Cleared OTC Interest Rate Swaps

Protecting OTC Market Participants Through the Security of Centralized Clearing

Security. Neutrality. Transparency.

June 2011

Cleared OTC IRS: Introduction

Overview and Background
On October 18, 2010, CME launched its interest rate swaps clearing solution, which now has 10

buy side participants who have cleared trades and 13 clearing members
CME worked in close collaboration with premier swap dealers, clearing firms, and buy-side

market participants to create a best in class clearing platform for OTC interest rate swaps
The buy-side contributed significant input to help design a solution that maintains current

execution processes, affirmation platforms, and product economics of bilateral OTC contracts

Benefits of the Solution

Builds on the strength of CME Groups market leading interest rate products business Enables customers to negotiate, execute and submit OTC trades through multiple venues to

CME Clearing, including Bloomberg VCON, MarkitSERV, and TradeWeb

Protects customers through legal safeguards of U.S. bankruptcy law and CFTC Part 190

Bankruptcy Regulations
Seeking CFTC permission to allow customer capital efficiencies via cross margining of OTC

products with benchmark Treasury and Eurodollar futures

Provides operational flexibility of a multi asset class solution via one integrated platform

2011 CME Group. All rights reserved

Cleared OTC IRS: Product Scope

Current Eligible Products for Clearing
USD vanilla interest rate swaps 3 Month LIBOR Index on the floating leg Flexible coupons, effective dates, roll conventions, accruals, payment

frequencies, business days, resets, etc

Maturity dates out to 31 years

Future Product Rollouts

Spreads over/under LIBOR
1M LIBOR and 6M LIBOR indexes Additional currencies, starting with EUR, GBP, YEN, and CAD

Cleared OTC IRS: Open Access Platform

Clearing IRS trades real-time throughout the day, every day providing immediate cleared trade confirmation, significantly reducing counterparty credit exposure
CME OTC Cleared IRS Model
Bloomberg MarkitSERV TradeWeb Other 3rd Party Platforms

CME Clearing
IRS Clearing Members (FCM)

IRS Clearing Member (FCM)

IRS Clearing Member (FCM)

IRS Clearing Member (FCM)

Negotiate, execute, and submit trades through multiple venues to CME Clearing

Straight through processing and T+0 confirmation

Full life cycle trade management by CME Clearing More than 100 years of experience in clearing, settlement and risk management

2011 CME Group. All rights reserved

Cleared OTC IRS: Trade Workflow Mechanics

1 Client executes swap with Executing Broker (ED)
Client
1

ED

2 ED alleges swap to Client

Affirmation Platform
4 5

3 Client selects Clearing Member and affirms swap 4 Affirmation Platform sends matched trade to CME for Clearing 5 After validating product, account and applying credit limits set by Clearing member(s), CME accepts swap for clearing
5

CME Clearing House

Product Account Credit

5 CME sends Cleared notification to Affirmation Platform which displays trade status to principals
Clearing Member (Client) Clearing Member (ED)

5 CME sends a Clearing Confirmation to Clearing Member(s)

Validations, notifications and confirmations are real-time and allow Straight Through Processing

2011 CME Group. All rights reserved

Cleared OTC IRS: Valuation

Valuation Overview
USD IRS positions will be marked to market once per day at 3pm EST Pricing inputs obtained from wire service feeds

Pricing Inputs
LIBOR: O/N, T/N FRA: 0 x 6 CME Eurodollarsfirst 6 Quarterly Eurodollar contracts, convexity adjusted

Par Swap Rates: 2Y 10Y, 15Y, 20Y and 30Y. (SA, 3M LIBOR)

Interpolation and Generation

CME uses monotone convex interpolation and Bootstrap Generator to produce a Zero Coupon curve

Discounting
LIBOR is currently used to discount future cash flows, but CME is converting over to OIS discounting in July 2011

2011 CME Group. All rights reserved

Cleared OTC IRS: Margin Methodology

Objectives
Coverage meets target of 99% confidence interval for a 5-day move Net portfolio margining isolates the true curve risk in a portfolio and assesses the appropriate

margins to cover that risk

Scalable to margin other IRS currencies and Futures Stable margins during periods of low volatility, but reactive to changes in rate and volatility

regimes
Transparent to market participants and easy to replicate

Overview
Historical Value at Risk (VaR) model is targeted to replace the existing Principal Component

Analysis model
The historical VaR model uses 5 years of historical data for all observed tenors to create 1250+

shock scenarios
CME is targeting to have the historical VaR model available in the testing environment in July

and in production in August

2011 CME Group. All rights reserved

Acceptable Collateral for Initial Margin

Collateral Pledged by Clearing Member Firm to CME Clearing for the Customer OTC Account Class:
U.S Dollars Non-U.S. Cash (Euros, British Pounds, and Canadian Dollars)
Haircut on FX: 5%

Select Foreign Debt (Canada, France, UK, Germany, Sweden)

Haircut: 3%-10% depending on maturity

US Treasuries
Haircut: 2%- 5% depending on maturity (plus 0.5% for off the run securities)

Select US Government Agencies

Discount notes up to 12 months issued by FHLB, FNMA, FFCB, FHLMC; Bonds up to 30

years issued by FFCB, FHLB

Haircut: 3%- 6% depending on maturity (plus 0.5% for off the run securities)

Mortgage Backed Securities

15 or 30yr maturity issued by Fannie Mae, Freddie Mac, Ginnie Mae Haircut: 10% on the market value of all securities

2011 CME Group. All rights reserved

CME Group Risk Management

Information available to CME Clearing that allows
a comprehensive view of customer portfolios across all Clearing Members (i.e., improves transparency)

CME Clearing Risk Management Best Practices

Buyer Buyer Buyer
CME Clearing

The CME monitors both Clearing Members and

Customers for risk concerns (e.g., unusual trading, P&L swings, concentration risk, etc.) across all asset classes cleared at CME

Seller Seller Seller

Real-time, 24 hour a day by 6 days a week

monitoring of both clearing firm and account level position and exposure levels for CDS and all other asset classes at CME

CME auditing financials of all clearing firms to ensure capital compliance levels CME audits of customer segregation and related requirements to ensure all customer account
performance bond requirements are appropriately accounted

Credit controls that allow clearing firms to limit the OTC positions taken on by any specific account
Stress testing of all CME clearing firm and account level positions over largest market moves and
multiple defaults to ensure clearing firm capital wherewithal

2011 CME Group. All rights reserved

CME Group Customer Protection Mechanism

Any bankruptcy of a FCM Clearing Member would be governed by U.S. Bankruptcy Code and CFTC regulatory framework (Part 190 Bankruptcy Rules)
Mandated separation of customer positions and property from the positions and property of the clearing firm per CFTC account class Customers funds and positions in defined account classes are not property of the debtors estate in a FCM bankruptcy Recently, the CFTC amended its Part 190 bankruptcy rules to create a new customer account class for cleared OTC derivatives

New CFTC Part 190 Rules provide customer protection parallel to the existing 4d/futures account class
CME adopted new rules for the OTC account class which mirror CFTC regulations for the 4d/futures account class, including but not limited to rules regarding separation of customer and FCM assets and investment of customer funds In early October 2010, CME implemented new rules with substantive requirements for the treatment of customer cleared OTC derivatives that are cleared by CME

* See the New OTC Derivatives Account Class Q&A document on the CME Group website for more information.
2011 CME Group. All rights reserved

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CME Group Clearing Model

In the more than 110-year history of CME Clearing, there has never been a failure by a clearing member to pay settlement variation or meet a performance bond call, nor has there ever been a clearing member failure resulting in a loss of customer funds

CME Clearing

Financial safeguards Transparent daily margining Multilateral position netting

Clearing Member (FCM)

Collects margin Processes mark to market from clients in accordance with CME
Clearing policies & other regulatory requirements

Customer positions and margin held in separate account from FCMs

assets

Collateral and Positions protected through separate accounts that

Buy-side Firm

are separate from FCM assets

Margins calculated on net portfolio basis

2011 CME Group. All rights reserved

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CME Group Portability of Customer Accounts

Portability of Customer Positions & Margin in the Event of a Clearing Member Default Customer Protection Standards

CME Clearing

The same customer protection standards apply to

cleared OTC derivatives as to exchange-traded futures

Clearing Member Firms are monitored and audited

for risk, capital adequacy and compliance with customer protection rules and regulations

Default Management

Defaulting Clearing Member

Non-Defaulting Clearing Member

Client positions and margin held at CME Clearing

may be ported to a non-defaulting clearing member firm

Positions of the defaulting firm may be auctioned

and/or liquidated in accordance with CME rules

Portability Buy-side Firm

Clients can transfer positions and associated margin
to another clearing firm upon request

CME Rule 853 (Transfers of Trades) covers CMEs

terms under which trades may be transferred

2011 CME Group. All rights reserved

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Legal Documentation
Documentation between CME and Customer Exchange User License Agreement (EULA) New customers must register their firm(s) online via the CME Exchange User License Agreement (EULA), which may be found at: http://www.cmegroup.com/clearport/registration.html CME Group has developed an alternative registration process which offers the flexibility for an investment advisor/fund manager (Fund Manager) to complete the registration process for itself and its managed funds, provided it has the authority to do so Fund Managers may take advantage of this alternative registration process by notifying the CME ClearPort Facilitation Desk via email at custcare@cmegroup.com Documentation between Clearing Member and Customer Clearing Member FCM Agreement and OTC Addendum The OTC Addendum template may be used as a basis to negotiate the terms and conditions of individual agreements OTC Give-up Agreement Both templates are available on our website at: www.cmegroup.com/irs

2011 CME Group. All rights reserved

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Customer On-boarding Resources

CME CORE Margin Tool Web-based margin calculator Generate portfolio initial margin requirements via the User Interface or file upload Run what-if scenarios Access both CME production and new release environments through a single login Download initial margin results by firm and position in PDF and CSV formats Live for OTC CDS and in development for OTC IRS Dedicated On-boarding Staff Team of experts who work with buy side clients to help them prepare to clear IRS and CDS Extensive work with the affirmation platforms, and ability to connect customers to the right resources at those firms Customer Reporting Daily valuation reporting for OTC Cleared products, both CDS and IRS Daily trade and position reporting Daily end-of-day settlement price file IRS curve inputs, forward rates and discount factors Product reference file listing all clearing eligible products and their applicable identifiers for mapping internal systems

2011 CME Group. All rights reserved

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Cleared OTC IRS: Next Steps and Contact Us

Getting Started
Establish a relationship with a participating CME IRS Clearing Member
Discuss and agree on trade capture options and trade flow Complete required Clearing Member Customer Documentation Work with Clearing Member throughout testing cycles Begin clearing trades

For more information, please contact:

North America Jack Callahan Steve Dayon Europe Robert Hammond Asia Way Yee Bay 656-593-5560 wy.bay@cmegroup.com +44-207-796-7100 robert.hammond@cmegroup.com (312) 454-8312 (312) 466-4447 jack.callahan@cmegroup.com steven.dayon@cmegroup.com

2011 CME Group. All rights reserved

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Key IRS Dealer / Clearing Firm Contacts

Firm
Bank of America Merrill Lynch Barclays

Contact Name
John Bell Bill Cleary Todd DAgosta Sandy Fleischman Stephen Li Patrick Corrigan Avi Pemper Gavin Dixon Chris Perkins Neil Monaghan Steve Mahoney Eric B. Miller Elliot Barr Luciana Miranda Joe Cassidy Mike Dawley Jack McCabe Piers Murray Catherine Bartzos Mark Jewsbury Jason Swankoski Mark Bortnik Sandeep Kohli Stephen Scalzo William Knottenbelt Kevin Collins Ed Pla Reinhardt Olsen Jeff G. Gore Dan Thomas

Email
j.bell@baml.com wcleary@bankofamerica.com todd.dagosta@baml.com sandy.fleischman@barcap.com stephen.li@barcap.com patrick.corrigan@barcap.com avi.pemper@americas.bnpparibas.com gavin.dixon@americas.bnpparibas.com christopher.perkins@citi.com neil.j.monaghan@citi.com steve.mahoney@credit-suisse.com eric.b.miller@credit-suisse.com elliot.barr@db.com luciana.miranda@db.com joe.cassidy@db.com michael.dawley@gs.com jack.mccabe@gs.com piers.murray@jpmorgan.com catherine.bartzos@jpmorgan.com mark.a.jewsbury@jpmorgan.com jason.swankoski@morganstanley.com mark.bortnik@morganstanley.com sandeep.kohli@nomura.com stephen.scalzo@nomura.com william.knottenbelt@rbs.com kevin.collins@rbs.com edward.pla@ubs.com reinhardt.olsen@ubs.com jeffrey.gore@wellsfargo.com dan.thomas@wellsfargo.com

Phone Number
415-274-7171 312-234-2066 646-855-9813 212-526.6548 44-20-3134-8748 212-526-7101 212-841-3753 44-20-7595-8417 212-723-5943 212-723-5505 212-325-3872 212-325-1192 212-250-9831 212-250-8845 44-20-7547-8645 202-902-7582 202-902-3037 212-270-5445 212-834-3105 44-20-7777-1178 212-761-4723 44-20-7677-9685 212-667-2037 212-667-8981 44-20-7085-1531 203-897-9882 203-719-2602 203-719-3408 704-715-0528 704-374-2103

BNP Paribas
Citigroup Credit Suisse Deutsche Bank

Goldman Sachs

JPMorgan

Morgan Stanley Nomura RBS UBS Wells Fargo

2011 CME Group. All rights reserved

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Disclaimer
Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contracts value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. All references to options refer to options on futures. CME Group is a trademark of CME Group Inc. The Globe Logo, CME, and Chicago Mercantile Exchange are trademarks of Chicago Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. NYMEX is a registered trademark of the New York Mercantile Exchange, Inc. All other trademarks are the property of their respective owners. The information within this brochure has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for any errors or omissions. Additionally, all examples in this brochure are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME, CBOT and NYMEX rules. Current rules should be consulted in all cases concerning contract specifications. Copyright 2011 CME Group. All rights reserved.

2011 CME Group. All rights reserved

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