STEERING COMMITTEE

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STEERING COMMITTEE OTC DERIVATIVES Electronic
Confirmation Service
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AGENDA September 16, 2002

• Overview of Trade Confirmation Initiative
• Preliminary Business Case Analysis
• Discussion Critical Planning Factors
• Next Steps

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OVERVIEW OF TRADE CONFIRMATION INITIATIVE
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RATIONALE FOR NEW DTCC SERVICE

• Current manual process is expensive and labor
  intensive, resulting in lengthy confirmation
  cycles, mistakes, and a generally difficult
  control environment, including difficulty in
  quickly identifying and responding to the most
  important discrepancies, non-standard provisions,
  etc.
• Less tangible, but real, costs include
• High probability of improper hedging due to
  uncertainty or misunderstanding of legally
  enforceable positions (write-offs)
• Limited ability to accommodate increased deal
  flow (business drag)
• Potentially, additional regulatory capital
  charges (capital costs)
• In addition, there is currently no single
  effective forum for streamlining confirmation
  process en masse or encouraging quicker/better
  internal processes and no facility with good
  buy-side connections

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RATIONALE FOR NEW DTCC SERVICE

• DTCC service will not only replace personnel
  performing manual matching of confirms, but will
  also provide deal certainty, improve internal
  control processes and facilitate ramp up of
  volumes, thus reducing less tangible, as well as
  the tangible, costs.
• In addition, by taking deal confirmation to the
  worlds largest industry utility, the industry
  will
• Effectively discourage multiple one-off
  arrangements consensus reached quicker with an
  initial smaller group will have imprimatur of
  recognized utility
• Permit utility reporting on deal input
  timeframes, error rates, etc. DTCC successfully
  used this reporting process to clean-up prior
  industry-wide confirmation/matching problems in
  the municipal and corporate debt markets
• Have the only provider with strong buy-side
  connections, a product aimed at easing buy-side,
  as well as inter-dealer processing, and a place
  where buy-side players would be comfortable with
  one-stop shopping

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TRANSACTIONS COVERED

• DTCC service aims at covering all transactions,
  but, to build credibility and provide quick
  relief for the most problematic areas, DTCC
  proposes the following implementation schedule
• Within 8 months single reference entity credit
  derivatives and equity options initial trade
  only
• Year 2 subsequent events other credit and
  equity derivatives begin fixed income
  implementation (probably rate and currency
  options)
• Years 3 - 5 rate and currency swaps, FRAs,
  commodities (schedule based on accumulated
  experience, need and state of industry, some
  items could be pushed up to year 2)
• Aggressive buy-side marketing follows each
  successful inter-dealer implementation (subject
  to analysis and approval by steering committee).

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OTHER HIGHLIGHTS FROM DEMOs

• Initial feedback from selected large buy-side
  players is positive, especially ability to accept
  or modify dealer confirms on-line in one place
  and use DTCC as central deal database.
• The following suggestions, received during demo
  process, have been incorporated into design and
  cost estimates for initial pilot implementation
• System will indicate to users when defined key
  items match (as specified by steering committee),
  even when non-key items remain unmatched
• Where not all key items match, system will
  suggest pairings of submissions based on some
  subset of key items matching (as specified by
  steering committee)
• System will indicate when there is no suggested
  pairing for a submission
• System will indicate whether a trade contains
  non-standard additional provisions, and when only
  they remain unresolved

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PLATFORM FOR FURTHER BENEFITS

• Daily automated price/deal reconciliation to
  facilitate collateralization process
• Payment tracking end-of-day net settlement at
  DTC
• Multi-lateral collateral and close-out netting
• Provides significant regulatory capital benefits
  under Basle as firms are required to accept
  non-zero risk-weight collateral
• As vetted with leading U.S. and U.K. bankruptcy
  counsel, proposed DTCC collateral netting
  facility will
• Permit multi-lateral netting of daily marks and
  close-out PL
• Reduce counterparty failure risk without loss
  sharing or independent pricing of deals parties
  to badly priced or volatile deals bear the risk
• Streamline and remove risk from the
  collateralization process

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PRELIMINARY BUSINESS CASE ANALYSIS
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KEY ASSUMPTIONS IN INITIAL BUSINESS CASE

• Two initial transaction types
• Credit Derivative Single Reference Entity
• Equity Derivative Equity Options?
• One set of XML messages per product
• Use FpML where it has been developed and
  satisfactorily tested for a product, otherwise
  develop an FpML-like XML (development led by Ops
  Tech group agreement reached by 11/1)

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KEY ASSUMPTIONS IN INITIAL BUSINESS CASE

• Core functionality in Release 1.0 for Q203
• Trade matching of two sides
• Acceptance/modification of counterparty input
• Field by field matching with tolerances where
  defined by group business rules
• System identified potential matches for users
• (Where key items match, where subset of key items
  match, etc.)
• Full transaction audit trail and history
• Transaction entry and modification through
  computer to computer transmission via the
  public Internet
• Multi-year transaction storage with on-line access

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KEY ASSUMPTIONS IN INITIAL BUSINESS CASE

• Real-time processing trade matching operates
  real time
• Reporting in real time (to be confirmed by group
  is more expensive than multiple batch cycles
• Processing of unmatched items can be done through
  computer transmission or via web interface
• Web interface will support functionality as shown
  in TRACER demo
• On-line exception viewing with user defined
  sorting filters
• Support for counter party identification data
• Multi-level entitlement structure administered by
  users
• Digital certificates for online authentication

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TIMING ASSUMPTIONS
Q302 Q402 Q103 Q203
11/15/02
Finalize Business Case Pilot commitment
11/1/02
Functional Specifications Pilot Participant
sign off
1/3/03
Technical Specifications
4/403
Systems Build
5/1603
Systems Test
5/30/03
Pilot Rollout
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VOLUME ASSUMPTIONS

• ISDA 2002 Operations Benchmarking Survey
• Adjusted to reflect Pilot Market Opportunity

e.g. 100 Trades
70 for vanilla template
38 interdealer market
60 -80 largest counterparties
Net 20-25 of your Daily Volume assumed in
Business Case
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DTCC EXPENSE ASSUMPTIONS

• 4million development expense amortized over 3
  years
• 2.5mm for release 1.0
• 1.5 for release 1.1
• Leverage trade matching engine existing data
  centers
• Pilot participation of 6, but expansion of
  participants to 35 by year 5
• Two sources of revenue
• Trade ticket starts at 100 with reductions
  anticipated with additional volume learning
  curve benefits
• 5,000/mo/product membership fee
• Fully loaded cost for line of business

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CALCULATION OF FIRM BENEFITS

• Reduction in Operating Expenses
• Headcount reduction based on ISDA reporting of
  Trades per FTE per week
• Fully loaded FTE 160,000
• Salary, bonus, benefits, technology support,
  space
• Risk reduction --- 300,000 per year
• One time implementation expense --- 250,000

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Review of Pro Formas See separate handout
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DISCUSSION OF CRITICAL PLANNING FACTORS
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DISCUSSION OF CRITICAL PLANNING FACTORS

• Items for Discussion
• Selection of specific product types for pilot
• Key technical and functionality assumptions
• Ops Tech working group responsibilities (see
  Next Steps)
• Should use of pared down templates be a goal
• Should there be a role for inter-dealer brokers
  and buy-side in the pilot

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NEXT STEPS
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NEXT STEPS

• Operations Technology Working Group
• Recommend specific functionality for each
  implementation phase
• Address message and interface details
• Recommend trade matching criteria, tolerances,
  key items, suggested pairings, etc.
• DTCC staff will be produce documentation for
  review by working group

Target first meeting week of Sept. 23rd weekly
thereafter until initial specs completed by
November 1
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NEXT STEPS

• Steering Committee
• Meet every two weeks beginning week of Sept. 30
• Review Ops Tech progress on technical issues,
  sign off on business issues
• Prior to next meeting, provide trade data
  estimates needed to finalize pricing and general
  feedback on business case
• Quick time to market requires early commitments
  to the pilot