Working Group ( OMWG ), facilitated by the Federal Reserve Bank of New York; The London Foreign Exchange Joint Standing Committee ( FX JSC ) and its Operations Sub Group, facilitated by the Bank of England; Euro CLS Group, chaired by the European Central Bank; Australian Financial Markets Association FX Operations Committee; The Tokyo Foreign Exchange Market Committee ( TFEMC ) and its Operations Standing Sub-committee, facilitated by the Bank of Japan; New Zealand Financial Markets Association Foreign Exchange Committee; CLS is contacted from time to time to provide information on its initiatives at meetings of other regional FX industry groups, such as: o o o o o Australian Foreign Exchange Committee European Operations Managers Group Treasury Markets Association ( TMA ) Singapore Foreign Exchange Market Committee Seoul Foreign Exchange Market Committee. From time to time CLS Bank institutes programs for Members and/or other participants, generally for reiterating and maintaining Member awareness of the respective roles and responsibilities of CLS Bank and the Members, and key aspects of the Settlement Service (e.g., the risk design and failure management processes). Recent examples of these programs include the ecosystem forum for Members submitting high volumes of instructions, as well as workshops related to the technical architecture of the CLS system. The Chief Risk Officer of CLS Bank has convened, and expects to continue to convene, risk forums involving senior risk personnel of Members, liquidity providers and other relevant participants. Additional working groups involving nostro banks may be convened in the future. 2.4 Notification of Operational Issues Affecting the CLS System CLS promptly advises Members of operational issues affecting the CLS System, including changes or disruption to the operational timeline or problems experienced by or affecting numerous Members. This information is communicated to the Members by CLS in accordance with well-established procedures; to enable familiarity among the Members (pre-prepared) templates are often used. If appropriate, the central banks, nostro agents for the Settlement Members and/or Deriv/SERV are advised as well. In addition, CLS utilizes a crisis-wide communications protocol to ensure receipt of timely feedback from the marketplace and provide a single channel for CLS to reach the wider stakeholder community, i.e., Members, nostro agents and central banks. 2.5 Aggregation Service As discussed further in response to Core Principle VII, the design and architecture of the systems used to operate the Aggregation Service seek to mitigate operational risk by ensuring 35

that it is operationally reliable and resilient. The Aggregation Rules establish the legal framework that governs, and sets high-level parameters for, the delivery of the Aggregation Service by CLSAS. The Aggregation Rules are available to the Settlement Members participating in the Aggregation Service through a secured website, are provided to the CLS Oversight Committee central banks and set forth all of a participant s obligations in connection with the Aggregation Service. The Aggregation Rules specify, among other things: Criteria for participation in the Aggregation Service. Criteria for the inclusion of a currency in the Aggregation Service. Scope of liability of CLSAS; indemnification obligations of participants. Responsibility of participants for their trade messages; deadlines for rescinding trade messages. Minimum validation requirements applied to trade messages. Conditions under which transactions identified in trade messages will be aggregated; consequences of aggregation. Requirement that if an aggregated transaction involves two currencies which are eligible for the Settlement Service, payment instructions for each side of the aggregated transaction will be submitted to CLS Bank s Settlement Service. Reasons for which CLSAS may take remedial action against or terminate a participant (including appeal process). Amendments to the Aggregation Rules must be approved by the CLSAS Board of Directors, and become effective 60 days following notice being provided to the Settlement Members participating in the Aggregation Service (and affiliated Aggregation Parties sponsored by these participating Settlement Members). The CLSAS Board of Directors or chief executive officer may provide for an earlier effective date if he determines that exigent circumstances exist, and an earlier effective date is necessary to protect CLSAS or aggregation participants, or to comply with applicable legal or regulatory requirements. In addition, proposed amendments are provided to the Oversight Committee central banks for review. 3 CORE PRINCIPLE III: The system should have clearly defined procedures for the management of credit risks and liquidity risks, which specify the respective responsibilities of the system operator and the participants and which provide appropriate incentives to manage and contain those risks. 3.0 Assessment of Compliance The CLS system observes Core Principle III. Credit and liquidity risks to Members in the CLS system are managed principally by CLS Bank through a robust set of analytical and operational processes and procedures to eliminate settlement risk, and to manage and contain the credit and liquidity risks associated with the provision of the Settlement Service. The risk design of the CLS system incorporates many tools that: (i) enable prompt and efficient settlement of payment instructions using the funds it has received from Settlement Members; (ii) ensure that CLS Bank is able to complete its Pay-Out obligations to Settlement Members; and (iii) manage the failure of a Settlement Member to satisfy its funding obligations. In addition, through the various tools such as the availability of real-time information, application of risk management tests, algorithms that withhold Pay-Outs from the CLS system, and assessment of fees, CLS Bank provides strong incentives for the management of these financial risks. 36

The response to Core Principle II identified the key financial risks (operational, legal, market, credit and liquidity risk) associated with the Settlement Service, while this response to Core Principle III focuses primarily on the means by which credit and liquidity risk is managed in the CLS system. 3.1 CLS Bank: Management of Credit Risk 3.1.1 Membership Criteria Financial Requirements CLS Bank s overall risk design is based upon the membership criteria set forth in the CLS Bank Rules. These criteria are intended to limit membership to those financial institutions which are capable of successfully participating in CLS Bank without undue risk to the CLS system. Each Settlement Member is required to satisfy initial and continuing financial requirements for membership. These requirements include: (i) capital equal to or in excess of capital and capital ratio requirements imposed from time to time by its primary regulator; (ii) minimum short and long term debt or deposit ratings; and (iii) the provision of financial statements and material regulatory filings to CLS Bank on a periodic basis. Following a comprehensive evaluation of the Member and currency eligibility criteria, CLS Bank modified these criteria in 2007 to enable noninvestment grade financial institutions with a minimum rating of S&P BB- (or the equivalent) from a non-investment grade country to apply for direct participation in CLS Bank. CLS Bank manages the increased risk associated with admitting non-investment grade Settlement Members by assigning a zero Aggregate Short Position Limit to all such Members. While User Members do not maintain Accounts at CLS Bank and must have their payment instructions authorized by a sponsoring Settlement Member, each User Member is nonetheless subject to certain membership requirements. Although it does not need to satisfy minimum credit ratings criteria, a User Member must demonstrate that it has adequate financial resources to meet certain obligations to CLS Bank, as well as adequate operating capabilities. CLS Bank may only approve an application for membership upon the applicant meeting all of the eligibility criteria, and notification to the Board of Directors, the Members and the central bank for the applicable jurisdiction. An applicant that has been denied membership may appeal CLS Bank s decision in accordance with the procedure set forth in the CLS Bank Rules. After membership is approved, and to confirm the appropriate Aggregate Short Position Limit that has been established for the Settlement Member (as described below), CLS Bank periodically re-evaluates the ability of each Member to satisfy the Settlement Member or User Member criteria (as applicable). This includes monitoring the overall financial condition of the Member (e.g., changes in its ratings or Tier 1 capital (or capital equivalent)), as well as operational performance (e.g., the frequency with which the Settlement Member fails to satisfy a Pay-In requirement on a timely basis). At any time, CLS Bank has discretion to reduce any Member s Aggregate Short Position Limit based on these and other factors. 3.1.2 Risk Management Tests The three risk management tests applied to settlement processing of payment instructions in the CLS System (described in this section and in Section 0.3.3 above) mitigate the credit, market and liquidity risk associated with the Settlement Service. These tests are applied to all payment instructions, regardless of whether they relate to single or two-currency payment instructions. An example of the application of these three tests to one way payments is provided in Appendix A. As described above in Section 0.3.3, the settlement of each payment instruction across the Accounts of Settlement Members, on the books of CLS Bank, is subject to an automated set of three risk management tests: (i) positive adjusted Account Balance; (ii) currency-specific short 37

position limits; and (iii) the Member-specific, Aggregate Short Position Limit. The most important of the three tests is the requirement that the Settlement Member have an overall positive adjusted Account Balance at all times. A currency-specific short position limit is established for each currency, is the same for all Settlement Members, and is calibrated by determining the amount of committed liquidity facilities available to CLS Bank for that currency (subtracting from the total for each currency the largest amount available from any single liquidity provider). In contrast to the currency-specific short position limits, each Settlement Member is assigned its own unique Aggregate Short Position Limit, based on CLS Bank s assessment of factors related to the risks the Settlement Member present to CLS Bank and the other Settlement Members. Although the financial condition of the Settlement Member is just one of several factors considered in this assessment, CLS Bank automatically assigns a zero Aggregate Short Position Limit to any non-investment grade Settlement Member. The CLS system imposes these three risk management tests on the settlement and Pay-Out processes on a real-time basis. These controls are applied at all times, without regard to the type of underlying transaction to which the payment instruction relates. These controls ensure that no payment instruction is settled across a Settlement Member s Account which would: (i) create a negative overall, net U.S. dollar equivalent, Account Balance (after adjustment for currency haircuts) for the Settlement Member; (ii) create an individual short position in any currency that is greater than allowed by the applicable short position limit; or (iii) cause all of the short positions in the Account to exceed the Settlement Member s Aggregate Short Position Limit. These controls also ensure that no amounts are paid out to a Settlement Member without there being equivalent value held in the form of balances in another currency, maintained in one of CLS Bank s central bank accounts. The risk design of the CLS system ensures that CLS Bank has sufficient funds to satisfy its Pay- Out obligations relating to payment instructions that have settled, even if the Settlement Member with the largest Pay-In obligation relating to the settled payment instructions (which for this purpose is also assumed to be a Liquidity Provider) fails to satisfy this Pay-In obligation (and fails to fulfill its commitment to provide liquidity). The currency haircuts applied by the CLS system are designed to ensure that there is more than sufficient value in the central bank balances of CLS Bank to satisfy CLS Bank s Pay-Out obligations to the other Settlement Members. The short position limit in each currency may not exceed, and is effectively capped by, the aggregate amount of the committed liquidity facilities less the amount of the largest committed liquidity facility for that currency. As a result, even if CLS Bank were unable to draw on the largest liquidity facility in the currency that the Settlement Member has failed to pay to CLS Bank, CLS Bank nonetheless would have sufficient funds and liquidity facilities in place to obtain this currency, and therefore would be able to make Pay-Outs to the other Settlement Members in the expected currency in connection with payment instructions that have settled. If, however, this Settlement Member failure situation is coupled with either (i) the inability of CLS Bank to draw on multiple liquidity facilities, and/or (ii) the failure of an additional Settlement Member or Members to satisfy Pay-In obligations to CLS Bank, CLS Bank may resort to making Pay-Outs to the other Settlement Members in an alternate currency or currencies; i.e., in a currency other than the currency expected by the non-failing Settlement Members in connection with payment instructions that have settled. 3.1.3 Haircuts The currency haircuts applied to the currency balances in the Settlement Members Accounts, coupled with the suspension of Pay-Outs to failing Settlement Members described below in Section 3.1.4, are designed to minimize the risk that the value of these central bank balances is insufficient to satisfy CLS Bank s Pay-Out obligations to the other Settlement Members whether 38

by drawing on CLS Bank s liquidity facilities or by making a Pay-Out in an alternative currency. (See Sections 2.2.6, 3.3.4 and 3.3.5.) In addition, the haircuts are designed to ensure that CLS Bank does not suffer an FX market related loss after it enters into a transaction under a liquidity facility, by creating excess assets in CLS Bank s central bank accounts. For example, after settling the first part of an FX swap with a Liquidity Provider (the today leg), it is possible that the value of currency that CLS Bank is obligated to return to the Liquidity Provider in the second leg (the tomorrow leg) rises in value. In the event that CLS Bank has to purchase such currency in the market (e.g., based on a failing Settlement Member s continued failure to make the required Pay-In), these excess assets in CLS Bank s central bank accounts would provide a cushion against such adverse FX rate movements. 3.1.4 Suspension of Pay-outs In the event that a Settlement Member fails to satisfy its Pay-In obligations, CLS Bank will suspend all Pay-Outs to the Settlement Member until it becomes fully compliant with the requirements of its Pay-In Schedule. 3.1.5 Finality of Settlement and Funding As described above in the response to Core Principle I, settlement of payment instructions of a Settlement Member across the books of CLS Bank, and funding from the Settlement Member to CLS Bank s central bank accounts, are final and irrevocable even in situations where a Settlement Member subsequently becomes subject to an insolvency proceeding. (See Sections 1.2 and 1.3 above.) 3.2 Members: Management of Credit Risk 3.2.1 Exposure to CLS Bank Each Settlement Member is exposed to the credit risk of CLS Bank with respect to the long positions in its Account. This risk is mitigated by the duration of the funding period, which is five hours, and the efficiency of the Pay-In and Pay-Out algorithms. (See Section 3.3.2 below.) 3.2.2 Exposure to Other Members (General Discussion) As discussed above in Section 2.2.5, a continued failure by a Settlement Member to satisfy its funding requirements, coupled with significant FX market movements in excess of the currency haircuts applied to the Accounts, could result in an FX market loss for CLS Bank and could affect the ability of CLS Bank to satisfy its Pay-Out obligations to the non-failing Settlement Members. Because the CLS Bank Rules require a mandatory assessment of these FX market losses to the Settlement Members through a loss sharing procedure, the credit risk of the non-paying Settlement Member is ultimately borne by the other Settlement Members. The CLS Bank Rules require that this FX market loss be allocated as a combined loss allocation to the Settlement Members which, on the date of such failure, had settled payment instructions with the non-paying Settlement Member. The combined loss allocation assessed against a Settlement Member is an amount equal to the sum of all Account credits and debits attributable to settled instructions with the non-paying Settlement Member (but such sum may not be less than zero (0)). Assessing the combined loss allocation in this manner, without any cap, incentivizes each Settlement Member to evaluate its credit risk with respect to each of its counterparty Settlement Members, and if appropriate control such exposure by limiting its settlement activity with one or more counterparties. The CLS Bank Rules also provide for additional loss allocations (general loss allocations), which are capped. For example, Settlement 39

Members are exposed to a potential general loss allocation if one or more Settlement Members fail to satisfy their respective combined loss allocations. CLS Bank believes, however, that the risk of potential combined and general loss allocations to Settlement Members is mitigated by the haircut methodology and risk management tests, and most significantly by CLS Bank s management of credit risk to the Settlement Members through initial and continuing financial requirements for membership (see Section 3.1.1 above). The membership criteria are designed to minimize the risk of disruptions to the Settlement Service due to Pay-In failures or operational problems, by limiting membership to those institutions that have the financial and operational capabilities to satisfy their obligations to CLS Bank. In particular: (i) Settlement Members must meet specific financial, credit and operational criteria to qualify for initial and continuing membership in CLS Bank; (ii) CLS Bank sets an Aggregate Short Position Limit for each Settlement Member, which has the effect of capping the magnitude of any loss allocation that could be assessed as a result of the continued failure by that Settlement Member to satisfy its funding requirements (even assuming significant FX market movements in excess of the currency haircuts applied to the Settlement Members Accounts); and (iii) CLS Bank considers factors such as creditworthiness, liquidity and operational capabilities when setting or maintaining (or exercising its discretion to reduce) a Settlement Member s Aggregate Short Position Limit. It is important to note that the Aggregate Short Position Limit does not restrict the volume or value of payment instructions that a Member may submit for settlement. This limit only controls to the extent to which payment instructions can be successfully settled across the Settlement Member s Account as Pay-Ins are made during the settlement period. 3.2.3 User Members; Third-Parties; Pre-Settlement Risk Any Settlement Member that sponsors a User Member is exposed to the credit risk of its User Member. The CLS system does not process any payment instruction of a User Member for settlement unless the instruction has been authorized by its sponsoring Settlement Member. The sponsoring Settlement Member provides this authorization, and therefore effectively controls this credit exposure, by employing certain automated authorization functionality (specifically a User Member short position limit, Aggregate Short Position Limit and credit limit) or individually authorizing the instruction, in each case in the CLS system. With respect to credit risk that may exist between a Member and any customer for which it provides third-party CLS-related services, the Member controls this exposure through its bilateral arrangements with its customer, which do not involve CLS Bank and is outside the CLS system. In some cases, the Member may decline to submit one or more payment instructions involving a customer to the CLS system or, in other cases, may rescind any such instruction previously submitted by the Member involving that customer. It should also be noted that participation by a Member in CLS Bank does not address presettlement risk, because CLS Bank does not guarantee the settlement of any transaction. Presettlement risk is the risk that a particular FX transaction fails to settle on either side of the transaction (as distinct from settlement risk which is the risk of paying out sold currency without receiving the purchased currency in return). One example is a Member s failure to make a Pay-In by the relevant currency close deadline, with the resulting short position causing the Member to fail one or more of the risk management tests described above in Sections 0.3.3 and 3.1.2. Unless both submitting Members have satisfied these risk management tests, the pair of matched instructions will be rejected. This failure to settle the FX transaction exposes the submitting Members to gross replacement value risk, which is the risk associated with having to replace the unsettled contract with a new, more costly FX transaction. Pre-settlement risk and gross replacement value risk are also relevant in connection with CLS Bank suspending a Member during a settlement session as described above in Section 1.3.3. In addition, in the event that one or more matched pairs of instructions 40

resulting from a split instruction settle while other pairs do not settle, the unsettled pairs of matched instructions would be subject to pre-settlement risk and gross replacement value risk. 3.3 CLS Bank: Management of Liquidity Risks 3.3.1 Multilaterally Netted Funding The multilateral netting aspects of funding in the CLS system significantly reduces a Settlement Member s Pay-In obligations. Multilaterally netted funding is most efficient from a liquidity perspective, because each Settlement Member is able to meet its payment obligations to CLS Bank in any currency by paying in an amount of such currency that is substantially less than it would need to make to each other Settlement Member as part of a bilateral settlement process. Netted funding encompasses all payment instructions, including single-currency payment instructions, and applies both to Settlement Member Pay-Ins and also Pay-Outs from CLS Bank to the Settlement Members. The inclusion of single-currency payment instructions in the CLS system extends the benefits of multilaterally netted funding to such instructions. Given the number of and values associated with the single-currency payment instructions relating to credit derivative and NDF transactions relative to two-currency payment instructions relating to FX transactions, the commingling of these single-currency payment instructions with two-currency payment instructions in the CLS system does not materially adversely affect the benefit of multilateral netting for FX transactions across all currencies. 3.3.2 Funding Period; Efficient Pay-In and Pay-Out Algorithms A funding period of several hours facilitates liquidity management by allowing Settlement Members (and if applicable their nostro agents) to spread the timing of their payments and make the best use of the overlapping opening hours of the RTGS systems. Pay-In Schedules are structured to ensure that settlement of all payment instructions occurs by the settlement completion time (09:00 CET), and Pay-Outs can be made in the currencies with early RTGS closing times. To accomplish these goals, the Pay-In algorithm requires a certain percentage of each Settlement Member s funding obligations to be paid to CLS Bank by specified times within the funding period to ensure that sufficient amounts are paid in by: (i) the settlement completion target time so that the Settlement Member s Account Balance will be within the applicable currency-specific short position limits, and the (Member-specific) Aggregate Short Position Limit; and (ii) the funding completion target time for the Asia Pacific currencies, so the Settlement Member has sufficient value in its Account to receive Pay-Outs in those currencies before the Asia-Pacific RTGS systems close. CLS Bank seeks to make Pay-Outs of long positions to Settlement Members throughout the settlement process, in accordance with a Pay-Out algorithm which incorporates a set of defined criteria to ensure that sufficient value is retained in the Accounts to allow for the settlement of payment instructions, while minimizing the liquidity impact on the local markets. The Pay-Out algorithm reflects the criteria set forth in clauses (i)-(v) below and, to the maximum extent practicable, the criteria set forth in (vi) and (vii) (without regard to preferences of any Settlement Member): (i) (ii) no Pay-Out will be made to a Settlement Member if it would cause such Settlement Member to have a negative Adjusted Account Balance; Pay-Outs will only be made in currencies where a Settlement Member is projected to have a long position after taking into consideration the effect of its unsettled payment instructions (i.e., CLS Bank would not make a Pay-Out of a temporary intra-day long position); 41

(iii) (iv) (v) (vi) (vii) if a Settlement Member has unsettled payment instructions, its Pay-Out will be in an amount that assures that sufficient value is retained in its Account to allow these Instructions to settle irrespective of a large intra-day FX market move; the Pay-Out of currencies with later currency close deadlines will be in an amount that assures that sufficient value is retained in the Settlement Members Accounts to allow for the Pay-Out of currencies with earlier currency close deadlines; any Settlement Member receiving Pay-Outs has made some Pay-Ins of one or more currencies to CLS Bank; the currencies in which CLS Bank holds the largest balances are generally to be paid as early as possible; provided, however, that currencies with earlier payment system closing times are generally paid before others (taking into account the need to create liquidity in certain currency markets by giving priority to Pay-Outs in such market s currency); and Pay-Outs in any currency are first made to Settlement Members who have the largest Account Balances. To the extent that any funds received from a Settlement Member are not needed for settlement purposes on a specified settlement date, they will be taken into account by the Pay-Out algorithm and be automatically paid-out to the Settlement Member on that date. In normal circumstances where settlement of all payment instructions is completed, CLS Bank completes Pay-Outs of the long balances in its central bank accounts to Settlement Members before the close of each RTGS system. As a result, each Settlement Member will have a zero balance in its Account, and CLS Bank will have no funds in its central bank accounts, at the end of each settlement date. 3.3.3 Pay-In Calls Pay-In Calls are viewed as the first means of raising additional liquidity in the event that a Settlement Member fails to satisfy its Pay-In requirements, regardless of whether the failure is related to an operational or credit issue. As previously indicated, however, Pay-In Calls could pose significant liquidity issues for Settlement Members because they are unexpected. Pay-In Calls are issued at fixed times prior to each currency close. There are two types of Pay-In Calls Pay-In Calls for settlement and Pay-In Calls for currency close. CLS Bank will issue a Pay-In Call for settlement to Settlement Members that have unsettled payment instructions with the Settlement Member that has failed to satisfy its funding obligations, in order to maximize the number and value of settled payment instructions during the settlement session. CLS Bank will issue a Pay-In Call for currency close prior to the closing time of an RTGS system for a particular currency, where a Settlement Member with a short position in the currency (based upon payment instructions submitted by the Settlement Member that have already settled) has an insufficient Account Balance to allow for the Pay-Out of a long position. 25 25 See the discussion of the window period above at Section 0.3.2 Overview of Funding. As a general matter, RTGS systems for Asia-Pacific currencies (located in Asia-Pacific time zones) close before RTGS systems in Europe, South Africa and North America. 42

3.3.4 Liquidity Facilities As described above in Section 2.2.6, the continued failure of a Settlement Member to satisfy its funding obligations to CLS Bank would create a situation where CLS Bank may have sufficient funds (in terms of value), to satisfy its Pay-Out obligations to other Settlement Members, but not in the currency or currencies that the other Settlement Members are expecting to receive. This is because the unexpected and continued extension of any short positions must be offset by long positions in the Settlement Member s Account; in the absence of such offsetting long positions, the Settlement Member would not receive the benefit of the extension of any short positions in any currencies. CLS Bank maintains committed liquidity facilities to provide funds in the needed currency to CLS Bank, to mitigate this liquidity risk. In the case of a continued Settlement Member failure, CLS Bank will access its committed liquidity facilities to make Pay-Outs to eligible Settlement Members in the expected currency or currencies. CLS Bank maintains committed liquidity facilities in each currency for which the Settlement Service is provided, under which CLS Bank may cause its liquidity providers to enter into FX swaps or outright transactions intra-day (in each case upon demand). In an FX swap with a liquidity provider, CLS Bank would raise liquidity in the currency it needs to fulfill its Pay-Out obligations by exchanging currency in which CLS Bank has balances in its central bank accounts. These balances effectively represent the long positions in the failing Settlement Member s Account, funds which CLS Bank would have paid out to the Settlement Member if the Settlement Member did not fail to cover its short position(s). The currency haircuts applied to the currency balances in the Settlement Members Accounts and the withholding of Pay-Outs to failing Settlement Members are designed to minimize the risk that these central bank balances will be insufficient to satisfy CLS Bank s Pay-Out obligations to eligible Settlement Members. Under any FX swap entered into with a liquidity provider, in the second leg of the swap CLS Bank will be obligated to re-deliver the acquired currency to the liquidity provider. Upon any such re-delivery in full, the amount of the liquidity facility will be restored to the original amount (in the same way as an everyday revolving line of credit). CLS Bank, at a minimum, maintains sufficient liquidity facilities in each currency to satisfy its Pay-Out obligations in the correct currency if there is a Pay-In failure by the Settlement Member with the largest short position in that currency (even if the failing Settlement Member is also a liquidity provider in that currency). However, in several currencies, CLS Bank has committed liquidity facilities that allow it to satisfy its Pay-Out obligations in the correct currency if there is a Pay-In failure by the Settlement Members with the two largest short positions in the currency. In those currencies where CLS Bank has only the minimum coverage, it is primarily due to the inability to acquire further committed facilities in the local market. In those situations, CLS Bank has the option of lowering the applicable short position limit to accommodate multiple failures. This would involve a trade-off between the benefits of accommodating a multiple Pay-In failure in the relevant currency, and the systemic costs of imposing a lower short position limit for that currency (as the lower short position limit would either reduce the number of instructions that can be settled in that currency or require Members to make larger pay-ins relative to their settlement activity). 3.3.5 Pay-Out of Equivalent Value in an Alternate As described above in Section 2.2.6, CLS Bank may satisfy its Pay-Out obligations using a currency that was not otherwise expected by the Settlement Members. This may occur if more than one Settlement Member fails to satisfy its funding obligations on the same date. As described in more detail in Section 3.3.4 above, CLS Bank may have insufficient liquidity facilities for a currency in which it has Pay-Out obligations, e.g., in a multiple failure situation. A Pay-Out in an alternative currency may also be required if a liquidity provider fails to satisfy its obligations to CLS Bank under the liquidity facility. 43

3.4 Members: Management of Liquidity Risks 3.4.1 Information The amount of funding which must be paid to CLS Bank, and the required timing of such funding, has liquidity implications for the Settlement Members. CLS Bank performs projections of anticipated future Pay-In requirements to identify abnormally large funding obligations. CLS Bank will notify those Settlement Members having large projected funding obligations to ensure that they are aware of any such obligation. In addition, Settlement Members receive real-time information on the status of all of their payment instructions and the related Pay-Ins and Pay- Outs in each currency, thereby significantly strengthening their crisis management abilities if an issue arises with another Settlement Member. 3.4.2 In/Out Swap Program Settlement Members may participate in the In/Out swap program provided by CLS Services, and enter into intra-day FX swap transactions (In/Out swap transactions) as a liquidity management tool for reducing a Settlement Member s funding obligations to CLS Bank. This program is separate and distinct from the Settlement Service. An example of the functioning of the In/Out swap program is provided in Appendix B. As described above in Section 0.4, the multilateral netting aspects of funding yields a payment netting benefit of approximately 95.9%. 26 With respect to the residual 4.1% (i) 1.1% represents the Settlement Members Pay-In obligations to CLS Bank for the settlement of payment instructions in the CLS system and (ii) 3.0% represents the Settlement Members funding for settlement which occurs outside the CLS system for the out leg of In/Out swap transactions. After the initial Pay-In Schedule is issued by CLS Bank at 00:00 CET, CLS Services, as calculation agent, calculates and identifies potential In/Out swap transactions between participating Settlement Members. 27 The In/Out swap program relies on an automated algorithm that identifies positions in excess of individual currency trade-down targets, and then calculates the swap transactions based upon counterparty credit limits set by the participating Settlement Members. Some participating Settlement Members may enter into the swap transactions even though their positions are less than the currency trade-down targets, because they may become counterparties to swap transactions with other participating Settlement Members whose positions are over the targets. In any event, these potential In/Out swap transactions would, if entered into, reduce the Settlement Member s short positions in certain currencies, while at the same time reducing other Settlement Members long positions in those same currencies. The first leg (the in leg) of any such swap transaction is submitted by the two relevant Settlement Members for same-day settlement inside CLS Bank prior to the issuance of the revised Pay-In Schedule at 06:30 CET. Because the second leg (the out leg) of such swap transaction is settled that same day outside CLS Bank, settlement risk exists with respect to this out leg and must be managed and controlled by the participating Settlement Members (e.g., by setting the appropriate level of counterparty credit limits in the In/Out Swap program). For the first three quarters of 2011, the magnitude of this settlement risk re-introduction was approximately 3.0% of the total gross settlement value, as compared to 3.3%, 3.7% and 3.9% in 2010, 2009 and 2008, respectively. In addition to the In/Out swap program provided by CLS Services, a subset of Settlement Members participate in a Member-organized liquidity management program referred to as 26 27 These percentages are the median of the daily payment netting benefit (represented by a percentage on each business day) during the first three quarters of 2011. Currently, there are 50 participants in the In/Out swap program. 44

Semaphore. Through the use of a Reuters page, this program provides a mechanism for interested Settlement Members to indicate their desire to bilaterally agree to In/Out swap transactions on the business day prior to the relevant settlement date. 3.5 Incentives to Manage Credit and Liquidity Risks In addition to the various tools available for controlling or mitigating the credit and liquidity risks inherent in the Settlement Service, CLS Bank provides Settlement Members with incentives for managing these risks. CLS provides Settlement Members with real-time information on the status of each individual payment instruction that it has submitted, and the related Pay-Ins and Pay-Outs in each currency. This real time provision of information strengthens a Settlement Member s crisis management abilities, in the event of potential problems with respect to one or more of the Settlement Member s counterparties which are also Settlement Members. Settlement Members are fully aware of the risk management tests governing the settlement of their payment instructions, and the times by which funding requirements must be satisfied. If CLS Bank is unable to settle a payment instruction by the applicable currency close deadline because the risk management tests are not satisfied by both relevant Settlement Members, the payment instruction will be rejected by the CLS System. Under these circumstances, the decision as to how to handle the settlement of the payment instructions is made by the Members, and/or their third-party customers if applicable. Depending on the reason for the failure, the Members may decide to resubmit the unsettled payment instructions to the CLS system for settlement on another settlement date, settle outside of the CLS system or, in an insolvency or other credit situation, proceed with closing out the transactions under the relevant master agreement. It is in a Settlement Member s best interest to satisfy its funding requirements because, as the Settlement Member pays funds to its Account, CLS Bank can make Pay-Outs in other currencies to the Settlement Member. In the event that a Settlement Member fails to satisfy its funding obligations, CLS Bank will suspend all Pay-Outs to the Settlement Member until it becomes fully compliant with the requirements of its Pay-In Schedule. This is a significant protective mechanism for CLS Bank, and is an effective way to incentivize the Settlement Member to avoid a Pay-In failure. Each Settlement Member also has a strong incentive to satisfy its funding obligations in order to avoid costs related to use of CLS Bank s liquidity facilities, and compensation claims from other Settlement Members that may have received Pay-In Calls as a result of the Settlement Member s failure. CLS Bank provides further incentives for timely Pay-In performance through the imposition of fees for late Pay-Ins. Failure of a Settlement Member to satisfy its funding obligations may also result in other sanctions under the CLS Bank Rules (e.g., suspension of membership rights, or reduction to or elimination of an aggregate short position). 3.6 Effective Management of Credit and Liquidity Risk; Extension of Settlement Service to New Currencies and Products; Stress Scenario Impacts These tools outlined above in this response to Core Principle III provide CLS Bank and Settlement Members with a means of managing the liquidity implications of a Pay-In failure by the Settlement Member with the largest net position. The effectiveness of these tools and the processes associated with them are continually reviewed by CLS management and through the formal oversight of the Risk Management Committee of CLS Group Holdings and the Board of Directors of CLS Bank. As CLS Bank extends its Settlement Service to additional currencies and products, it continually re-evaluates the effect of these tools on the risk design of the CLS System. Based upon the projected volume of these additional currencies and products, CLS Bank has each time 45

confirmed the manageability of the impact, both in normal and stress situations, of their inclusion in its Settlement Service. In addition to modeling the impacts of various scenarios during times of normal operations, CLS conducts risk impact analyses for each participant for various systemic stress scenarios. The liquidity impact of these scenarios is analyzed for both the system and for individual settlement members. The results of these scenarios are discussed with settlement members jointly and in bilateral risk discussions so that participants understand the risks and their responsibilities and are able to incorporate the results into their own risk models. 4 CORE PRINCIPLE IV: The system should provide prompt final settlement on the day of value, preferably during the day and at a minimum at the end of the day. 4.0 Assessment of Compliance The CLS system observes Core Principle IV. Settlement of payment instructions on the books of CLS Bank, and funding between Settlement Members and CLS Bank in central bank money, are final and irrevocable once the relevant accounts have been appropriately debited and credited. Settlement and funding take place each business day within those hours of the day during which all of the central banks RTGS systems are open at the same time (often referred to as the settlement window ). 4.1 Final and Irrevocable Settlement As described in the response to Core Principle I, settlement of payment instructions by CLS Bank and funding in the CLS system using central bank funds are final and irrevocable, even in the event that a Member becomes subject to insolvency proceedings. See Sections 1.1.2, 1.2 and 1.3.1 for more information. 4.2 Operational Timeline 4.2.1 Timing of Submission of Instructions As illustrated in Diagram 3 (see Section 0.2.2 above), a Member may generally submit payment instructions to the CLS system at any time leading up to, and even on, the specified settlement date. As a matter of practice, payment instructions relating to FX transactions are typically submitted within hours of the execution of these transactions. This is also the case for FX transactions that are aggregated by the Aggregation Service. Payment instructions relating to NDF transactions are generated after the applicable valuation (or fixing) information has been submitted by the Members to the CLS system. Payment instructions relating to credit derivative transactions are transmitted by Deriv/SERV to the CLS system on the day prior to settlement, after Deriv/SERV has calculated the bilateral net payment obligations under the transactions. In all cases, however, each instruction received by the CLS system must be successfully authenticated, validated and matched (except for credit derivative payment instructions that have been pre-matched by the Warehouse) before the time at which the revised Pay-In Schedules are issued to the Settlement Members by CLS Bank (06:30 CET on the settlement date). 4.2.2 Amending or Rescinding Payment Instructions Members have the ability to amend or rescind payment instructions submitted to the CLS system, subject to the unilateral rescind deadline and the bilateral rescind deadline. Payment instructions may be amended or rescinded on a unilateral basis before the initial Pay-In 46

Schedule is issued at 00:00 CET on the settlement date, and rescinded on a bilateral basis before the revised Pay-In Schedule is issued at 06:30 CET on the settlement date. 4.2.3 Funding and Settlement of Payment Instruction on Settlement Date As described above in Section 3.3.3, Pay-In Schedules are structured to ensure that settlement of all payment instructions occurs by the settlement completion target time (09:00 CET). Under normal circumstances, the settlement period is 07:00 CET to 09:00 CET on the settlement date, with approximately 99% of payment instructions settled by 08:00 CET and the remaining 1% of payment instructions settled by 09:00 CET. CLS issues a Pay-In Schedule binding Settlement Members to make Pay-Ins to CLS Bank of certain amounts in the various currencies by certain times. The Pay-In Schedule is an algorithm generated by the CLS System using certain pre-set parameters, based on the actual and projected settlement activity occurring during the settlement session. This algorithm may generate a different Pay-In Schedule from day to day (because settlement activity changes from day to day), but generally results in approximately 80% of all Pay-In obligations being required to be paid by 10:00 CET, with the remaining 20% paid to CLS Bank by 12:00 CET. The failure of Settlement Members to satisfy their respective funding (Pay-In) requirements by these deadlines may result in delayed settlement, or settlement of less than all payment instructions. In the event of a Pay-In failure by a Settlement Member, CLS Bank will issue a Pay-In Call for settlement to Settlement Members that have unsettled payment instructions with the Settlement Member that has failed to satisfy its funding obligations, so as to maximize the number and value of settled payment instructions during the settlement session. In contrast to settlement, funding requirements (Pay-Ins) are calculated on a multilaterally netted basis, taking into consideration all of the Settlement Members payment instructions scheduled for settlement on that settlement date and without regard to the type of underlying transaction. A pair of matched payment instructions for an FX Transaction, or a single-currency instruction in the case of an NDF or OTC derivative transaction, will not settle if following settlement a Settlement Member s Account would not satisfy the three risk management tests described above in Section 3.1.2. However, it should be noted that the failure of a pair of instructions or a single-currency instruction to settle does not affect the ability of other payment instructions to settle in the CLS System (and has no effect on any payment instruction which has already been settled). CLS Bank completes Pay-Outs to Settlement Members of the long balances in its central bank accounts before the close of each RTGS system. As a result of the Pay-Outs, each Settlement Member will have a zero balance in its Account, and CLS Bank will have no funds in its central bank accounts, at the end of each business day. 47

5 CORE PRINCIPLE V: A system in which multilateral netting takes place should, at a minimum, be capable of ensuring the timely completion of daily settlements in the event of an inability to settle by the participant with the largest single settlement obligation. 5.0 Assessment of Compliance The CLS system observes Core Principle V. The risk design of the CLS system incorporates many tools that enable prompt and efficient settlement of payment instructions with multilaterally netted funding, and ensures that CLS Bank can complete its Pay-Out obligations for those instructions that have settled, even if the Settlement Member with the largest Pay-In requirement in a single currency is unable to satisfy its funding obligations. Various factors relating to the CLS system s compliance with Core Principle V are also covered in the response to Core Principle III above, which contains information on the risk management tests, volatility haircuts, multilaterally netted funding, Pay-In and Pay-Out algorithms, and Pay-In Calls (see in particular Section 3.1.2 Risk Management Tests). 5.1 Settlement and Effective Liquidity Management While settlement of FX transactions takes place on a gross basis, funding between CLS Bank and its Settlement Members occurs on a multilateral net basis. Specifically, the funding requirements are based on a multilateral net calculation of the expected debits and credits in each applicable currency, taking into consideration all of the Settlement Members payment instructions scheduled for settlement on that settlement date, and without regard to the type of transaction associated with the instructions. This multilateral netting is solely for the purpose of effective liquidity management. The failure of a Settlement Member with the largest funding obligation in a single currency to satisfy this obligation is managed by CLS Bank through tools that enable settlement to occur promptly, and in a manner that makes efficient use of the multilaterally netted funding in the CLS system. CLS Bank also conducts liquidity impact simulations and analyses to assess the ability of Settlement Members to handle the Pay-In failure of the Settlement Member with the largest funding obligation, and discusses the results of these simulations and analyses with the Settlement Members, nostro agents and liquidity providers. 48

6 CORE PRINCIPLE VI: Assets used for settlement should preferably be a claim on the central bank; where other assets are used, they should carry little or no credit risk and little or no liquidity risk. 6.0 Assessment of Compliance CLS Bank observes Core Principle VI. Funding and settlement in the CLS system are separate and distinct, but related, processes. Although the multilaterally netted funding to and from CLS Bank is effected through central bank funds, each Settlement Member is exposed to credit and liquidity risk with respect to the funds due from CLS Bank. However, these risks are limited due to the design of the CLS System, which uses carefully tested, CLS system-administered algorithms to ensure the efficient use of central bank funds on an intraday basis. 6.1 Funds of CLS Bank at the Central Banks All Pay-Ins are received, and Pay-Outs made, by CLS Bank using central bank funds, specifically CLS Bank s account with each central bank for whose currency it provides Settlement Service. CLS Bank receives notice of each Pay-In made by a Settlement Member (or its nostro agent) from the relevant central bank, once the funds have been credited to CLS Bank s account at the central bank and are therefore available for CLS Bank use. These long positions of CLS Bank are CLS Bank funds and claims on the relevant central bank. In addition, the Settlement Member (or its nostro agent) receives notice of each Pay-Out from CLS Bank from the relevant central bank once the funds have been credited to the Settlement Member s (or the nostro agent s) central bank account. 6.2 Funds of the Settlement Member at CLS Bank Once a Pay-In is received by CLS Bank, it credits the same amount and currency to the Settlement Member s Account on the books of CLS Bank. More specifically, a credit is created in the appropriate amount in the appropriate currency in the Settlement Member s multi-currency Account. Separately, each settlement of payment instructions by CLS Bank also results in the appropriate debit and/or credit being made in the appropriate currency in the Settlement Member s Account. Individual currency balances within each Settlement Member s Accounts are updated on an ongoing basis to reflect all credits and debits to that Account. The long positions of the Settlement Member in the Account are claims on CLS Bank. As described in the response to Core Principles II and III (see Sections 2.2.2 and 3.3.2), the CLS System employs carefully tested, CLS System-administered algorithms to ensure an efficient use of funds within a limited period of time: the three hour funding period (07:00 10:00 CET) for Asia-Pacific currencies (including the Israeli shekel for this purpose) and the five hour funding period (07:00 12:00 CET) for the other currencies. As a systemically important payment system regulated and supervised by the Federal Reserve and subject to oversight by the CLS Oversight Committee, CLS Bank must consistently demonstrate that its Settlement Service performs as designed. Because the algorithm is designed to minimize the liquidity impact on the various local markets, under normal operations Settlement Members only have intraday credit exposure to CLS Bank; specifically, credit exposure only arises during the five-hour funding period. Long positions of Settlement Members are offset by short positions, which consist of obligations due from the Settlement Member to CLS Bank. As these short positions are covered by a Settlement Member, the long positions are paid out to the Settlement Member, subject to applying an appropriate haircut to each currency balance in the Account. Resulting net long positions (following application of the currency-specific haircuts) are retained in the CLS System 49

only as necessary to retain value in each Account that is determined to be sufficient to satisfy the three risk management tests applicable to settlement of any as yet unsettled payment instructions. 28 CLS Bank will pay out Settlement Member s long positions resulting from the settlement of payment instructions more quickly if the Settlement Member covers its short positions by satisfying its Pay-In obligations to CLS Bank in a timely manner. This process is handled automatically by the Pay-Out algorithm. The net credit risk to which a Settlement Member is exposed in the CLS System is limited in time and amount. This net credit risk is limited to a comparatively short five-hour funding period and, because long positions in a Settlement Member s Account are offset by any short positions in the Account, to the aggregate haircut amounts applicable for that day to that Account. In normal circumstances where settlement of all payment instructions is completed, CLS Bank completes Pay-Outs of the long balances in its central bank accounts to Settlement Members before the close of each RTGS system. As a result, at such time each Settlement Member will have a zero balance in its Account. 28 These risk management tests are described in detail above in Section 3.1.2. 50

7 CORE PRINCIPLE VII: The system should ensure a high degree of security and operational reliability and should have contingency arrangements for timely completion of daily processing. 7.0 Assessment of Compliance The CLS system observes Core Principle VII. The CLS system has a high degree of operational reliability due to its resilient technical architecture and infrastructure, which enables CLS Bank to provide its Settlement Service to its Members. CLS Bank has a fully resilient systems and communications infrastructure supported by the provision of network and system management services. Contingency operations are tested on a regular basis and operate effectively. Stringent security standards protect the CLS system applications and its payment instructions. All aspects of technology and operations in support of this section are now overseen by the newly created Technology and Operations Committee of the CLS Group Holdings Board ( TOPS; see also Section 10.2 below). The TOPs Committee oversees the development and implementation of the technological and operational aspects of any strategic or significant tactical enhancement or modification to the existing core system ( Special Projects ). 29 CLS is also putting in place a single project management framework supported by a dedicated Program Management Office, designed to align projects to CLS s business strategy and support decisionmaking in a more cost and time-efficient manner, and designed to be compatible with IBM as CLS s primary vendor. Under the IBM Agreement, IBM provides operational services for the CLS system, and service management and support functions. CLS and IBM review operational performance against the service levels on a monthly basis. Service levels are reviewed at least annually in connection with changes in CLS business operations, for purposes of making operational or technical improvements. 7.1 Resilient Technical Architecture and Infrastructure The technical architecture and infrastructure of the CLS system enables CLS Bank to provide a reliable Settlement Service to its Members. CLS Bank has a fully resilient systems and communications infrastructure supported by the provision of network and system management services. IBM has established a CLS-dedicated group, and command centers for the operation of core production services and service management. A key element of the CLS system design is the high degree of symmetry. All key network and infrastructure system components are duplicated. CLS s networks and power sources are also diverse and, consequently, the design of the CLS system allows for recovery and resilience at many different levels. CLS Bank, which is located in New York, and CLS Services, which is located in London, are linked to each other and the representative office of CLS UK Holdings in Tokyo, by dual and diverse network links. Additionally, there are business continuity sites in both the U.S. and U.K., should the main offices of CLS Bank or CLS Services be destroyed or become inaccessible. 29 Such strategic and significant tactical enhancements or modifications would include without limitation, two technology projects currently under consideration. One of these projects is intended to enhance the processing speed, capacity and communications capabilities of the CLS computer system (also known as project TIGER ) and the other would provide for a staged transition to a new componentized architecture and a new program language for the core settlement system. 51

There are two main core production service central processors, located in two geographically separate data centers containing identical sets of supporting systems, which are supported by IBM. In the event that one site is not available, the Settlement Service can still be provided to the Members using the alternate site. The second data center, which replicates data on a synchronous basis and provides full out of region capability and resilience, is designed to ensure that the CLS system is aligned with globally recognized standards, such as the Interagency Paper on Sound Practices to Strengthen the Resilience of the U.S. Financial System, jointly published in April 2003 by the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the and the Securities and Exchange Commission in the United States. The two data centers are supplied by different electricity suppliers from separate sources, and are also connected by two separate fibre networks, each capable of supporting the full volume of payment instructions received and processed by the CLS system. The data centers are supplied with market data by two Reuters links, one to each data center. Both links are accessible from each data center. Administrative oversight of the core production service central processors at each data center can be performed at CLS s business operations centers in the U.K. and the U.S. CLS has four business operations centers, with primary sites in London and New York, and disaster recovery sites for the business operations centers located elsewhere in both the U.K. and U.S. Each data center is connected to the CLS business operations centers (two in the U.K. and two in the U.S.) using separate networks. The technical and operational functions of the core production service central processors are also monitored at two active command centers maintained by IBM, one located in the U.K. and the other in the U.S. IBM conducts a series of linked processes internally which are parallel to the processes operated by CLS internally in order to provide the Settlement Service to Members. The CLS system connects to the central bank payment systems for CHF, JPY and USD, using two separate links (per RTGS) to global networks. For AUD, CAD, DKK, EUR, GBP, HKD, ILS, KRW, MXN, NOK, NZD, SEK, SGD and ZAR payment systems the CLS systems connect using two separate links to the SWIFTNet network for FIN service connectivity. The CLS system has various communication contingency processes in place should these links fail, including the use of stand-alone terminals, secure file transfer mechanisms or authenticated fax messages. The CLS system also has payment contingency processes that can be employed in the event that there are severe operational difficulties affecting a central bank, RTGS system or the Settlement Member (or its nostro agent). In the case of JPY, the Tokyo representative office provides contingency access to the JPY RTGS system. The CLS system connects to Member systems using two separate links, per data center, to the SWIFTNet network and two different points of presence (located in two jurisdictions) for FIN service connectivity. Similarly, the CLS system connects to Deriv/SERV s system using two separate links, per data center, to the SWIFTNet network. Because all standards of duplicate alternative diverse connections (which apply to the connectivity from and to Members) are also applied to the connectivity from and to Deriv/SERV, the resilience of the CLS system is unchanged by introduction of a new interface with Deriv/SERV s system. Since CLS actively switches between its sites, the resilience of the CLS system is constantly demonstrated. CLS Bank subjects each Member and Deriv/SERV to an initial technical approval process in which the adequacy of its technical architecture (as it relates to the CLS system) must be demonstrated before it may participate in the Settlement Service. As part of this process, the Member or Deriv/SERV, as the case may be, is required to demonstrate that it can successfully communicate with the CLS system using a minimum of two alternative sites and provide sufficiently detailed information about its technical architecture to enable the CLS Technology Office to assess the resilience and security of the architecture. Testing is done in the joint acceptance service environment to determine the Member s eligibility to progress to operational 52

approval for the core production service environment. IBM conducts active monitoring of the CLS system during testing and produces reports which enable CLS to make this evaluation. In addition, each Member and Deriv/SERV is required to provide written confirmation of its current technical architecture on an annual basis, or more frequently if there are changes to its architecture this information is reviewed by the CLS Technology Office. Additionally, Members and Deriv/SERV are required to meet all of the Settlement Service s deadlines. In the case of Deriv/SERV, for example, if the credit derivative payment instructions are not transmitted to the CLS system before the agreed deadline, the ability of CLS Bank to continue to process the other payment instructions in the CLS system for settlement is unaffected. There are no system linkages between the Settlement Service and the Aggregation Service; Members are required to submit payment instructions related to transactions calculated by the Aggregation Service to the Settlement Service by the Settlement Service deadlines, as is the case with other instructions. The symmetrical design of the CLS system and all significant aspects of its infrastructure are designed to ensure that the system is resilient. CLS Bank can recover its operational activities promptly should there be a complete loss of CLS Bank s or CLS Services s main offices. Disruption to the Settlement Service in the event of a site disaster at the primary data center is limited to the time it takes to start processing at the backup site. The CLS system is designed to allow the resumption of technical processing without loss of data within 40 minutes of the decision to transfer live production to the secondary site. Following such transfer, an additional 20-30 minutes is required before all operational checks are completed and the Settlement Service is fully monitored. The symmetrical design also allows CLS Bank to rotate the operation of its Settlement Service between its two data centers; by performing this rotation approximately every 8 to 12 weeks, the availability of these alternative sites is effectively tested and proven on a regular basis. Under normal circumstances, the core production service central processors (at the primary or secondary site) are used to provide the Settlement Service. In the unlikely event that all these processors become unavailable, CLS Bank may resort to the use of an entirely separate utility application to commence or complete the settlement and funding processes. This utility was developed to strengthen the resilience of the Settlement Service by providing CLS Bank with an alternative mechanism for these key processes. 7.1.1 Operational Reliability The CLS system performs reliably on a daily basis. In the previous 12 months beginning August 2010, the CLS system has been available 99.93% of the time it has been scheduled for operation. 30 If operational problems do occur, there is a formal incident reporting and problem management process to facilitate the successful resolution of any service incidents. This process defines the roles and responsibilities of CLS and its vendors and provides a mechanism for tracking an incident from its inception to successful resolution and closure. IBM monitors, tracks and records all incidents and proposes resolution plans to CLS. IBM and CLS hold triage and status calls if an incident affects a critical element of operational services. CLS and IBM will review a major incident follow-up plan prepared by IBM, including analyses of the cause of the incident, an explanation of how it was identified, a chronology of events, workarounds and program changes made in response, a summary of how the incident was managed, and lessons learned going forward. CLS and IBM also hold daily sweep calls during an incident, and weekly service review calls with SWIFT. 30 The CLS system is determined to be unavailable during its regularly scheduled hours of operation if an issue arises which prevents any one or more of the following activities, even if the system is otherwise operable: submission of new instructions, settlement, Pay-Ins or Pay-Outs. 53

The CLS system also has an automated service level reporting application that measures and reports a collection of performance data. This data tracks the system performance against various service targets and is used to predict future performance. 7.1.2 Capacity Planning The CLS Group has in place a framework, reviewed annually, for performance and capacity planning which involves conducting an extensive review of the future capacity investment requirements for the CLS system as part of its annual budget and strategic plan. An integral part of this annual business planning process involves discussions with Members that are key FX market participants to determine a reasonable forecast of the anticipated volumes to be received by the CLS system in the following year, and anticipated overall trends in FX market activity. This information, together with CLS s and IBM s knowledge of technical architecture and infrastructure and past performance of the CLS system and therefore limitations on capacity and scalability (e.g., relating to hardware, networks, software applications, etc.) form the basis on which capacity planning is conducted. The results of these assessments form part of the input into CLS s change programs for the next 12-24 months. These are classified into tactical or Hotspot, or medium and long term, improvements. Tactical or Hotspots are typically those performance changes that require code optimization or configuration tuning to achieve the necessary capability and are usually achievable within the next 12 months. Medium to long term improvements would usually mean a level of re-design or re-engineering of a module or functional component, where delivery would usually be beyond 12 months. As further validation of the performance of, and in anticipation of possible stress points for, the CLS system, the application is stress tested at least annually to identify extreme volume performance challenges. In addition, the CLS acceptance system is run daily at volumes of payment instructions that are typically six months in advance of actual volumes. CLS continually assesses its existing and forecasted volumes against the contracted IBM service capacity for the CLS system, as well as proven capability and design points for hardware product selection and software development. All application software releases are regression tested against contracted service volumes and, for release with specific performance and capacity increases, a discrete set of tests are performed. During the past 12 months CLS has proven that the enhanced application can process extreme volumes higher than those encountered during May 2010. CLS conducted market volatility testing with a single input day of 2.8 million and a sustained throughput of 1 million inputs in 5 hours. In addition, a period of saturation testing has been conducted against the application to identify possible future performance changes. The CLS strategic programs for 2012 and beyond include improvements related to design and functionality, to bring about increased capacity. These improvements are designed to ensure that operational service levels can be maintained under the new volumetric structure of both double and exceptional days considered as 5 times the projected business daily average and validated at volumes beyond the volumetric service levels. CLS will continue to review future capacity investment requirements in order to determine what actions may be required to ensure capacity and scalability of the CLS system at future key capacity points. 7.1.3 Business Continuity Testing CLS Bank and CLS Services have an all hazards business continuity plan ( BCP ) in place for each functional department, including those directly involved in providing or supporting the Settlement Service. Each plan is predicated on a comprehensive business impact assessment that identifies key risks to technology, people, premises and utility services, and the development of mitigating controls to ensure that key business processes can be maintained in the event of any type of disaster or incident, even in cases of extreme duration or severity. 54

Business continuity incidents are managed by an Incident Response Team comprising an appropriate representative from key functional departments. 31 The Incident Response Team has responsibility for making decisions, including but not limited to the coordination of CLS resources and internal and external communications, during such incidents. The Incident Response Team, which is supported by company executives, is led by the CLS Chief Security and Business Continuity Officer who calls upon a team of specialists, depending on the nature of the incident. In addition, IBM develops contingency plans to resolve any business or service continuity incidents which cause the Settlement Service to be unavailable. Upon the occurrence of a contingency event, IBM executes recovery plans for the relevant operational services in accordance with these contingency plans as agreed with CLS, and maintains secure backups for the CLS system s operational environments which allow them to be rebuilt. All functional departments undergo collective and individual testing as part of CLS s annual BCP testing program. This includes an annual company-wide exercise that typically results in the loss of a site and the fail-over of associated technology, as well as desktop exercises for executives and a quarterly failover of CLS s operations to a secondary site. The testing program incorporates realistic but challenging scenarios designed to disrupt customary business operations and activities in order to test and strengthen the ability of the various departments to manage the disruptions. CLS is also a participant in market-wide BCP exercises, including the FRBNY disaster recovery test and UK FSA Market Wide Exercises. In addition, CLS participates in disaster recovery and business continuity with key service providers and strategic partners. Through this testing program, CLS has a high degree of assurance that it meets applicable continuity and recovery targets (including targets set out in the Interagency Paper described above). In support of CLS s BCP testing, each Member is also required to re-confirm annually that it has a CLS-related BCP that is current and comprehensive, and has been tested in the past six months. Members are also asked to confirm that they have proven their contingency pay-in arrangements for each CLS-eligible currency during the past twelve months. By way of example, CLS sought assurance from Members as to their ability to function in the event of a pandemic. 7.1.4 Member Responsibilities The CLS Bank Rules require Members to maintain minimum operating capabilities as part of CLS Bank s continuing membership criteria under the CLS Bank Rules. Included in these requirements is the maintenance of current and comprehensive business contingency plans that address both the operational and technical aspects of the Settlement Service. On an annual basis, each Member is required to certify to CLS Bank that it has successfully tested its business contingency plans within the previous six months, and that this test included the use of its contingency site, and the participation of any operational staff nominated by the Member to act in a contingency event affecting the Settlement Service. A Member must also certify that it has proven its contingency Pay-In arrangements for each currency settled by CLS Bank during the past 12 months, either during a planned test or in response to a real need to invoke a contingency arrangement. 7.1.5 Aggregation Service The resilience of the technical architecture and infrastructure of the Settlement Service is unaffected by the Aggregation Service because there are no system linkages between the Settlement Service and the Aggregation Service. CLSAS s system for the Aggregation Service 31 The Incident Response Team representatives have nominated deputies who can replace them when they are unavailable or in the event of a protracted incident. 55

itself is generally aligned with globally recognized standards and is operated in a completely segregated environment, with two data centers which are synchronously linked using standard database synchronization software, and satisfy the 2-hour recovery limit for critical infrastructures set forth in the above-mentioned Interagency Paper on Sound Practices to Strengthen the Resilience of the U.S. Financial System. CLSAS s system for the Aggregation Service is appropriately monitored, and management of incidents and crisis escalation is handled in a similar manner to the Settlement Service. The Aggregation Rules require Aggregation Parties to satisfy minimum operating capabilities. Included in these requirements are adequate contingency plans for maintaining operational capabilities if a natural disaster, operational or technical failure, or other extraordinary event occurs. In addition, the Aggregation Rules specify clear cut-off times for the receipt of trade messages for aggregation. These times provide sufficient time for a Member to submit payment instructions, relating to eligible aggregated transactions, to the Settlement Service via the Member s standard CLS interface and within the deadlines separately specified in the CLS Bank Rules. In the event that a trade message has been submitted to but not aggregated by the Aggregation Service for any reason, details of the trade are nonetheless permitted to be submitted to the Settlement Service for matching and settlement in the normal manner. CLSAS does not net or settle trades, or provide any other services apart from the Aggregation Service. 7.2 Security Requirements Logical security is an integral part of the CLS system s layered security model, and is designed to ensure effective authentication, authorization and accountability across all systems. All IT systems are configured in accordance with defined policies, processes and standards, and regular systems compliance verification and vulnerability assessments are routinely undertaken by CLS and external third parties. In connection with these processes, IBM monitors and manages security events affecting operational environments, and reports high severity security events immediately to CLS and reports their status monthly to CLS. All environments are subject to an ongoing program of independent internal audits, the results of which are reported to management and to the Audit and Finance Committee of the CLS Group Holdings Board. In addition, an external auditor performs an annual review of IT security as part of its financial audit of the CLS Group, and all IT security activities are subject to regulatory oversight. All logical security controls and configurations are the subject of strict change control practices that are enforced across the CLS System and its service providers. Data within the CLS system, including data contained in the payment instructions received by the CLS system, is subject to a well-defined data classification policy designed to ensure that data is securely processed and stored to preserve confidentiality and integrity. Data management includes routine back-ups and off-site storage, layered defenses including enterprise class firewalls, intrusion detection systems, event management and correlation, and secure communication channels provide additional protection. Access to data is strictly controlled through discretionary access controls and encryption services that are used where required. Secure operation of the CLS system is ensured through diversely routed and separated communication networks and highly resilient command and data centers that host high availability IT infrastructures and business applications. The data centers benefit from fully resilient environmental controls and a package of comprehensive security measures, including electronic access control systems, CCTV, intruder alarms and caged areas for critical components. Access to CLS Bank and CLS Services sites is also strictly controlled and monitored by dedicated security and reception teams. 56

The security policies of the CLS system are generally aligned with the international ISO 17799 standard comprising best practices in information security, and those contained in the U.S. National Institute of Standards and Technology and the Federal Financial Institutions Examinations Council. CLS assesses, mitigates and monitors security risks for the Settlement Service (and any new initiative) from the concept phase through to implementation, and thereafter. This process involves the identification, assessment, measurement, mitigation, ongoing evaluation and monitoring of security risks and exposures which facilitate the development and implementation of appropriate controls to reduce such risks to an acceptable level, in accordance with legislative/regulatory and customer requirements. Communication protocols exist to escalate risks, and established reporting mechanisms ensure proactive management of security risks. 8 CORE PRINCIPLE VIII: The system should provide a means of making payments which is practical for its users and efficient for the economy. 8.0 Assessment of Compliance The CLS system observes Core Principle VIII. The CLS system operates efficiently, providing high-quality, practical services to its Members. CLS Bank regularly seeks feedback from its Members regarding the CLS system and Settlement Service to ensure continuing efficiency and practicality. The pricing policy of CLS Bank is cost-recovery based and frequently reviewed in consultation with the Members. 8.1 Economic benefits The Settlement Service was designed by the private sector to address settlement risk. As of April 2010, CLS settles 58% of global FX trading activity with settlement risk (by value), with a market share of 63% if only the market for which CLS Bank provides services (i.e., the 17 currencies) is taken into account. 32 The CLS system makes efficient use of funds by employing carefully tested, system administered algorithms for determining Pay-Ins and Pay-Outs. As described above in Sections 0.4 and 3.4.2, the multilateral netting aspect of funding yields a payment netting benefit of approximately 95.9%. The residual 4.1% is split between approximately 1.1% representing Settlement Member Pay-In obligations, and approximately 3.0% representing Settlement Member funding for the out leg of In/Out swap transactions (occurring outside the CLS system). Based on its experience since 2007 settling single-currency payment instructions relating to credit derivative and NDF transactions, CLS Bank does not expect the inclusion of these types of instructions to materially affect these netting benefits in the foreseeable future. 33 In addition, CLS Bank has facilitated improved operational standards and straight through processing, and has helped to reduce the need for reconciliation among its Members. Moreover, the finality and irrevocability of settlement and funding in the CLS system helps ensure a stable and reliable payment system by minimizing systemic risk. In 2010, the Aggregation Service was introduced to improve post-trade efficiency and reduce costs arising from high frequency, low value FX trades; for example, trades attributable to algorithmic trading, prime brokerage and retail aggregators. Participants in the Aggregation Service also receive the benefit of settlement risk reduction by submitting payment instructions for the resulting aggregated transactions to the Settlement Service. 32 33 Source: Analysis of the BIS 2010 Survey on global FX market turnover. CLS Bank monitors the effects of single-currency payment instructions on this multilateral netting benefit, as part of its continuing modeling plans on liquidity risk. 57

8.2 Pricing Policy CLS Bank s pricing policy is approved by the CLS Bank Board of Directors and is available to each Member. The pricing policy is designed to cover all costs of providing an effective, efficient, and resilient Settlement Service. When preparing its annual budget, CLS recognizes its dual public-private mandate and is cognizant of its responsibility to keep costs reasonable while ensuring that CLS has the financial foundation to meet its current and reasonably anticipated future obligations. The current pricing policy has two basic components one based on instruction value and the other based on instruction volume (i.e., number of instructions). For any particular Member, application of the pricing policy is determined by (in summary): (i) the aggregate value of instructions submitted by all of the Members; (ii) the aggregate volume of instructions submitted by all of the Members; and (iii) the average daily volume of instructions submitted by the particular Member. With regard to volume of instructions, it should be noted that CLS Bank separately settles each pair of matched FX instructions i.e., on a gross basis. If the other factors in the pricing policy are assumed to be held constant, a sufficiently large increase in the average daily value of all Member instructions will generally result in a decrease in the costs borne by each Member. Similarly (holding the other factors in the pricing policy constant) a sufficiently large increase in the average daily volume of all Member instructions will generally result in a decrease in the costs borne by each Member. (Conversely, decreases in the average daily value or average daily volume of all Members may result in cost increases.) In addition, a Member may receive the benefit of a reduction in the per-transaction (volumebased) charge based on its own, individual, increased volume of payment instructions. Conversely, decreases in a Member s own, individual, volume of payment instructions may result in an increase in the per-transaction charge. The current pricing policy accordingly also strikes a balance between individual usage and usage by the Settlement Members as a group. CLS continues to evaluate its current and other pricing models to achieve the goals of keeping costs reasonable while ensuring that CLS has the financial foundation to meet its current and reasonably anticipated future obligations. It should also be noted that different payment system pricing models have different types of impact with respect to the fair and open access provided for in Core Principle IX (which is discussed below). For example, open access is furthered by assessing a charge for each individual instruction, rather than allocating costs strictly equally between the Members. In its assessments of the balance between individual usage and usage by the Settlement Members as a group, CLS is cognizant of its responsibilities under Core Principle IX. 8.3 Service Practicality CLS Bank strives to ensure the efficiency of the CLS System by providing high-quality, practical services to the Members. As discussed above in Section 0.3.2, CLS offers different ways of connecting to the CLS System. CLS Bank regularly seeks to improve the efficiency and practicality of the CLS System. For this reason, CLS Bank participates in numerous external user group forums (see Section 2.3 above) to obtain information on best practices, other innovations in the market, Member business needs and demand for new features. In addition, CLS Bank frequently seeks input on specific issues through one-on-one meetings with Members, Member surveys, and focused working group meetings. Members are formally requested to comment on any proposed operational, IT, risk and legal changes which will affect their participation in the CLS System. In addition, CLS s business development and operations departments provide support and problem resolution related to specific service issues. 58

As mentioned above, CLS Bank has also expanded coverage of its Settlement Service from the initial 7 currencies to the current 17 currencies that in aggregate account for approximately 94% of daily foreign exchange turnover. 34 For each of these currencies, the CLS Settlement Service provides an array of settlement risk reduction, straight through processing and liquidity benefits. As described in Section 3.1.1, following a comprehensive evaluation, CLS Bank modified its Member and currency criteria in 2007 to enable non-investment grade financial institutions with a minimum rating of S&P BB- (or the equivalent) from a non-investment grade country to apply for direct participation in CLS Bank. CLS Bank manages the increased risk associated with admitting non-investment grade Settlement Members by assigning a zero Aggregate Short Position Limit to all such Members. These modifications have extended the benefits of the Settlement Service to a significant number of institutions that were previously ineligible for direct participation in the CLS System. CLS Bank has also committed to extending its coverage to further reduce settlement risk by adding new currencies and jurisdictions in an orderly and focused manner. In conjunction with this effort, CLS has begun work on two comprehensive system development programs. The first of these projects will provide enhanced capacity and reporting features, while the second and larger program will consider a more broad based restructuring of CLS s technology to provide greater flexibility, scalability and ease of maintenance and modification. 34 BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 2010 Final Results (December 2010). 59

9 CORE PRINCIPLE IX: The system should have objective and publicly disclosed criteria for participation, which permit fair and open access. 9.0 Assessment of Compliance CLS observes Core Principle IX. Access to the CLS System is available to financial institutions and companies, either directly as Members (in the case of financial institutions) or indirectly as customers of Members that provide CLS-related services to third parties. The criteria for direct participation by Members and inclusion of currencies for settlement in the CLS System are objective and publicly disclosed. The goal of restricting Membership to financial institutions meeting such criteria (i.e., excluding financial institutions failing to meet the criteria) is to protect the integrity of the settlement and funding processes and mitigate any financial risks associated with participation in the CLS system. 9.1 Access to the CLS System The initial and continuing eligibility requirements for direct participation in the CLS System are objective and expressly set forth in the CLS Bank Rules and Member Handbook, which are available to Members and the overseeing central banks. As indicated above, these criteria are based on the goal of protecting the integrity of the settlement and funding processes and mitigating any financial risks associated with participation in the CLS system The key criteria are: Shareholder requirement. Each Member or an affiliate thereof must be (i) a qualifying shareholder of CLS Group Holdings; or (ii) a central bank which issues or (if applicable) otherwise circulates a currency that is settled in CLS Bank. Financial requirements. Each Settlement Member must maintain capital equal to or in excess of capital and capital ratio requirements imposed from time to time by its primary regulator, maintain minimum short and long term debt or deposit ratings, and provide financial statements and material regulatory filings to CLS Bank on a periodic basis. 35 Operational requirements. Each Settlement Member must: (i) satisfy minimum operational capabilities as established by CLS Bank, including the ability to make payments to and receive payments from CLS Bank in different currencies within specified times; (ii) ensure that adequate contingency plans are in place to address its or its nostro agents inability to satisfy funding obligations; (iii) be able to maintain its operational capabilities in the event of a natural disaster, operational failure or technical failure; and (iv) ensure that appropriate procedures and contingencies are in place for the effective operation of its connectivity to, and management of, its static data in the CLS system. Each User Member must satisfy the same requirements, except those relating to making payments to and receiving payments from CLS Bank and nostro agents. Financial institution requirement. Each Settlement Member must be a financial institution that is subject to prudential supervision by an authority acceptable to CLS Bank. In contrast, a User Member can be any type of institution that has demonstrated to the Board of Directors of CLS Bank that its business and 35 Certain of these requirements do not apply to a Settlement Member that is a central bank. 60

capabilities permit it to use the Settlement Service without undue risk to CLS Bank and its Members. Jurisdictional legal opinion. The Member s head or home office must be located in a jurisdiction for which CLS Bank has received a satisfactory legal opinion addressing the items described above in Section 1.3. Anti-money laundering jurisdiction. The Member s head or home office must be located in a jurisdiction which adheres to internationally recognized money laundering standards. More specific information on these requirements is available on the CLS Group website (www.cls-group.com). In addition, CLS Bank shares the CLS Bank Rules and Member Handbook with institutions contemplating membership in CLS Bank following the execution of an appropriate non-disclosure agreement. Because of the considerable responsibilities assumed by Members and the risk design of the CLS System, not all institutions are eligible for membership. In addition, restrictions on the types of institutions (and jurisdictions in which they may have their head or home offices) are necessary to preserve the well-established legal framework that supports the Settlement Service. CLS Bank recognizes the trade-off between complete, open access, and the necessity to maintain strict membership standards to protect the integrity of its settlement and funding processes and minimize the potential disruptions to other Members. As described above in Section 3.1.1, CLS Bank modified the Member and currency eligibility criteria in 2007 to enable non-investment grade financial institutions with a minimum rating of S&P BB- (or the equivalent) to be eligible to apply for Membership in CLS Bank. CLS Bank manages the increased risk associated with admitting non-investment grade Settlement Members by assigning a zero Aggregate Short Position Limit to all such Members. In addition, a currency whose sovereign credit rating is not less than S&P BB- (or the equivalent) may also be considered for inclusion in the Settlement Service, assuming all other applicable eligibility criteria are satisfied (more specific information about these currency eligibility requirements is also available on the CLS Group website). Furthermore, as mentioned above, CLS is actively working to expand the number of currencies and jurisdictions that are settled in the CLS System. CLS believes that these efforts will further expand access to the CLS System and result in additional new Members. The impact of the trade-off between complete open access and the necessity to maintain strict membership standards is also mitigated by the ability of all types of financial institutions and other companies to access the CLS System indirectly as a third party customer of a Member. As of September 30, 2011, twenty-six (26) Members provide CLS related services to unaffiliated third parties on commercially competitive financial terms, and such third parties may receive copies of the CLS Bank Rules and Member Handbook from the relevant Member. Approximately 7,000 third parties participated indirectly in the CLS System during the first three quarters of 2011. While over 90% of such third parties are funds, this group also includes banks, as well as corporations and other non-financial institutions. Although CLS Bank has no relationship with third parties, it participates in the CLS Third Party Working Group which focuses on common issues relating to third-party-related services. The Working Group endeavors to find solutions helpful to the third-parties as a whole and (where appropriate) makes recommendations concerning best practices and other procedures. 9.2 Suspension or Termination of Access to the CLS System CLS Bank has the right to limit its exposure to any Member. CLS Bank periodically re-evaluates the ability of each existing Member to continue to satisfy the Membership criteria, by monitoring 61

operational performance and the overall financial condition of the Member. CLS Bank may consult with a Member to address non-compliance, or potential non-compliance, with the Member s obligations under the CLS Bank Documents. If a Member presents undue risk to CLS Bank or the other Members, CLS Bank may take remedial action against the Member, including taking steps to reduce this exposure by unilaterally reducing its Aggregate Short Position Limit, imposing certain administrative fees, or requiring pre-funding or credit enhancements. In extreme cases, CLS Bank may suspend the Member s ability to receive Pay-Outs or have payment instructions processed for settlement, or prohibit the Member from using the CLS system altogether by terminating its Membership. A Member has the right to appeal a termination or suspension in accordance with the procedures set forth in the CLS Bank Rules. 9.3 Aggregation Service The initial and continuing eligibility requirements for direct participation in the Aggregation Service are objective and expressly described in the Aggregation Rules, which are available to participants and the CLS Oversight Committee central banks. Each institution that wishes to submit its trade messages to the Aggregation Service (such institution, an Aggregation Party ) must be an affiliate of and sponsored by an Aggregation Participant which has agreed to assume responsibility for the institution under the Aggregation Rules, and with which CLSAS enters into a contractual agreement. (Unaffiliated customers of an Aggregation Participant may be able to participate in the Aggregation Service in the future.) Each sponsoring Aggregation Participant must be a CLS Bank Member because, as described below, the Aggregation Participant must be able to submit payment instructions to CLS Bank. Each CLS Bank Member is eligible to apply to be an Aggregation Participant. An Aggregation Participant must be able to submit payment instructions to CLS Bank relating to aggregated transactions involving two currencies which are eligible for the Settlement Service. Each Aggregation Participant and Aggregation Party must satisfy minimum operational capabilities as established by CLSAS, including the ability to submit and rescind trade messages, and maintain operational capabilities in the event of a natural disaster, operational failure or technical failure. 62

10 CORE PRINCIPLE X: The system s governance arrangements should be effective, accountable and transparent. 10.0 Assessment of Compliance The CLS system broadly observes Core Principle X. CLS believes that its current governance arrangements are largely clear and transparent, promote the safety and efficiency of the CLS Settlement System, and support the stability of the broader financial system, other relevant public interest considerations, and the objectives of relevant stakeholders. Importantly, however, while CLS believes this to be true, it also has determined that its governance structure and processes can and should be improved. CLS recognizes that it serves a systemically important role in the financial markets, and that accordingly, it must take all reasonable efforts to ensure that it is capable of fulfilling its obligations at a high level of performance and resiliency. CLS understands that fulfilling these obligations requires a well-coordinated and high functioning organization that is well managed and responsive. Governance is the mechanism and process for providing the oversight that ensures these results. In the course of the past year, CLS has determined that there were several areas of governance that merited further consideration. Accordingly, CLS initiated a corporate governance review process that examined, among other things, the CLS governance structure and processes with a view to improving efficiency, effectiveness, transparency and accountability. CLS believes that while its current corporate governance framework and process adequately serve all constituencies, the significance of CLS to the smooth operation of the financial markets strongly supports its pursuit of improvement in this area. In particular, CLS has noted that current events warrant more frequent board meetings and has recently decided to move from quarterly board meetings to monthly board meetings. Additionally, the Board of Directors of CLS Group Holdings (the CLS Holdings Board ) has created a new committee to focus on strategic and regulatory matters so that it may better understand the significantly changing regulatory framework and how CLS may best position itself in the evolving financial market. The CLS Holdings Board previously had addressed these matters as a group and in retrospect not as comprehensively as now seems appropriate. The CLS Holdings Board has also undertaken a review of the charters or terms of reference for each of its existing committees and those of the CLS Bank Board and has made a number of changes that are intended to refocus and realign these committees. Most notably, a new Risk Management Committee was created at the CLS Holdings Board (and the corresponding risk management committee of the CLS Bank Board was disbanded) to provide a better vantage point for oversight of the risk function throughout the CLS Group. Further, the charter of the Audit Committee was expanded to cover finance matters in their initial instance (and was renamed the Audit and Finance Committee) and the charter of the Operations Committee was expanded to include responsibility for the oversight of technology matters and was renamed the Technology and Operations Committee. Perhaps most importantly, the CLS Holdings Board determined that the inclusion of directors on the board who were not affiliated with the existing owner/user group of Settlement Members would provide a significant and likely objective view that would enhance the quality of discussion of the CLS Holdings Board and its oversight function. Working with the assistance of advisors, the CLS Holdings Board developed a set of criteria to ensure sufficient independence from CLS and its Settlement Members as well as additional areas of subject matter expertise that would further promote effective oversight of key functional areas. At an Extraordinary General Meeting ( EGM ) of the CLS Holdings shareholders that took place on December 22, 2011, three new 63

additional independent directors were elected to the CLS Holdings Board 36. These new directors, together with the previously elected independent Chairman, also were (by resolution approved by the CLS Holdings shareholders at the EGM) deemed to meet new more specific criteria for independence and designated as Outside directors. Finally, the CLS Holdings Board has instituted a new evaluation process that includes both a subjective self-assessment of skills and performance process and an external evaluation of skills by an experienced third party. In conjunction with this measure the CLS Holdings Board determined to rebalance the competing needs for continuity and new views by recommending to the CLS Holdings shareholders that board terms be changed from two years to three years while shortening the term limit for all new directors (other than the Chairman) from eight years in aggregate to six years in aggregate. These changes to the Articles of Association of CLS Holdings also were approved by CLS Holdings shareholders at the EGM.. It is intended that the CLS Bank Board will have a membership identical to that of the CLS Holdings Board and the four new CLS Holdings directors that were elected at the EGM will be elected to CLS Bank Board in the very near term. The CLS Bank Board has no board committees. 10.1 Governance Structure The CLS Holdings Board has established, with the recently approved enhancements, a governance structure that is intended to enable effective representation of all relevant constituencies, including without limitation, CLS shareholders, the CLS System central banks, FX market participants and the financial markets generally. Additionally, the CLS Holdings Board takes into consideration traditional corporate matters such as taxation, efficiency and the effect of jurisdiction on the ability of CLS to provide the Settlement Service most effectively. While CLS, as a closely held company, is not technically required to follow any governance code applicable to public companies, CLS does look to rules and codes applicable to public companies for guidance. Among those codes that CLS considers in whole or in part are the Swiss Code of Best Practice for Corporate Governance and the U.K. Combined Code where applicable and consistent with the business needs of the CLS Group, and laws, rules and regulations applicable to Edge Act corporations and to bank holding companies subject to regulation and supervision by the Board of Governors of the Federal Reserve System. CLS has selected these particular references based upon its corporate organizational structure. Most recently, the CLS Holdings Board began a significant review of a number of key governance factors with a view to substantially improving the effectiveness of the CLS Holdings Board. Among these factors are: geographic representation; the size and composition of the CLS Holdings Board; the addition of a number of independent or outside directors; the skills, experience and expertise of directors individually and as a group; and commitment to spend significant time on CLS matters. The CLS Holdings Board also has initiated a process for enhancing director self-evaluation and education. While this review will continue, it already has resulted in a number of significant changes including the restructuring of a number of CLS Holdings Board committees, the utilization of a web-based board communication tool, monthly board meetings and the addition of three new additional Outside Directors. 36 In addition to the election of these three new additional Outside Directors being elected to the CLS Holdings Board at the December 22, 2011 EGM, an additional director was elected who had been identified through the new selection and nomination process for non-outside Directors to fill an existing vacancy on the CLS Holdings Board. Each of the four new directors was elected to serve a three-year term. 64

10.2 Corporate Structure; Boards and Committees CLS operates through a collection of companies that are organized in Switzerland, the United Kingdom and the United States. This structure is intended to address certain legal, taxation, regulatory and general business issues. As described above, 37 CLS Group Holdings is a Swiss company that is owned by the 73 shareholders, each of which (with limited exceptions) is a Settlement Member or an affiliate of a Settlement Member. 38 CLS Group Holdings is ultimately responsible for the oversight of all CLS companies and provides overall CLS Group management and strategic direction. CLS Group Holdings is the sole owner of CLS UK Holdings which is organized and headquartered in the United Kingdom. CLS UK Holdings facilitates the coordination and management of its two wholly-owned subsidiaries, CLS Bank and CLS Services. Pursuant to a Master Services Agreement, CLS Services provides certain administrative, operational and technology related services to CLS Bank. In December 2009, CLS Bank formed a new subsidiary, CLSAS, while simultaneously selling 49% of such subsidiary to Traiana Inc. ( Traiana ). CLSAS provides a trade aggregation service to participants active in the OTC FX market. The CLS Group s corporate structure is represented in Diagram 5 below. Diagram 5 37 38 See the response to Core Principle I above. Shareholders may also be (or be affiliated with) institutions which have not yet become Settlement Members. In limited cases, shareholders are or are affiliated with former Members or prospective Members. 65

10.2.1 Shareholder Representation The CLS Holdings Board recognizes the importance of understanding the interests of shareholders in sound governance and accordingly has undertaken a number of initiatives to allow it to better understand and consider the views of CLS Group Holdings shareholders. While this is the responsibility of all board directors, in the context of CLS Group Holdings this is particularly important for two reasons: first, the Articles of Association of CLS Group Holdings effectively limit shareholder influence by limiting the votes of any individual shareholder to 100, and limit the transferability of shares; and second, CLS Group Holdings shareholders are Settlement Members or affiliates of Settlement Members, i.e., CLS Group Holdings is a concentrated owner-user model. CLS Group Holdings provides information to its shareholders on a regular basis at the Annual General Meeting, in correspondence, in bilateral meetings and on the CLS website. Additionally, as users of the CLS Settlement System, shareholders also communicate with CLS through industry working groups. Shareholder representation on the CLS Holdings Board is determined based on several key criteria which have been determined by the CLS Holdings Board. These criteria are intended to ensure that each director has qualities, skills, expertise, knowledge and experience that make him or her individually a well-qualified director. Additionally each director must evidence a commitment to be actively engaged in board and committee work as a CLS Holdings Board director. Directors nominated by shareholders are further subject to selection based upon a flexible matrix of criteria that focus on the geographic area in which the headquarters or home office of the institution that nominates a director is located 39 and the volume of transactions settled through the CLS Settlement System or CLSAS of such nominating institution. 40 CLS recognizes that each director has a fiduciary duty to represent all constituencies, including shareholders and market interests from geographic areas other than those in which their nominating shareholder is headquartered; however, CLS believes that this approach to director selection enhances the representation of designated regional interests and those of small institutions or institutions that are not large users of the CLS Settlement System. Outside directors of CLS Group Holdings must meet additional criteria regarding their independence from CLS, its directors, officers and employees. 41 Additionally, CLS intends that 39 40 41 The CLS Holdings Board has designated four global geographic areas: Europe, the Americas, Asia and the Rest of the World ( ROW ). Assuming a target of an aggregate of 20 to 23 CLS Holdings Board Directors, these geographic areas have the following target representations: at least 1 but not more than 8 for Europe (with at least 3 for mainland Europe, and at least 1 each for the United Kingdom, Switzerland and the Nordic countries as a group); at least 1 but not more than 7 for the Americas (with at least 4 for the United States and at least 1 for Canada); at least 2 but not more than 4 for Asia (with at least 1 for Japan and at least 1 for either Hong Kong or Singapore); and at least 1 but not more than 4 for the ROW (with at least one for Australia or New Zealand). The CLS Holdings Board has as a target (assuming an aggregate of 20 to 23 CLS Holdings Board Directors), that at least 5 directors be nominated by shareholders that are among the largest 10 users of the CLS Settlement Service measured by volume of transactions settled. The total number of authorized board seats is 26 for the CLS Holdings Board. An Outside Director of the CLS Holdings Board is defined to be an individual who: (i) is not an executive officer, as defined in section 215.2(e)(1) of Regulation O of the Board of Governors (12 C.F.R. 215.2(e)(1)), or other employee of CLS, its affiliates, settlement members, or user members; (ii) is not an executive officer, other employee, director, or shareholder of CLS; (iii) is not a related interest, as defined in section 215.2(n) of Regulation O of the Board of Governors (12 C.F.R. 215.2(n)), of any of the above executive officers, employees, directors, or shareholders; and (iv) is not an immediate family member, as defined in section 225.41(b)(3) of Regulation Y of the Board of Governors (12 C.F.R. 225.41(b)(3)), of any of the above executive officers, employees, directors, or shareholders. 66

each Outside Director have specific expertise, knowledge or experience in one or more of the following areas: finance; risk management, technology and public affairs. CLS believes that the inclusion of a number of Outside Directors will bring additional objectivity to the functioning of the CLS Holdings Board and will balance the industry views that may be better represented by directors that are nominated or employed by shareholders that use the CLS Settlement System. The Chairman of the CLS Holdings Board is not an employee of a shareholder, nor was he nominated by a shareholder in accordance with the terms of the CLS Articles of Association. The President and Chief Executive Officer of CLS Group Holdings is the only executive director on the CLS Holdings Board. While the CLS Group Holdings Articles of Association provide for up to 26 directors, the CLS Holdings Board is currently comprised of 23 members following the election of three additional Outside directors. Similarly, the By-Laws of CLS Bank provide for up to 25 members of the CLS Bank Board; however, it currently has 19 members and following the election of three additional Outside Directors and the new director who was elected to replace a director who had retired, it too will be comprised of 23 members. The composition of the CLS Holdings Board and the CLS Bank Board is intended to be the same. Representation on the committees of CLS Group Holdings is now limited to Board directors whereas, historically, members of committees of the CLS Group Holdings and CLS Bank Boards could be and sometimes were not members of such boards. The CLSAS board has been structured to provide for directors to be nominated by CLS Bank, Traiana and CLS Members that use the Aggregation Service. Currently, CLS Bank has the right to nominate two directors, Traiana has the right to nominate one director, and Member users of the Aggregation Service have the right to nominate ten (10) directors. The CLS UK Holdings board (the CLS UK Holdings Board ) is comprised of two members, the CLS Group Holdings Deputy CEO and the CLS Group Holdings Chief Financial Officer. These individuals are also the only members for CLS Services board of directors (the CLS Services Board ). The CLS UK Holdings Board and the CLS Services Board meet periodically as needed to consider such matters and to take such actions as they deem appropriate to manage the affairs of their respective companies in a manner that is consistent with the direction and affairs of CLS Group Holdings and the sound operation of CLS Bank. 10.2.2 Board Responsibilities The Board of Directors for CLS Group Holdings is responsible for overseeing and directing the management, business and strategic affairs of the CLS Group to ensure effective delivery of the Settlement Service, to manage relationships with shareholders and to ensure compliance with all legal and regulatory requirements. Additionally the CLS Holdings Board oversees the management, business and regulatory affairs of CLS Bank (both indirectly and with the assistance of the CLS UK Holdings and CLS Bank Boards); oversees the technical and operational aspects of the Settlement Service (indirectly and with the assistance of the CLS UK Holdings and CLS Services Boards); and oversees the management and business affairs of CLSAS, identifying priorities to support aggregation services for the FX market (with the assistance of the CLS UK Holdings, CLS Bank and CLSAS Boards). 10.2.3 Committees of the Boards The CLS Group Holdings Board has organized and uses six committees to assist it in fulfilling its obligations: Chairman s Committee. The Primary purpose of the Chairman s Committee is to provide counsel to the Chief Executive Officer and President of CLS Group Holdings and to the Chairman of the CLS Group Holdings Board on various matters and to assist in setting the agenda for meetings of the CLS Holdings Board. In addition, the 67

Chairman s Committee will also agree on the annual remuneration program and, from time to time, deal with any human resources issues that require board-level consideration. The Chairman s Committee shall also serve the function of monitoring compliance with any matters raised by the Federal Reserve or any other member of the CLS Oversight Committee. The Chairman s Committee shall perform a similar function with respect to CLS Bank. Nominating and Governance Committee. The role of the Nominating and Governance Committee of CLS Group Holdings is to provide advice and counsel to the CLS Holdings Board to ensure the proper governance of CLS and its subsidiaries as a whole, in particular with respect to its compliance with all applicable provisions of applicable law and regulations, including without limitation, regulations of the Federal Reserve Board of Governors. In addition, the NGC makes recommendations to the CLS Group Holdings Board and to the CLS Bank Board regarding governance matters generally and regarding the nomination of new directors. Audit and Finance Committee. This committee oversees all audit activity within the CLS Group, including CLS Bank and CLSAS. It ensures that the system of internal controls of the CLS Group as a whole is appropriate to the requirements of applicable company law and regulatory frameworks (including substantial compliance with the U.K. Combined Code and other governance codes relevant to the business of the CLS Group); monitors the integrity of the financial statements of CLS Group Holdings; reviews the scope and effectiveness of the systems established by management to identify, assess, manage and monitor financial and non-financial risks; oversees the relationship with the external auditor for the CLS Group; and monitors and reviews the effectiveness of the internal audit function. The Audit Committee also reviews the Company s whistle-blowing arrangements to ensure staff may in confidence raise concerns about possible wrongdoing in financial reporting, financial controls or any other matters. The Audit and Finance Committee is also responsible for providing oversight of the finance function at CLS Group Holdings and each of its subsidiaries, including oversight of budget, financial planning, all tax related matters, insurance matters and pricing policy. Risk Management Committee. The role of the CLS RMC is to provide advice, counsel and recommendations to the CLS Group Holdings Board on the key risk management policies and practices of CLS Group Holdings and all of its subsidiaries and in particular CLS Bank and the responsibilities of CLS Group to the FX market and the payment systems of which it is a member or with which it interacts. The risks of significant concern for the CLS RMC include without limitation credit risks, market risks, liquidity risks, legal risks, compliance risks, payment risks and operational risks. The CLS RMC will assist the CLS Group Holdings Board in setting the risk appetite of CLS Group (and, as appropriate, of each of its constituent entities); the proper oversight of the Risk Management function of CLS Bank and of the risk in the CLS Group. Strategy Committee. The role of the Strategy Committee is to provide advice, counsel, and recommendations to the CLS Board with regard to the development and implementation of the business strategy of CLS Group Holdings and all of its subsidiaries (CLS Group Holdings together with such subsidiaries), and in particular CLS Bank, giving due consideration to the responsibilities of the CLS Group to the FX market and the payment systems of which it is a member or with which it interacts. The Strategy Committee will among other things provide oversight of the further development and implementation of the CLS strategic vision, and all 68

associated business and resource plans. The Strategy Committee will monitor the impact of the regulatory landscape on the CLS strategy and services. The Strategy Committee shall serve as a means of facilitating and expediting the interaction of CLS management and the CLS Holdings Board on strategic matters and give support to the preparation of the strategy meetings of the CLS Holdings Board. Technology and Operations Committee. The role of the Technology and Operations ( TOPs ) Committee is to provide advice, counsel and recommendations to the CLS Holdings Board on the key technical and operational aspects for the CLS Settlement Service and related programs and services. The TOPs Committee shall take the lead on behalf of the CLS Holdings Board with regard to providing advice, counsel and oversight of the development and implementation of the technological and operational aspects of any strategic or significant tactical enhancement or modification to the existing core system ( Special Projects ) and shall coordinate with the Audit and Finance Committee with regard to financial matters associated with any such project. 42 The TOPs Committee will also provide advice, counsel and recommendations to the CLS Holdings Board as may be requested from time to time with respect to the key technical and operational aspects of the Aggregation Service provided by CLSAS. The TOPs Committee, with the support of management of CLS Group Holdings, CLS Bank and CLS Services may from time to time organize and coordinate one or more task forces (a TOPs Taskforce ) which shall be comprised of a group of individuals identified and selected by the TOPs Committee as having identified expertise deemed to be beneficial or necessary in order to provide additional technical or operational knowledge, experience, advice and information regarding the key technical and operational aspects of the CLS Settlement System, the Special Projects, the Aggregation Services and such other technical or operational matters as may reasonably affect CLS Group Holdings or any of its subsidiaries. 10.3 Audit Framework The CLS Group has a comprehensive audit program reflecting its status as a critical market infrastructure and its regulatory oversight. The Audit and Finance Committee provides advice and counsel to the CLS Group Holdings Board that there is a sufficient, systematic, embedded risk-based review of the internal control arrangements for the CLS Group and that any weaknesses in internal control are being corrected. CLS s Internal Audit function is responsible for advising CLS management and the CLS Group Holdings Board, through the Audit and Finance Committee, on the quality of the business operations with particular emphasis on systems of control. The Internal Audit function prepares and follows an annual risk based audit work program that ensures that all high risks (determined by Internal Audit using an independent risk assessment) across the business are reviewed every year. The CLS Group is also subject to review by its external auditor whose primary objective is to express an opinion on the financial statements of the CLS Group and its subsidiaries. 42 It is understood that the CLS Holdings Board has tasked the Audit and Finance Committee with taking the lead for oversight of the financial aspects of any such project. 69

APPENDIX A: EXAMPLE OF FX TWO-CURRENCY PAYMENT INSTRUCTIONS AND SINGLE-CURRENCY PAYMENT INSTRUCTIONS Assume that the CLS system received the following payment instructions relating to two separate FX transactions and two separate single-currency transactions from a Settlement Member for settlement on Day 1. Payment Instruction CCY Buy / Sell Amount CCY Buy / Sell Amount FX 1 EUR Buy 100,000,000 USD Sell -115,000,000 Single ccy1 USD Sell -5,000,000 Single ccy2 USD Buy 10,000,000 FX 2 EUR Sell -50,000,000 USD Buy 75,000,000 Based on the above positions, the Settlement Member has a Pay-In requirement of 35 million USD. STEP 1. The CLS system begins processing payment instructions on the settlement processing queue for settlement at 07:00 CET, starting with the evaluation of FX payment instruction 1 against the three risk management tests. CCY Settlement Member s actual Balance (original currency) FX Payment Instruction 1 Simulated Balance (original currency) Rate Simulated Balance (base currency) Haircut Simulated Haircut Adjusted Balance EUR 0 100,000,000 100,000,000 1.3600 136,000,000 10.0% 122,400,000 USD 0-115,000,000-115,000,000 1.0000-115,000,000 10.0% -126,500,000 Simulated Account Balance 21,000,000 Simulated Adjusted Account Balance -4,100,000 Result: FX payment instruction 1 does not settle because settlement would result in a negative adjusted account balance. STEP 2. The CLS system continues to process the payment instructions on the queue by evaluating the payment instructions, in this case payment instruction single-currency 1, against the three risk management tests: CCY Settlement Member s actual Balance (original currency) Single- Payment Instruction 1 Simulated Balance (original currency) Rate Simulated Balance (base currency) Haircut Simulated Haircut Adjusted Balance EUR 0 0 0 1.3600 0 10.0% 0 USD 0-5,000,000-5,000,000 1.0000-5,000,000 10.0% -5,500,000 Simulated Account Balance -5,000,000 Simulated Adjusted Account Balance -5,500,000 A-1

Result: Payment instruction single-currency 1 does not settle because settlement would result in a negative adjusted Account Balance. STEP 3. The CLS system continues to process the payment instructions on the queue by evaluating the payment instructions, in this case single-currency payment instruction 2, against the three risk management tests:.ccy Member s actual Balance (original currency) Single- Payment Instruction 2 Simulated Balance (original currency) Rate Simulated Balance (base currency) Haircut Simulated Haircut Adjusted Balance EUR 0 0 0 1.3600 0 10.0% 0 USD 0 10,000,000 10,000,000 1.0000 10,000,000 10.0% 9,000,000 Simulated Account Balance 10,000,000 Simulated Adjusted Account Balance 9,000,000 Result: Single-currency payment instruction 2 does settle because settlement would result in a positive adjusted Account Balance. STEP 4. The CLS system continues to process the payment instructions on the queue by evaluating the payment instructions, in this case FX payment instruction 2, against the three risk management tests: CCY Member s actual Balance (original currency) FX Payment Instruction 2 Simulated Balance (original currency) Rate Simulated Balance (base currency) Haircut Simulated Haircut Adjusted Balance EUR 0-50,000,000-50,000,000 1.3600-68,000,000 10.0% -74,800,000 USD 10,000,000 75,000,000 85,000,000 1.0000 85,000,000 10.0% 76,500,000 Simulated Account Balance 17,000,000 Simulated Adjusted Account Balance 1,700,000 Result: FX payment instruction 2 does settle because settlement would result in a positive adjusted Account Balance. STEP 5. The CLS system continues to process the payment instructions on the queue by evaluating the payment instructions, in this case FX payment instruction 1, against the three risk management tests: CCY Member s actual Balance (original currency) FX Payment Instruction 1 Simulated Balance (original currency) Rate Simulated Balance (base currency) Haircut Simulated Haircut Adjusted Balance EUR -50,000,000 100,000,000 50,000,000 1.3600 68,000,000 10.0% 61,200,000 USD 85,000,000-115,000,000-30,000,000 1.0000-30,000,000 10.0% -33,000,000 Simulated Account Balance 38,000,000 Simulated Adjusted Account Balance 28,200,000 A-2

Result: FX payment instruction 1 now does settle because settlement would result in a positive adjusted Account Balance. STEP 6. The CLS system continues to process the payment instructions on the queue by evaluating the payment instructions, in this case single-currency payment instruction 1, against the three risk management tests: CCY Member s actual Balance (original currency) Single- Payment Instruction 1 Simulated Balance (original currency) Rate Simulated Balance (base currency) Haircut Simulated Haircut Adjusted Balance EUR 50,000,000 0 50,000,000 1.3600 68,000,000 10.0% 61,200,000 USD -30,000,000-5,000,000-35,000,000 1.0000-35,000,000 10.0% -38,500,000 Simulated Account Balance 33,000,000 Simulated Adjusted Account Balance 22,700,000 Result: Single-currency payment instruction 2 now does settle because settlement would result in a positive adjusted Account Balance. Following the successful settlement of all four payment instructions (two FX payment instructions and two single-currency payment instructions) of the Settlement Member, if the Settlement Member would then fail to cover its short position of 35 million USD, the short position is fully offset by its long position in EUR. If the Settlement Member does not respond to a Pay-In Call for currency close, CLS Bank will access its committed liquidity facilities in USD to acquire the 35 million USD it needs to complete its Pay-Out obligations to Settlement Members with long positions in USD. It is important to remember that CLS Bank does not guarantee the settlement of any payment instruction. Assume a situation where a Settlement Member has submitted one single-currency payment instruction where the Member is paying currency to another party. Payment Instruction CCY Buy / Sell Amount CCY Buy / Sell Amount Single ccy1 USD Sell -5,000,000 Based on the above position, this Settlement Member has a Pay-In requirement of 5 million USD. As illustrated below, if this Pay-In is not satisfied, then this payment instruction will not settle because settlement would result in a negative adjusted Account Balance and, accordingly, be rejected by the CLS system at the end of the currency close for USD. A-3

CCY Member s actual Balance (original currency) Single- Payment Instruction 1 Simulated Balance (original currency) Rate Simulated Balance (base currency) Haircut Simulated Haircut Adjusted Balance EUR 0 0 0 1.3600 0 10.0% 0 USD 0-5,000,000-5,000,000 1.0000-5,000,000 10.0% -5,500,000 Simulated Account Balance -5,000,000 Simulated Adjusted Account Balance -5,500,000 The CLS system applies the three risk management tests to each payment instruction in the same manner, without regard as to whether it is a single-currency payment instruction or an FX payment instruction. The application of the tests to single-currency payment instruction 1 is no different from the application of the tests to FX payment instructions. Assume, for example, a situation where a Settlement Member has submitted one FX payment instruction: Payment Instruction CCY Buy / Sell Amount CCY Buy / Sell Amount FX 1 EUR Buy 100,000,000 USD Sell -115,000,000 Based on the above position, this Settlement Member has a Pay-In requirement of 115 million USD. As illustrated below, if this Pay-In is not satisfied, then this payment instruction will not settle because settlement would result in a negative adjusted Account Balance and, accordingly, be rejected by the CLS system at the end of the currency close for EUR. CCY Member s actual Balance (original currency) FX Payment Instruction 1 Simulated Balance (original currency) Rate Simulated Balance (base currency) Haircut Simulated Haircut Adjusted Balance EUR 0 100,000,000 100,000,000 1.3600 136,000,000 10.0% 122,400,000 USD 0-115,000,000-115,000,000 1.0000-115,000,000 10.0% -126,500,000 Simulated Account Balance 21,000,000 Simulated Adjusted Account Balance -4,100,000 A-4

APPENDIX B: EXAMPLE OF IN/OUT SWAP TRANSACTIONS Assume that Member In/Out Swap participants have the following Initial Pay-in Schedule positions (in USD dollar equivalent). The target trade-down position is: (i) any short position for non-asia/pacific currency and (ii) any long position in an Asia/Pacific currency in excess of 50 (the shaded amounts are in excess of the trade-down target). Initial Table Member Positions Member Positions JPY EUR GBP USD M 1 1,250-3,500-1,500 3,250 M 2-2,750 1,500-1,750 2,750 M 3-1,500 2,500 3,000-3,750 M 4 3,000-500 250-2,250 Total 0 0 0 0 Also assume that Member In/Out Swap participants have the following counterparty credit limits: Initial Table Credit Limits Member Credit Limits M 1 M 2 M 3 M 4 M 1-500 1,250 250 M 2 1,000-750 500 M 3 1,000 500-100 M 4 500 500 500 - The In/Out swap algorithm targets positions in excess of the trade-down target in descending order based upon USD equivalent value. The algorithm will calculate In/Out Swap transactions by maximizing: (i) the trade-down based upon the value of the counter currency, and (ii) the available credit limit between the two In/Out swap participants. In/Out Swap Transaction 1 In this example Member 3 has the largest position in excess of the 50 trade-down target, -3,750 USD. Member 3 s largest value counter currency is 3,000 GBP. Two counter parties, Member 1 and Member 2 have opposite USD / GBP positions. The largest counterparty credit limit availability is 1,000 between Member 3 and Member 1. As a result the following In/Out swap transaction is calculated: In leg - Member 3 buying 1,000 USD selling 1,000 GBP with Member 1. Out leg - Member 3 buying 1,000 GBP selling 1,000 USD with Member 1. The positions are updated: B-1

Table 1A Member Positions JPY EUR GBP USD M 1 1,250-3,500-500 2,250 M 2-2,750 1,500-1,750 2,750 M 3-1,500 2,500 2,000-2,750 M 4 3,000-500 250-2,250 Total 0 0 0 0 Also assume that Member In/Out Swap participants now have the following counterparty credit limits available following Transaction 1: Table 1B Member Credit Limits M 1 M 2 M 3 M 4 M 1-500 250 250 M 2 1,000-750 500 M 3 0 500-100 M 4 500 500 500 - In/Out Swap Transaction 2 Now Member 1 has the largest position in excess of the 50 trade-down target, -3,500 EUR. Member 1 s largest value counter currency is 2,250 USD. However, only Member 3 has opposite currency balances that could be traded down. No swap is possible because there is no credit availability between Member 3 and Member 1. Member 1 s next largest value counter currency is 1,250 JPY. One counterparty, Member 2, has an opposite EUR / JPY position and available credit limits. As a result the following In/Out swap transaction is calculated: In leg - Member 1 buying 500 EUR selling 500 JPY with Member 2. Out leg - Member 1 buying 500 JPY selling 500 EUR with Member 2. The positions are updated: Table 2A Member Positions JPY EUR GBP USD M 1 750-3,000-500 2,250 M 2-2,250 1,000-1,750 2,750 M 3-1,500 2,500 2,000-2,750 M 4 3,000-500 250-2,250 Total 0 0 0 0 B-2

Also assume that Member In/Out Swap participants now have the following counterparty credit limits available following Transaction 2: Table 2B Member Credit Limits M 1 M 2 M 3 M 4 M 1-0 250 250 M 2 500-750 500 M 3 0 500-100 M 4 500 500 500 - In/Out Swap Transaction 3 Now Member 4 has the largest position in excess of the 50 trade-down target, 3,000 JPY. Member 1 also has a -3,000 EUR position but has no further credit limit availability to trade down the position. Member 4 s largest value counter currency is -2,250 USD. One counterparty, Member 2, has an opposite JPY / USD position and available credit limits. As a result the following In/Out swap transaction is calculated: In leg - Member 4 buying 500 USD selling 500 JPY with Member 2. Out leg - Member 4 buying 500 JPY selling 500 USD with Member 2. The positions are updated: Table 3A Member Positions JPY EUR GBP USD M 1 750-3,000-500 2,250 M 2-1,750 1,000-1,750 2,250 M 3-1,500 2,500 2,000-2,750 M 4 2,500-500 250-1,750 Total 0 0 0 0 Also assume that Member In/Out Swap participants now have the following counterparty credit limits available following Transaction 3: Table 3B Member Credit Limits M 1 M 2 M 3 M 4 M 1-0 250 250 M 2 500-750 0 M 3 0 500-100 M 4 500 0 500 - In/Out Swap Transaction 4 Now Member 3 has the largest position in excess of the 50 trade-down target, -2,750 USD. Member 3 s largest value counter currency is 2,000 GBP. One counterparty, Member 2, has an opposite USD / GBP position and available credit limits. As a result the following In/Out swap transaction is calculated: B-3

In leg - Member 3 buying 500 USD selling 500 GBP with Member 2. Out leg - Member 3 buying 500 GBP selling 500 USD with Member 2. The positions are updated: Table 4A Member Positions JPY EUR GBP USD M 1 750-3,000-500 2,250 M 2-1,750 1,000-1,250 1,750 M 3-1,500 2,500 1,500-2,250 M 4 2,500-500 250-1,750 Total 0 0 0 0 Also assume that Member In/Out Swap participants now have the following counterparty credit limits available following Transaction 4: Table 4B Member Credit Limits M 1 M 2 M 3 M 4 M 1-0 250 250 M 2 500-250 0 M 3 0 0-100 M 4 500 0 500 - In/Out Swap Transaction 5 Now Member 4 has the largest positions in excess of the 50 trade-down target, 2,500 JPY and - 1,750 USD. Member 4 s next largest value counter currency is -500 EUR. One counterparty, Member 3, has an opposite JPY / EUR position and available credit limits. As a result the following In/Out swap transaction is calculated: In leg - Member 4 buying 100 EUR selling 100 JPY with Member 3. Out leg - Member 4 buying 100 JPY selling 100 EUR with Member 3. The positions are updated: Table 5A Member Positions JPY EUR GBP USD M 1 750-3,000-500 2,250 M 2-1,750 1,000-1,250 1,750 M 3-1,400 2,00 1,500-2,250 M 4 2,400-500 250-1,750 Total 0 0 0 0 B-4

Also assume that Member In/Out Swap participants now have the following counterparty credit limits available following Transaction 5: Table 5B Member Credit Limits M 1 M 2 M 3 M 4 M 1-0 250 250 M 2 500-250 0 M 3 0 0-0 M 4 400 0 500 - In/Out Swap Transaction 6 Now Member 4 has the largest position in excess of the 50 trade-down target, -1,750 USD. Member 4 s next largest value counter currency is 250 GBP. One counterparty, Member 1, has an opposite USD / GBP position and available credit limits. As a result the following In/Out swap transaction is calculated: In leg - Member 4 buying 250 USD selling 250 GBP with Member 1. Out leg - Member 4 buying 250 GBP selling 250 USD with Member 1. The positions are updated: Table 6A Member Positions JPY EUR GBP USD M 1 750-3,000-250 2,000 M 2-1,750 1,000-1,250 1,750 M 3-1,400 2,00 1,500-2,250 M 4 2,400-500 0-1,500 Total 0 0 0 0 Also assume that Member In/Out Swap participants now have the following counterparty credit limits available following Transaction 6: Table 6B Member Credit Limits M 1 M 2 M 3 M 4 M 1-0 250 0 M 2 500-250 0 M 3 0 0-0 M 4 150 0 500 - In this example, no further In/Out swap trade-down is possible because of lack of credit limit availability. B-5