Valuation of IR Derivatives in a new Regulatory Environment

1. Valuation of IR Derivatives in a new Regulatory Environment Speakers: Eduardo Pereira Risk and Regulation Specialist: Bloomberg L.P Bernardo Santos Andrade Senior Manager, Toyota Motor Finance (Netherlands) B.V Dutch Association of Corporate Treasurers Event: Hotels Van Oranje, Noordwijk, The Netherlands. 11th November 2013.

2. OIS Discounting: A new valuation framework; • CSA Agreements; • CVA; • CSA Agreements – Bloomberg ‘MARS’ solution; • TMFNL: Collateral Operation Case Study. Agenda

3. OIS Discounting

4. Prior to Credit Crisis credit & liquidity effects were largely ignored in IR derivatives pricing • Subsequent to Credit Crisis • Stronger Focus on Counterparty Risk (Credit) • Evaluating Exposure • Risk Management • Stronger Focus on Funding (Liquidity) • Divergence between “risk free” rates and funding levels • Funding arbitrage opportunities • New framework required as credit & liquidity effects can no longer be ignored in pricing Overview of OIS Framework

5. 26th Oct 2005: 10MM EUR 7yr Pay 3.10%, q/q

6. IR swaps can have both negative or positive values • If market value is positive • Counterparty owes money And if counterparty defaults • Loss for everything that can’t be recovered........ • Credit mitigation very important • Changes in Regulation • Banks to be penalised for uncollateralised swaps Counterparty Risk

7. Mitigating credit exposure (interbank) • Netting Agreements • Credit Support Annex (CSA) agreement • Central Counterparty (CCP) clearing • CSA: Collateral posted between counterparties • CCP (e.g. LCH.Clearnet): “Variation Margin” paid (or received) each day by clearing member (in addition to “Initial margin”) • Both CSAs & CCP define how interest accrues on funds (collateral or margin payments) Swaps in the Interbank Market

8. Credit & Liquidity Premium in Euribor LOIS EUR <GO>

9. Credit & Liquidity Premium in Euribor Credit Crunch: Market First Fears

10. Credit & Liquidity Premium in Euribor Bear Stearns ‘Bailout’

11. Credit & Liquidity Premium in Euribor Lehman Bankruptcy

12. Credit & Liquidity Premium in Euribor Ireland Crisis

13. IR swaps can have both negative or positive values • If market value is positive • Counterparty owes money And if counterparty defaults • Loss for everything that can’t be recovered........ • Credit mitigation very important • Banks generally have agreements to post collateral to each other • Credit Support Annex (CSA) agreement • Central Counterparty Clearing (CCC) • Generally corporates do not wish to sign CSAs or agree to CCCs • Both parties exposed to counterparty risk Counterparty Risk

14. Counterparty Valuation Adjustments

15. For a swap how do you currently determine what you are being charged for your credit risk? • By using the Bloomberg CVA/DVA calculator  • My relationship banks provide full disclosure on these charges  • Unaware of any such charges  • We calculate using other methods   • We do not get charged   Webinar Poll 2 - Question

16. Webinar Poll 2 Results

17. Calculating Credit Spreads CVA/DVA Calculator

18. Calculating Credit Spreads Calculate Exposure from Counterparties Perspective

19. Calculating Credit Spreads Market Information: Credit, Rates & Volatility

20. Calculating Credit Spreads DVA: Cost to Bank of Corporate Defaulting

21. Calculating Credit Spreads CVA Calculation: Cost to Corporate of Bank Defaulting

22. Calculating Credit Spreads Bilateral Calculation

23. Exposure Graph Bilateral Calculation

24. Charting Net Cash Flows Net Cash Flows affect Exposures