FX Prime Brokerage: Risks and Challenges

1. FX Prime Brokerage: Risks and Challenges Global Operations Managers Conference Hosted by the FX Joint Standing Committee April 20-21

2. Overview: Foreign exchange prime brokerage (FXPB) came to the forefront in the late 1990’s but had limited traction. Over the last 3 to 4 years, the Industry has seen explosive growth in this business fueled by increased interest in FX as an asset class and the soaring number of new hedge funds. Entering the FXPB space may be a valuable way for banks to leverage existing infrastructure and investment. Primary clients: Hedge funds Commodity trading advisors (CTA’s) Traditional asset managers & regional banks How it works: Clients trade with an executing brokers, who then "give-up" their trades to the FXPB for trade processing. The FXPB acts as a central counterparty to the clients’ transactions: Holding any collateral required for trading Extending credit lines Becoming the central back office for the client Growth of FX Prime Brokerage

3. FX Prime Brokerage Model Client Trades with a number of bank counterparties Executing broker Execution + PB instructions Client may out-source operational functions PB confirms block trade with Broker Trade given up to PB Allocations + broker instructions Prime Broker Operations confirms allocations with Client and/or middle office provider Service Provider Manages the operational support for the client FX Prime Broker

4. Value Proposition Client • Access to multi-dealer pricing and liquidity • Realize operational efficiencies, STP and reduction in capital expenditures • Collateral requirements aggregated with the FXPB • Trade allocation, confirmation and settlement consolidated with FXPB • Consolidate and customize reporting through the FXPB. • Primary documentation required only with the FXPB FXPB • Generate new fee-based revenue stream • Develop new and strengthen existing client relationships • Leverage technology and operating infrastructure Executing Broker • Increase execution flows by transacting business with less credit worthy counterparties by implementing Give-Up Agreements • Efficient operational flows as the parties to the trade are dealers • However, a complex web of relationships is created which has prompted review by the Industry

5. Risks & Challenges for the Prime Broker

6. Risks & challenges for the Executing Broker

7. Risks & Challenges for the Client

8. Industry Initiatives • Market participants, central banks and industry organizations have come together to address some of the broader systemic risks emerging in the FXPB business. Current Initiatives: • The FXJSC Prime Brokerage/E-Commerce Sub Group is conducting an analysis of the development and risks associated with FXPB with the goal of making recommendations of guidelines to be included in the NIPS Code. • The NY Fed FX Operations Managers Prime Brokerage Sub Group is reviewing the operational issues and risks associated with the FXPB business • NY Foreign Exchange Committee (FXC) / Financial Markets Legal Group (FMLG): • The FXC published a standard Give-Up Agreement • The FMLG is undertaking a review, in consultation with the U.S. Department of Treasury, of the KYC responsibilities foreign exchange executing brokers have under the U.S. Patriot Act • Participating dealers must continue to work together to create automated solutions for the notification process. Existing vendor solutions provided by Traiana and FXall but are still in the early stages.