Document Ref: OTCD001-003 27-July-09 v0-8 Draft

Classification of derivative instruments

Introduction
ThisreporthasbeenwrittentoidentifyhowtoextendISO10962theClassificationof FinancialInstruments(ISOCFI)tosupportfinancialinstrumentsthatareprimarilybasedaround cashflows(normallyclassifiedOTCderivativeinstruments).Giventhenatureofthefinancial industryandtheeverincreasingregulatoryrequirements,overtimetheseproductsarelikelyto becomemoremainstreamandthereforestandardized,andmaynotnecessarilystayintheOTC domain. ThedocumentincorporatesrecommendationsfromFinancialProductsMarkup Language(FpML)andInternationalSwapsandDerivativesAssociation(ISDA). TheproposalalsoexaminestheOptionsandWarrantsdomainswithintheCFIandprovides somerecommendations.

Financial instruments within scope

AlltheinstrumenttypesidentifiedintheBankofInternationalSettlementsderivative instrumentclassificationpublication,GuidelinesforsemiannualOTCderivativesstatisticsare coveredwithinthisproposalaswellasthoseidentifiedinFpMLandISDApublications.In addition,theECBsstatisticalclassificationswerealsoexamined. However,fromaclassificationperspectiveitisimportanttohighlightthatitisonlypossibleto identifybasiccashflowcharacteristicsandconstraintsappliedonthosecashflows. Theproductsidentifiedwithinthisreportarebrokendownunderintothefollowingheadings: Interestratederivatives; InflationSwaps(thoughcontractuallythesameasInterestRateSwaps,themarket tendstoprefertodifferentiatebetweenanagreementbasedonaninterestrateand onethatisbasedonaneconomicrate) Crediteventderivatives; Assetbasedcashflowderivatives: o Financialassets. EquitySwaps, TotalReturnSwaps, o Commoditiesassets Forwards.

Itisworthhighlightingthatderivativeinstrumentsbasedonunderlyingfinancialproductsare semanticallydifferentfromthosebasedoncommodities(includingtheirlegaldefinitions), thereforethesehavebeenseparatedintodistinctgroupswithintheproposal,thisalsoadheres tothecurrentversionofthestandard.

2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

Business Context
TheISOCFIhastwomainbusinesscontextsinwhichitiswidelyused.Firstlyforidentifyingthe appropriateallocationruleforISINsandsecondlyforregulatorytransactionreportingprimarily tosupportMiFID. TheCallforEvidencebyCESRinFebruary2009,toidentifyanappropriatemechanismfor classifyingOTCderivativeinstrumentshighlightedtheneedforactioninthisareaandthis reportwassanctionedbyTC68/SC4/WG6toidentifytheappropriatesolutionthatcouldbe appliedtoISO10962.NeverthelessthesenewclassificationscanbeusedoutsideoftheISO standard,hencetheuseofdiagramstorepresenttheclassifications.

Interest rate derivatives (category)

Interestratederivativeproductsdefinetheexchangecashflowsofinterestpaymentsbetween parties,typicallyafixratesteaminexchangeforavariablerate.Theymayalsocompriseof foreignexchangecomponent. Forinterestrateswaps,currencyisdefinedasacharacteristicofarate(Interest/Inflation) swap.Tosupportthis,theCFIgroupsubdividestheinstrumentsintosinglecurrencyorcross currency.Forboththesegroupshavethesamesetofattributes.
class Interest rate deriv ativ es Interest rate derivatives Floater/Fixed - Interest rate (e,.g. interbank rate) against fix rate

Floater/Floater - Interest rate against interest rate

Attribute 1 - Cash flow legs

Single currency

Attribute 4. Redemption/reimbursement

Cancellable Attribute 2 - Floating rate leg constrainst(s) Redeemable/ Extendable Extendable Redeemable

Attribute 3 Maturity Simple Capped Floored Corridored Collared

One year or less

Over 1 and up to 5 years

Over five years

Figure1.ClassificationforSingleCurrencyInterestRatederivativeinstruments Attribute1Cashflowlegs:classifiescashflowlegs(floater/fixed,floater/floater) Attribute2Floatingratelegconstraints:basicconstraintsonthefloatingrateleg, Attribute3Unused. Attribute4Redemption/reimbursement:Oneyearorless,onetofiveyears,orgreaterand whethercancellable,redeemable,extendable

2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

Example Coding (Interest rate swap)

AssumingtheCFIstructureisfollowed,eachelementwouldbeidentifiedbyasinglecharacter. Forexample:ISFBSE I=ACategoryofInterestratederivatives S=Singlecurrency B=Collared(Bothflooredandcapped) S=Oneyearorless(Shortterm) E=Extendable

2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

Inflation based derivatives

ThesamestructureasforInterestRatesSwaps.
class Inflation deriv ativ es Inflation derivatives Floater/Fixed - Economic rate (e.g. inflation - CPI) against fix rate Attribute 1 - Cash flow legs Single currency Attribute 4. Redemption/reimbursement

Perpetual

Floater/Floater - Economic rate against Interest rate Attribute 2 - Floating rate leg constrainst(s) Redeemable/ Extendable Extendable

Cancellable Redeemable

Attribute 3 Maturity Simple Capped Floored Corridored Collared Over five years

One year or less

Over 1 and up to 5 years

Credit derivatives (category)

Underthiscategoryresideswhatiscommonlyknowascreditdefaultswaps,theseare contractswhichcommitstwocounterpartiestoexchangeaperiodicfeeinexchangefora paymentcontingentonanevent(normallyadefault).
class Credit Deriv ativ es North American Corporate Credit derivatives Emerging European Corporate Standard North American Corporate (fixed income payments) Western European Sovereign European Corporate

Debt instruments Others Stock-Equities (Miscellaneous)

Loans

Credit event/default Index Attribute 1 Underlying (reference) asset Attribute 3 - ISDA agreement types

Latin America Sovereign US Municipal Revenue

Basket Index tranche Basket tranche Cash Bankruptcy

IRS Attribute 2 - Credit event type and standard combinations of

Spread & CDO CDS FRA Future

Just a snapshot of the possible "standard" Credit event agreements, 22 in total. As more become exchange traded these variants are expected to become fewer.

As defined by ISDA Failure to Pay Restructuring Failure to Pay, Repudiation/Moratorium & Restructuring Bankruptcy, Failure to Pay & Restructuring Bankruptcy, Failure to Pay (Grace Period Extension: Applicable), Obligation Acceleration, Repudiation/Moratorium & Restructuring Bankruptcy, Failure to Pay (with Grace Period Extension), Obligation Acceleration, Repudiation/Moratorium & Restructuring (with Multiple Holder Obligation: Not Applicable)

Obligation default Obligation acceleration Repudiation or moratorium Bankruptcy, Failure to Pay & Restructuring (Modified Restructuring Maturity Limitation and Conditionally Transferable ObligationApplicable). Bankruptcy, Failure to Pay & Restructuring ( Restructuring Maturity Limitation and Fully Transferable Obligation Applicable.

Figure2.ClassificationforCrediteventderivativeproducts
2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

Attribute1Underlyingasset:Thetypeofunderlyingassettowhichtheeventapplies, primarilycrediteventsareagainstDebtinstruments(bonds,convertibles)andloans. Attribute2:Attribute2Crediteventtypeandstandardcombinationsof:Identifiesthetype oftheevent(s).ISDAidentifiessixkindsofevents;neverthelessthemostsignificantare Bankruptcy,FailuretoPayandRestructuring.Thesesixarenormallynotusedinisolationand tendtobegroupedtogetherinstandardagreements,henceboththeindividualeventtypes andstandardizedgroupsarecoveredbythisattribute. Attribute3ISDAAgreementtypes,Thereare22ISDA"standard"Crediteventagreements.As morebecomeexchangetradedthesevariantsareexpectedtobecomefewerinnumbers.Each agreementtyperepresentsastandardisedsetofattributesused(26intotal),whicharedefined inspreadsheetformpublishedontheISDAwebsite(CreditDerivativesPhysicalSettlement Matrixxls). Theagreementtypesarelistedas: StandardNorthAmericanCorporate(fixedincomepayments) NorthAmericanCorporate EuropeanCorporate AustraliaCorporate NewZealandCorporate JapanCorporate SingaporeCorporate AsiaCorporate SubordinatedEuropeanInsuranceCorporate EmergingEuropeanCorporateLPN EmergingEuropeancorporate LatinAmericaCorporateB LatinAmericaCorporateBL JapanSovereign AustraliaSovereign NewZealandSovereign SingaporeSovereign LatinAmericaSovereign WesternEuropeanSovereign USMunicipalFullFaithandCredit USMunicipalGeneralFund USMunicipalRevenue

Attribute4Unused.

Asset based cash flow derivatives (category)

Thesearecashflowbasedfinancialinstrumentswheretheonepartyreceivespaymentsbased ontheperformanceofanunderlyingreferenceassetnormallyinexchangeforregularinterest
2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

paymentsfromtheotherparty.Theperformancemaybearesultofthechangeinvalueofthe underlyeraswellasincome,orjustoneofthesetwo.Thepaymentsfromthereferenceasset canbeprotectedagainstlosses(anattributenormallyassociatedwithTotalReturnSwaps).In someinstancespartiesmaywishtoexchangecashflowsassociatedwiththeunderlyingassets thattheyhold,withouttransferringownershipoftheholdingsthemselves,thesearealso supportedwithinthiscategory. Underthiscategorytwogroupsreside,adheringtothesameconstructusedwithintheexisting ISOCFIsFuturescategory,thusprovidingacleardifferentiationbetweenfinancialand commoditybasedfinancialproducts.

Financial assets (group)

Thisgroupsupportsallswapsthatarebasedononeormorereferenceassets(e.g.Stock Equity,indices,etc).ThisgroupencompassesAsset,Equity,VarianceandTotalReturn Swaps,amongothers.
class Financial assets Debt instrument against floating rate Incides against fixed rate Incides against floating rate Over 1 and up to 5 years Stock-equity against floating rate Attribute 1 - Swap legs Stock-equity against fixed rate Debt instrument against fixed rate Basket against fixed rate Basket against floating rate Stock-equity against stock-equity Stock-equity against Debt instrument Stock-equity against indices Stock-equity against basket Cancellable Extendable Redeemable Redeemable/ Extendable Financial assets Debt instrument against debt instrument Other (Miscellaneous) Indices against debt instrument Indices against indices

One year or less

Over five years Attribute 4. Redemption/reimbursement

Perpetual

Indices against basket

Attribute 3 - Delivery

Attribute 2 - Reference asset(s) payment rules

For scenarios with more than two legs or other combinations not specificed within this attributre list.

Cash Physical

Cross currency + credit event(s)

Other (Miscellaneous)

Income from reference asset

Change in value of reference asset

Both income and change in value of reference asset with protection against losses

Both income and change in value of reference asset

A attribute associated with Total Return Swaps.

Figure3.ClassificationofswapsbasedonFinancialassets Attribute1Swaplegs:Usedtoidentifythelegsofanoncommodityswap.Forexample,swap maycompriseofanequityreturnpaidagainstafixedrate(StockEquityagainstfixedrate).

2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

Attribute2Paymentrules:Identifiesthepaymentrulesthatapplyrelatingtothereference asset(s).Paymentsarebasedonincome,pricechangeintheunderlyingreferenceasset,etc... TheOthersdefinitionwouldbeusedtocaterforscenarioswherereferenceassetsareon bothsidesanddifferentreferenceassetpaymentrulesapplyorforothermorecomplex scenarios. Attribute3Delivery:CashorPhysicaldelivery. Attribute4Redemption/reimbursement:Oneyearorless,onetofiveyears,orgreaterand whethercancellable,redeemable,extendable

Commodities assets (group)

Fixedorvariable(floating)paymentsaremadetosecuretheinterestintheunderlyingasset,in returnforpaymentsreceivedbasedonitsmarketprice.Insomeinstancesthismayresultin physicaldelivery.
class Commodities I = Industrial products (Construction, manufacturing) against fix rate S = Services (Transportation, communication, trade) against fix rate A = Agriculture, forestry and fishing against fix rate

B = Agriculture, forestry and fishing against floating rate

J = Industrial products (Construction, manufacturing) against floating rate

T = Services (Transportation, communication, trade) against floating rate

E = Extraction resources (Metals, precious metals, coal, oil, gas) against fix rate

P = Power (e.g. Electricity) against fix rate

F = Extraction resources (Metals, precious metals, coal, oil, gas) against floating rate One year or less Over 1 and up to 5 years Attribute 4. Redemption/reimbursement Commodities assets Redeemable/ Extendable

Attribute 1 - Swap legs

Q = Power (e.g. Electricity) against floating rate

Other (Miscellaneous)

Over five years Perpetual Cancellable Extendable

For scenarios with more than two legs or other combinations not specificed within this attributre list.

Redeemable

Attribute 2 - Reference asset(s) payment rules Physical Attribute 3 - Delivery Other (Miscellaneous) Cash Both income and change in value of reference asset with protection against losses

Income from reference asset

Change in value of reference asset

Both income and change in value of reference asset

Figure4.Commodityderivatives Attribute1Swaplegs:Usedtoidentifythelegsofaswapwhereoneofthereferenceasset(s) isacommodity.

2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

Attribute2Identifiesthepaymentrulesthatapplyrelatingtothereferenceasset(s). Paymentsarebasedonincome,pricechangeintheunderlyingreferenceasset,etc...The Othersdefinitionwouldbeusedtocaterforscenarioswherereferenceassetsareonboth sidesanddifferentreferenceassetpaymentrulesapply. Attribute3Delivery:CashorPhysical,thisisdefinedinthe2001versionoftheCFIas:

P = Physical (The underlying instrument must be delivered when the option is exercised) C = Cash (The settlement of the option is made in cash)

Attribute4Redemption/reimbursement:Oneyearorless,onetofiveyears,orgreaterand whethercancellable,redeemable,extendable

Forwards (category)
ForwardsarewidelyusedintheOTCworld;howevertheISOCFIcurrentlyonlysupports Forwardsusingthe1stattributeoftheOtherAssetsCategorywiththevalueofMMFXXX, providingnodetailsabouttheforwarditself. TheproposalistocreateaForwardscategoryandlikeFutures,thiswouldbesubdividedinto twomajorgroups,financialforwardsandcommodityforwards.

Financial forwards (group)

Theclassificationforfinancialforwardswouldbebrokendownasfollows:
class Forw ards Forwards

Over 1 and up to 5 years Stock-Equities Debt instruments Financial forwards One year or less Attribute 1 Reference assets Over five years

Indices

Attribute 4. Redemption/reimbursement Basket Attribute 2 - Delivery Attribute 3 - Strategy Redeemable/ Extendable

Currencies Outright Spread Spot and forward pair (FX Swap)

Perpetual Cancellable Redeemable

Extendable

Physical

Others (Miscellaneous)

Cash

Forward pair (FRA)

Figure5.Financialforwards Attribute1Identifiesthereferenceassets. Attribute2Delivery:CashorPhysical. Attribute3Strategy:Outrightforward,spread,FXSwap(spotandaforward),FRA(two forwards)

2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

Attribute4Redemption/reimbursement:Oneyearorless,onetofiveyears,orgreaterand whethercancellable,redeemable,extendable

Commodities forwards (group)

class Forw ards A = Agriculture, forestry and fishing against fix rate E = Extraction resources (Metals, precious metals, coal, oil, gas) against fix rate Attribute 1 - Underlying assets I = Industrial products (Construction, manufacturing) S = Services (Transportation, communication, trade) against fix rate Redeemable/ Extendable Attribute 3 Strategy P = Power (e.g. Electricity) against fix rate Attribute 2 - Delivery Physical Forwards

Over 1 and up to 5 years One year or less Over five years Commodity forwards

Attribute 4. Redemption/reimbursement

Perpetual Redeemable

Extendable

Cash Cancellable Outright Spread Swap Others (Miscellaneous)

Figure6.Commodityforwards Thisgrouphasessentiallythesameattributeasfinancialforwards,howeverwithadifferent setofreferenceassets. Attribute1:UnderlyingassetsasdefinedforCommoditiesfutures,extendedinBold/Blue: E=Extractionresources(Metals,preciousmetals,coal,oil,gas) A=Agriculture,forestryandfishing I=Industrialproducts(Construction,manufacturing) S=Services(Transportation,communication,trade) P=Electricity?

2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

Option Considerations
Exchange-traded options
ExchangetradedoptionsarealwaysonaStockEquitiesoraFutureonanunderlyer(i.e.the holderhastherightstopurchase/selltheFuturenottheunderlyer).Forexample,onecanhave anoptiononaFutureofaninterestrateoranoptiononaFutureofabond.Therefore,ifone adherestothetextinthestandard,"thetypeofunderlyingassetsthattheoptionholderis entitledtopurchaseorsell",the2ndattribute:Underlyingassetsshouldonlybesetto"S"or "F".Otherthanthesetwotheuseofanyothervalueisratherconfusingasaresult.

Swap options (Swaptions and Credit derivative options)

Initscurrentform,thestandardisunabletoproperlysupportswaps.Swapscannotbe classifiedaseitheracallorputoptions,astheyareoptionsonagreementsthatdefinetheflow (cashorassets)betweenparties,thepartiesareeitherthereceiverorpayer. ThereforeaSwapoptionscategoryisproposedbrokendownbythefollowinggroupsFinancial Swaptions,CommoditySwaptionsandCreditDerivatives.
class Financial sw aptions American Swap Options Attribute 4 - Unused Attribute 1 - Excercise option style European

Burmuda

Attribute 3 - Unused

Financial swaptions Stock-equity against floating rate

Debt instrument against fixed rate Debt instrument against floating rate

Incides against fixed rate Basket against fixed rate Basket against floating rate Stock-equity against stock-equity Stock-equity against Debt instrument Stock-equity against indices

Stock-equity against fixed rate

Incides against floating rate

The right to enter into a swap agreement that is made up "Attribute 2" swap legs.

Floater/Fixed - Interest rate (e,.g. interbank rate) against fix rate

Attribute 2 - Swap legs Stock-equity against basket

Floater/Floater - Interest rate against interest rate Floater/Fixed - Economic rate (e.g. inflation - CPI) against fix rate Floater/Floater - Economic rate against Interest rate Debt instrument against debt instrument Other (Miscellaneous)

Indices against basket

Indices against debt instrument Indices against indices

For scenarios with more than two legs or other combinations not specificed within this attributre list.

Figure7.Financialswaptions
2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

10


class Commodity sw aptions American

Attribute 1 - Excercise option style

European

Burmuda Attribute 4 - Unused

Swap Options A = Agriculture, forestry and fishing against fix rate B = Agriculture, forestry and fishing against floating rate E = Extraction resources (Metals, precious metals, coal, oil, gas) against fix rate

Attribute 3 - Unused

Commodity swaptions

Attribute 2 - Swap legs

F = Extraction resources (Metals, precious metals, coal, oil, gas) against floating rate

The right to enter into a swap agreement that is made up "Attribute 2" swap legs.

P = Power (e.g. Electricity) against fix rate

I = Industrial products (Construction, manufacturing) against fix rate S = Services (Transportation, communication, trade) against fix rate J = Industrial products (Construction, manufacturing) against floating rate

T = Services (Transportation, communication, trade) against floating rate Other (Miscellaneous)

For scenarios with more than two legs or other combinations not specificed within this attributre list.

Figure8.Commodityswaptions

2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

11

class Credit ev ent/default options

American Attribute 1 - Excercise option style

Swap Options

European

Burmuda Attribute 4 - Credit event type and standard combinations of (see Credit Derivatives)

Loans

Debt instruments

Credit derivatives

Stock-Equities Attribute 2 Underlying reference/asset Others (Miscellaneous)

Index

Basket Index tranche Basket tranche Cash

Spread & CDO Attribute 3 - ISDA Agreement types (see Credit Derivatives) The right to enter into a credit event/default agreement based on a specific type of underlyer identify by "Attribute 2".

IRS

FRA

Future

CDS

Figure9.Creditderivativeoptions

Warrant Considerations
ThereisarequirementtoextendAttribute1Underlyingassetstoincludeadefinitionfor Interestrate.

2009LondonMarketSystemsLimited,68LombardStreetLondonEC3V9LJ Noportiontobereproducedwithoutpermission.

12