KDPW_CLEARPOOLSettlement Guarantor

Leszek Kołakowski – Deputy Director, Strategy and Business Development Department

Marcin Truchanowicz – Director, Clearing House

Żaneta Skorupska-Świrska – Head of Securities Settlement Division Team

Warsaw, 18 May 2010

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Examples of Guarantee Solutions on European Markets

Leszek Kołakowski Deputy DirectorStrategy and Business Development Department

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Agenda

1. Counterparty Credit Risk

2. Central Counterparty (CCP)

3. CCP Attributes

4. Alternative Guarantee Solutions

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Counterparty Credit Risk

Risk of the counterparty’s default under the terms of a transaction dueto the inability to pay financial liabilities.

Two types of potential losses generated by the counterparty’scontractual default:

Principal Loss: loss of securities or cash if only one counterpartydelivers required assets; Principal Loss risk is eliminated by DVP (delivery versus payment) mechanism;

Consequential Loss: loss generated by lack of settlement due to a counterparty’s insolvency (illiquidity, loss of corporate action rights/benefits, lost profits from the sale of assets, costs incurredto acquire missing assets, etc.).

Controlling counterparty risk exposure much more important sinceLehman Brothers.

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Central Counterparty (CCP)

The Central Counterparty (CCP) is: “an entity that interposes itself between counterparties to contracts in one or more financial markets, becoming the seller to the buyer and the buyer to the seller”

CPSS/ IOSCO

Recommendations for Central Counterparties

November 2004

The CCP operates under legal and contractual obligations arising fromsettled transactions. It usually becomes a party to a transaction under legal mechanisms including novation and open offer.

The CCP eventually takes over counterparty credit risk, unlike inmutualisation (sharing) of risk exposure by participants.

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CCP Attributes

Legal mechanism: novation or open offer

Risk centralisation

Technical novation or open offer

Anonymous clearing

Clearing members

Monitoring participants’ positions

Calculating and collecting margins

Risk mutualisation

Multilateral netting

Guarantee fund

Managing cases of participants defaulting under settlement liabilities

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Alternative Guarantee Solutions

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Legal mechanism: novation or open offer v

Risk centralisation v

Technical novation or open offer v v

Anonymous clearing v v

Clearing members v v v

Monitoring participants’ positions v v v

Calculating and collecting margins v v v

Risk mutualisation v v v v

Multilateral netting v v v v

Guarantee fund v v v v

Managing cases of participants’ default v v v v

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Alternative Guarantee Solutions

CCP – USA, Euronext (France, Netherlands, Belgium, Portugal – LCH

Clearnet SA), Germany (Eurex Clearing), UK (LCH Clearnet Ltd), Italy

(CC&G), Switzerland (SIS x-clear), Japan, Hungary (KELER CCP*), pan-

European CCP: EMCF, EuroCCP

Functional CCP – Poland (KDPW), Austria (CCP.A), Canada

Clearing house – Russia, Turkey, Korea

Settlement guarantee – Greece, Cyprus, Spain, South Africa

* Central counterparty without clearing house functions

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Scope of Changes to

the KDPW Settlement Guarantee System

Marcin Truchanowicz

Director, Clearing House

Status Quo

1. Clearing members’ assets:

guarantee fund made up of contributions to individual segments of the regulated market

participants’ contributions calculated by an algorithm

obligatory revision of contributions

obligatory recovery contributions if a payment is made from the fund

obligatory additional contributions to the extent that the assets of the fund areinsufficient to cover

guaranteed liabilities (no cap on additional contributions)

margins to secure the closing of positions in derivative instruments

initial margin

maintenance margin

2. Mechanisms used by the National Depository as a clearing house:

securities lending system (automatic lending);

buy-in transactions made by KDPW;

payment of the liabilities of an insolvent participant out of the participant’s

receivables as a KDPW participant (excluding receivables of the participant’s

clients)

current settlements on the futures market

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KDPW_CLEARPOOL: Changes to the

Settlement Guarantee System

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A new component: KDPW assets; once KDPW and KDPW_CLEARPOOL have

signed an agreement:

KDPW_CLEARPOOL assets will be available to pay liabilities under

transactions concluded on the regulated market;

participants’ additional contributions to the guarantee fund will be

capped at 110% of the total contributions of each participant to each part

of the fund.

Order of Use of Settlement Guarantee System Assets

1. Cash receivables of an insolvent participant / securities lending or acquisition on BISO market

2. Margins – for futures transactions

3. Contribution of an insolvent participant to the relevant part of the fund (covering the relevant market segment)

4. Insolvent participant’s contribution to other parts of the guarantee fund to the extent it does not guarantee liabilitiescovered by those parts of the fund

if KDPW and KDPW_CLEARPOOL have signed an agreement, and within its term

5. first tranche of additional contributions to the relevant part of the fund, up to 50% of the cap;

6. KDPW_CLEARPOOL assets up to PLN 20 million;

7. second tranche of additional contributions (possibly in combination with KDPW_CLEARPOOL assets)

8. Other KDPW_CLEARPOOL assets – in special justified cases

if KDPW and KDPW_CLEARPOOL have not signed an agreement, or after termination of the agreement

5. Unlimited additional contributions of participants to the relevant part of the guarantee fund

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Towards a CCP

Marcin Truchanowicz

Director, Clearing House

What Are We Planning To Do?

We are implementing a New Settlement Risk Management System

in KDPW

Risk management system: a set of interconnected elements to

assess, predict, and actively manage settlement risk

– guarantee system methodology

• two-tier system (margins + fund)

• SPAN®

– proprietary software

– SPAN® -RM-Clearing application

– technical infrastructure

New Risk Management System: Why?

To achieve more precise risk measurement;

To unify the guarantee system structure;

To implement the global standard SPAN®;

To comply with the requirement of transparency of methods used;

To ensure flexibility of solutions;

To identify ready-to-use IT products for investors and brokerage

houses supporting the methodology

Implementation Timeline

December 2010

Roll-out

October 2010

Participant tests start

August/September 2010

System simulation

Netting

Discontinue the process of generating separate settlementinstructions

(currently each exchange transaction requires separate instructions for the clearing system)

With netting, transactions will be grouped in aggregate instructions for the clearing system.

System Development

Cross-margining between the cash and the futures marketmargin requirements will be reduced for positions recorded in the same entity account

Introduce aggregate accountsaccounts configured by participants, used to calculate net margins

Support securities lending, repo and reverse repo transactionsSPAN® methodology

Add on-line monitoring of margins also on the cash market

Enter new markets

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KDPW_CLEARPOOL Implementation:

Benefits to the Market

Żaneta Skorupska-Świrska

Head of Securities Settlement Division Team

Features of a Depository-Settlement System

Safety

Correct clearing and settlement

Stability

Trust

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Implications of Creating a Settlement

Guarantor

First stage of creating a CCP Clearing House

Capping additional contributions to the Guarantee Fund

Additional assets available in the Settlement Guarantee System

No material amendment to KDPW regulations

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First stage of creating a CCP Clearing House

Start operations using techniques on the basis of guarantee liability.

Message to investors: The Polish settlement guarantee system has

started to evolve.

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Capped additional contributions to the

Guarantee Fund

Capped additional contributions of clearing members to

the guarantee fund.

Possibility to assess the risk of participation in the

Settlement Guarantee System.

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Additional assets available in the Settlement

Guarantee System

Settlement guarantor, later CCP clearing house,

operating as a separate legal entity.

Assets of the settlement guarantor available to the

Settlement Guarantee System.

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No material amendment to KDPW regulations

Amendment to regulations approved by PFSA.

No material change to clearing members’ systems and

regulations.

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www.kdpw.pl

National Depository for Securities

Krajowy Depozyt Papierów Wartościowych

4, Książęca St., 00-498 Warsaw

kdpw@kdpw.pl