40 Minute Briefing European and domestic reform: The day after tomorrow – EMIR, CASS & MiFID

1. 40 Minute BriefingEuropean and domestic reform: The day after tomorrow – EMIR, CASS & MiFID • Hannah Meakin, Partner • Norton Rose LLP • 5 December 2012

2. Introduction and timing

3. Introduction • Timing • The latest on client clearing • Proposed changes to CASS • Impact on trading structures

4. Timeline: EMIR, MiFID and CASS August 2012: EMIR enters into force 1 July 2015: Trades start to be reported to ESMA where there is no trade repository From 1 January 2014 at the earliest: Reporting obligations for credit and IRS apply From 1 July 2013 at the earliest: Reporting obligations for credit and IRS apply Q4 2013: First clearing obligations expected to apply Late Q1 2013: Most RTS expected to enter into force EMIR First half 2013: ESMA expected to consult on collaterisation Implementation of MiFiD II legislative proposals (at the earliest) 20 June 2012: Council of the EU begins publishing compromise proposals European Parliament considers legislative proposals in plenary and refers them to ECON for reconsideration 25-26 October 2012 MiFID 4 December 2012: ECOFIN meeting 2012 2013 2014 2015 December 2012: Final rules on Part I CP12/22 expected CASS First half 2013: FSA feedback on Parts II and III CP12/22 expected 1 January 2013: Handbook rules in PS12/20 will come into effect

5. The latest on client clearing

6. A quick reminder of the obligations in EMIR • OTC derivatives entered into or novated that are listed on ESMA register must be cleared through a CCP • Applies to transactions between: • Two financial counterparties • A financial counterparty and an in-scope non-financial counterparty • Two in-scope non-financial counterparties • A financial counterparty or an in-scope non-financial counterparty and a third country entity that would be subject to clearing if established in EU • Two third country entities that would be subject to clearing obligation if established in EU provided (a) contract has direct, substantial and foreseeable effect in EU or (b) if necessary and appropriate to prevent evasion of EMIR • Very few exemptions • Kicks in on date obligation takes effect but some contracts existing at that date will need to be front loaded Clearing • All OTC derivatives that are not CCP cleared • Timely, electronic confirmations, portfolio reconciliation, portfolio compression and dispute resolution • Daily marking to market or marking to model • Timely and appropriate exchange of collateral, segregated where possible • Hold capital to manage risk not covered by exchange of collateral Risk management • All derivatives concluded and any modification or termination must be reported to a trade repository • No later than the following working day • Can delegate but must avoid duplication • Backloading provisions Reporting

7. Central Counterparty S B Cleared contract Cleared contract CCP Rules CCP Rules B S Clearing Member (principal) Clearing Member (principal) S B Back-off contract Clearing Agreement Back-off contract Clearing Agreement B S Counterparty(principal) Original Trade Asset Manager (agent) ISDA Master Agreement or other agreement S B Fund(principal) A typical clearing structure

8. Client clearing: Segregation and porting • In order to comply with clearing obligation, a counterparty must: • Become a Clearing Member of a CCP or a Client of a Clearing Member • Establish indirect clearing arrangements with a Clearing Member • CCPs and Clearing Members must offer both: • Omnibus client segregation • Individual client segregation • Requirement to distinguish involves recording in separate accounts and not netting across accounts, not exposing assets in one to losses in another • CCPs must allow Clearing Members to open further accounts for their Clients • CCPs and Clearing Members must disclose levels of protection and costs - must be reasonable commercial terms • CCPs must commit to trigger procedure for porting - if Clearing Member becomes insolvent and Client so requests, transfer Client positions and assets to another agreed Clearing Member • CCPs can actively manage their risks by liquidating positions and assets if this cannot be done within a pre-defined timeframe • Client collateral can only be used to cover positions held for relevant Client account and any surplus on a Clearing Member default should be returned to Client or, if not possible, to Clearing Member for relevant Client account

9. Omnibus segregation: Books and records CCP books and records Clearing Member books and records Clients 1, 2 + 3 Client 1 Client 1 Client 2 Client 2 Client 3 Client 3 Clearing Member Clearing Member

10. Clearing Member books and records CCP books and records Client 1 Client 1 Client 1 Client 2 Client 2 Client 2 Client 3 Client 3 Client 3 Individual segregation: Books and records Clearing Member Clearing Member

11. CCP Cleared Contract, Rules, provision of collateral Back-up Clearing Member Clearing Member Back off contracts, Clearing Agreement, CCP mandated documentation, provision of collateral Client Porting of positions and assets takes place on Clearing Member default OTC Counterparty OTC derivative trade Client clearing: Porting

12. Omnibus and individual segregation compared Detailed risks depend on exact set-up and operation of accounts

13. Choice of accounts: Questions • Clearing Member must offer both • May offer variations – e.g. if omnibus, may be choice of net or gross margining • Omnibus or individual account at CCP level? • Client money protection or not at Clearing Member level • Client money currently incompatible with porting but will change • N/A if Clearing Member is a bank • N/A if margin if provided for on title transfer (and not retail) • Title transfer or security interest • Cash or securities? • Clearing Member may need to transfer to CCP so will need right of use if security interest • Possible choice of sub-pool if omnibus client account with client money protection • Sub-pools are subject of FSA Consultation • Objective is to facilitate porting in net margined omnibus accounts

14. CCP Clearing Member Client Indirect Client Indirect Client clearing • Client to honour obligations of Indirect Client to Clearing Member – contract between three parties • CCP will, on Clearing Member’s request, maintain separate records and accounts to enable Client to distinguish its positions and assets from those of Indirect Client • If Clearing Member wants to offer indirect clearing: • Implement individual and omnibus type accounts in its books and records • Establish procedures to manage a Client default including: • Mechanism for porting positions and assets to an alternative Client or the Clearing Member • Allowing for prompt liquidation of positions and assets and return of balance to Indirect Client • Publish terms and manage risks of arrangement • If Client wants to provide indirect clearing: • It must be an authorised credit institution or investment firm or equivalent third country entity • Offer Indirect Clients choice of individual and omnibus type accounts and inform Indirect Clients of risks including details of porting arrangements • If Client defaults, information about Indirect Client is given to Clearing Member

15. Proposed changes to CASS

16. Changes to CASS required by EMIR • Existing client money regime undermines porting • Client money is pooled on firm failure • Inconsistent with transferring to back-up Clearing Member • FSA has consulted on amendments to CASS (CP12/22) • Final text expected in December 2012 • Clearing Member must notify CCP but need not obtain trust acknowledgements • Clarifies that a firm can hold excess client money in a client transaction account if required to do so by law • On Clearing Member failure, balance on client transaction account is not part of general pool – it is: • Ported to back-up Clearing Member • Returned to Client • Returned to Clearing Member • Client may lose its client money regime protection if back-up Clearing Member is not subject to CASS • Clearing Member discharges client money responsibilities if money is ported or returned directly to Clients by the CCP

17. What about title transfer? • EMIR should not prevent the use of title transfer collateral arrangements between a Clearing Member and Client or Clearing Member and CCP • EMIR will require Clearing Members to offer choice of omnibus or individual segregation even if business is done on a title transfer basis • Clearing Members will need to have separate client transaction accounts at a CCP for positions held for its title transfer Clients and those held for any client money Clients • If the firm becomes insolvent then when this money is returned by the CCP it is not client money for the purposes of CASS but, in accordance with EMIR, must be held by the firm for the account of its Clients

18. Consequences of Clearing Member default 1. Port positions and margin 3. Return balance to defaulting Clearing Member 2. Return balance to Client CCP: Individual client account Omnibus client account Defaulting CM: Client money Not part of notional pool Notional client money pool Defaulting CM: Not Client money ‘For account of clients’? Full sum minus costs Sum rateable to client money entitlement Client:

19. Sub-pools idea for EMIR • Consultation period just closed • Feedback expected first half 2013 • Objective is to facilitate porting in net margin omnibus client accounts • Porting will require clients to double margin to cover back-up CM’s exposure to each of them • On Clearing Member default, there may be client money at Clearing Member level that would facilitate porting but which will be pooled • Firms could keep client money that relates to such an account but is not passed on to a CCP in a separate pool, which is used to facilitate porting on firm’s default • Pre-default, CASS applies separately to each sub-pool and to general pool (eg. segregation, reconciliations, diversification obligations) • On default, client money can be transferred to a CCP or back-up Clearing Member • Optional • Advantages and disadvantages

20. Sub-pools for EMIR From FSA CP 12/22

21. Requirements for sub-pools • Notify FSA 3 months ahead of establishing, amending and merging • Sub-pool terms – to identify beneficiaries and where client money is held • Disclosure document – to make Clients aware of risks arising from pool and other Clients sharing in it • Description of purpose, whether Clients are retail or not, business line to which it relates, advantages and risks to which Clients are exposed, how firm expects sub-pool to be distributed on failure, how beneficiaries can be identified, statement that beneficiary of pool will have no claim or interest to any other pool unless it is also a beneficiary of that other pool and (if relevant) statement that sub-pool is intended to facilitate porting • Provide to Client and get written acknowledgement and consent • Provide copy on Client’s request and give 3 months notice of material amendments and mergers, allowing Client to terminate relationship • Provide sub-pool terms and disclosure document to FSA on request

22. Possible introduction of sub-pools for wider purposes • FSA asking whether it should roll out sub-pools for other investment businesses • Could allow firms to decide whether and how many sub-pools • FSA recognises firms may get more benefit from creating bespoke arrangements • Operating multiple pools will be costly and not all firms and clients will see benefits in segregating along different lines • But potential lack of incentive given costs • Could mandate segregation: Retail v non-retail clients • Retail cash would not be exposed to risks taken by wholesale Clients and may allow more rapid distribution from retail pool as fewer contentious issues • Margined v non-margined • Volatile trades so riskier and likely to be more contentious issues • Alternatively, FSA could incentivise use of sub-pools by requiring firms to make Clients aware of risks with general client money pools and sub-pool options on the market

23. Sub-pools for wider use From FSA CP 12/22

24. Wider CASS review: Achieving better results • Discussion paper on wider review • FSA aims to produce consultation paper in first half 2013 • Objectives: • Improve speed of return • Reduce market impact of insolvency • Achieve greater return of assets • Review of special administration regime and broader issues arising from MF Global being undertaken by government in parallel • Current regime prioritises accuracy over speed – FSA questions whether this is right balance • Should it be different for retail and wholesale Clients? • Wider review will also cover matters raised in supervisory work: • Banking exemption • Alternative approach • Trust letters

25. Achieving greater returns Require firms to hold a buffer in client bank accounts OR seek private sector mutual insurance An alternative approach requiring firms to hold an equivalent amount to the approximation of the monies at risk in house accounts in client bank accounts Prioritising certain categories of Clients Speed of return Regular Client statements detailing balances and any right of use Placing more emphasis on the firm’s records of account segregation Limiting use of exclusions or requiring greater transparency Establishing lock-in or cooling off periods to reduce switching in days leading up to failure Incentivise operating via mandates Insolvency practitioners liquidating all assets and shortfall shared equally Looking at inappropriate use of term deposits by some firms Wider CASS review: FSA’s ideas • Reducing market impact • Dislocate primary pooling event and firm failure to provide option of selling business rather than immediate pooling • Get Client’s pre-consent to transfer their assets

26. Other changes to CASS: The mandate rules • Clarifies mandate rules: • Do not apply where firm holds client money or assets • Do not apply to operator of regulated collective investment scheme • Do not affect duties of another firm that holds client money or assets • Any means which a firm obtains in written form from (and with the consent of) the Client and subsequently retains, and which gives the firm the ability (without the client’s further involvement being necessary) to control the client’s assets or liabilities by: • Giving instructions to another person who holds an account for the Client • Giving instructions to another person who is responsible for holding the Client’s money • Giving instructions to another person who is responsible for holding the Client’s assets • Giving instructions to another person so that the Client incurs a debt or other liability • Confirms that firm must establish and maintain adequate records and internal controls in respect of its use of mandates • Other changes to detail of CASS and CMAR • Classification and oversight does not apply to firms that only arrange custody • Guidance from PS12/20 – will take effect on 1 January 2013

27. Impact on trading structures

28. Brokerage structures • Ultimate trade obligations • Initial trade obligations • Means of getting trade executed CCP Exchange Sponsored and Naked Access Direct Electronic/ Market Access Executing Broker Clearing Broker Introducing/Agency Broker Give-up Agreement Client

29. Trading venues • Regulated • Markets (RMs) • Non-discretionary • execution of transactions • Managed by marketoperator • Operating is not an investmentactivity or service • Multilateral TradingFacilities (MTFs) • Non-discretionaryexecution of transactions • Operating is an investmentservice but can be operated bymarket operators • Few conduct of business rules apply • Organised TradingFacilities (OTFs) (Commission proposal) • Discretion overexecution of transactions • Investor protection, conductof business and best execution requirements • Cannot trade against proprietary capital • Operating is an investment servicebut can be operated by market operator Systems that bring together third party trading interests and result in contracts

30. Organised Trading Facilities (OTFs) • Broadly defined: all types of organised execution and arranging of trading which does not correspond to RM or MTF • Includes: • Broker crossing systems which execute client orders against other client orders • Systems eligible for trading clearing-eligible and sufficiently liquid derivatives • Does not include: • Facilities where there is no genuine trade execution or arranging taking place in the system, such as bulletin boards, entities aggregating or pooling potential interests or electronic post-trade confirmation • There are two different levels of discretion: • When deciding to place an order on the OTF or to retract it again • When deciding if, when and how much of two or more client orders it wants to match within the OTF • Text now clarifies distinction between multilateral and bilateral systems • Parliament proposed to limit to bonds, structured finance, emissions allowances and derivatives and Council has followed • Clarification that simultaneous matched principal trading is permitted subject to strong conflicts management – UK govt agrees • Council text is more restrictive on what is permitted: • Prior express consent of Client needed • Not derivatives declared subject to mandatory trading

31. No more OTC derivatives trading?

32. Parliament amendments: Now a definition of high frequency trading and sponsored and naked market access Firms using a high frequency trading strategy must store raw audit trail of any quotation and trading activities performed on any trading venue Market makers must enter into a written agreement with the trading venue including terms and conditions on liquidity provision Investment firms shall not provide sponsored and naked market access to a trading venue Even more requirements on platforms for systems resilience, circuit breakers and electronic trading Algorithmic trading and direct electronic access • Council amendments: • New high frequency algorithmic trading definition • Market making need only be carried out during a specified portion of venue’s trading hours except under exceptional circumstances. • Market making firms shall take into account sound operational, commercial and risk management practices, as well as liquidity, scale and nature of specific market and the characteristics of instruments traded • New provisions for firms that engage in algorithmic trading pursuant to a market making strategy • I.e. a strategy, when dealing on own account, that involves porting firm, simultaneous two-way quotes of comparable size and at competitive prices relating to one or more financial instruments on a single trading venue or across different trading venues, with the result of providing liquidity on a regular and frequent basis to the overall market • Points to note • Many of these provisions reflect ESMA Guidelines which are already effective • UK govt thinks more evidence of impact is needed and is concerned about requirement to provide liquidity at all times

33. Pegasus: MiFID

34. OTC Oracle: EMIR

35. Disclaimer • The purpose of this presentation is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of NRLLP on the points of law discussed. • No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any constituent part of Norton Rose Group (whether or not such individual is described as a “partner”) accepts or assumes responsibility, or has any liability, to any person in respect of this presentation. Any reference to a partner or director is to a member, employee or consultant with equivalent standing and qualifications of, as the case may be, Norton Rose LLP or Norton Rose Australia or Norton Rose Canada LLP or Norton Rose South Africa (incorporated as Deneys Reitz Inc) or of one of their respective affiliates.