Management Outsource

IDEAS FOR A CHANGING GLOBAL ECONOMY FALL 2009
Forward
Focus
2 J.P. Morgan thought / Fall 2009
Thinking Out Loud
As we reect on 2009 and look forward to 2010, I want to
assure you that J.P. Morgan remains committed to helping
our clients mitigate risks, enhance revenues and increase
efciencies. We continue to invest in our technology,
infrastructure and people to serve your evolving needs. In
looking forward, we must be mindful of the events that forever
changed the nancial marketsacknowledging the critical
lessons learned and making renewed commitments to provide
full transparency and disciplined risk management.
In this issue of Thought, titled Forward Focus, we address the
expanding role collateral management has taken as an essential
tool for managing risk, the outlook for securities lending, best
practices in managing counterparty risk with OTC derivatives
collateral management, and our enhanced support for
long/short vehicles, among many other relevant topics.
Thank you for reading and as always, your questions and
comments are welcome, and can be sent to
thought_magazine@jpmorgan.com.
Conrad Kozak
Head of Worldwide Securities Services
Conrad
Kozak
Head of
Worldwide
Securities
Services
J.P. Morgan remains committed
to helping our clients mitigate
risks, enhance revenues and
increase efciencies.
Fall 2009 / J.P. Morgan thought 3
Fall 2009
J.P. Morgan
Worldwide Securities Services
Tom Christoferson
Global Sales and Client Executive
212-552-2919
thomas.christofferson@jpmorgan.com
Chris Lynch
Western Hemisphere
Sales and Client Executive
212-552-2938
chris.e.lynch@jpmorgan.com
Laurence Bailey
Asia-Pacic
852-2800-1800
laurence.bailey@jpmorgan.com
Francis Jackson
Europe, Middle East and Africa
44-207-325-3742
francis.j.jackson@jpmorgan.com
About J.P. Morgan
Worldwide Securities Services
J.P. Morgan Worldwide Securities
Services is a premier securities
servicing provider that helps
institutional investors, alternative
asset managers, broker dealers and
equity issuers optimize efciency,
mitigate risk and enhance revenue.
A division of JPMorgan Chase Bank,
N.A. (NYSE: JPM), Worldwide
Securities Services leverages the
rms unparalleled scale, leading
technology and deep industry
expertise to service investments
around the world. It has $13.7 trillion
in assets under custody and $3.7
trillion in assets under administration.

For more information, go to
www.jpmorgan.com/wss
6 16 30
18 Collateral Rising: Managing
Counterparty Risk with OTC
Derivatives Collateral Management
Keep up with the growth of OTC derivatives
trades and regulatory changes.
20 The Changing Global Regulatory
Environment
J.P. Morgans International Government
Relations group provides an overview of
key themes running through regulatory
reforms.
22 Regulation of Collective Funds:
Threat of Opportunity?
The evolution of the UCITS fund
framework and key points of its most
recently proposed reforms: UCITS IV.
24 Custodians to Drive Automation in
the Quest for Control and Efciency
Global custodians have helped clear a path
through nancial market turbulence.
26 Best Practices for Third-Party
Hedge Fund Administrators
The right third-party administrator can
provide important benets to hedge fund
managers.
28 House Education and Labor
Committee Proposes DB Funding
Legislation
Examining the key elements of H.R. 2989.
30 Collateral Management: Expanding
Role, Increasing Complexity
Institutions face an important decision:
increase infrastructure spending or turn to
an outsourcing provider.
4 The Great Debate: European
Pension Fund Management -
Outsource or In-House?
A duciary management model may
offer pension trustees a solution for the
increasing complexity and pressures of
securing long-term growth for their funds.
6 U.S. Market Changes Afect
Clearing & Settlement
Two signicant changes to the clearing and
settlement structure in the United States
may affect how you conduct business.
8 Derivatives Compass:
Are You On Course?
An increased focus on systemic risk brings
additional requirements in four major
areas.
10 How to Generate Greater
Alpha, Safely
Integrating key capabilities in order to
safely meet the challenges of an integrated
long/short investment strategy.
12 Securities Lending: Managing Value
Generation and Risk
The right agent lender can offer a number
of techniques to help manage risk.
14 New DOL Rules Cast Cloud of
Confusion Among Plan Service
Providers
Rules designed to increase transparency
left pension plans and their providers
struggling to sort out the requirements.
16 Releasing the Value of Cash
A four-step process for getting the most out
of your cash.
Trustees from European pension funds continue
to be tested by the increasing complexity of the
investment decisions that they must make, in order
to secure future long-term growth for their funds.
Whether it is valuing mispriced assets or
providing further programmes to get risk off
the table, trustees and their advisors recognise
that much closer attention is needed in terms of
managing assets and liabilities.
Pension fund trustees based in Germany, the
Netherlands and the U.K. have started to appoint
advisors. These advisors include traditional
consultants offering a duciary management
type of service, as well as boutique solvency and
fund managers.
One of the reasons why the appointment of
advisors is growing is the limited pool of in-
house investment talent at the underlying
pension funds. This is particularly prevalent for
mid-size pension funds, where sponsors struggle
to devote further resources to this pursuit.
For these reasons, trustees continue to grapple
with understanding best practice and the
levels of delegation they should consider, while
ultimately knowing that in many countries they
The
Great
Debate
European Pension Fund Management -
Outsource or In-House?
will retain the overall duciary responsibility for
their pension fund plans.
In the last few years, the concept of duciary
management has begun to take hold in the
Dutch pension market. Fiduciary management
represents a delegation of services along the
investment chain ranging from strategic asset
allocation (through an asset liability modelling
exercise) to manager selection, to monitoring
and reporting. This has been highly successful
in the Dutch market. Blackrock estimates that up
to 300 billion could be outsourced to duciary
managers by U.K. pension managers in the next
three years.
1

The concept is also beginning to take hold across
other countries in Europe, in particular the
U.K. and Germany, albeit the terms used may
differ, for example implemented consulting
or solvency management. The term duciary
management is somewhat confusing, since in
many countries trustees of pension funds cannot
legally outsource their duciary responsibility to
a third party.

The Fiduciary
Management Model
So what does a duciary management model
look like and what impact has this change in
governance had on the role of custodians? The
Benjie Fraser
Managing Director,
EMEA Pensions
Segment Head
U.K. market, with 27% of respondents already having a mandate in place
and another 26% considering such a mandate for their funds. The chart
above shows some true versatility in a duciary management mandate
and its adaptability to suit individual pension funds needs. Within the U.K.
there is a marginal preference for this type of mandate to be applied across
the entire fund (58% in favour) rather than part of the fund.

Summary
Fiduciary management is an outsourcing approach to pension fund
management which involves appointing an external organisation to
provide investment advice, implementation and oversight, subject to the
instruction of the funds trustees. Fiduciary management is a signicant
trend that is likely to continue within Europe, which is signicant as such
trends are usually seen coming from the United States and not Europe.
J.P. Morgan is well positioned to partner with trustees as they evolve the
governance models of their pension funds and implement new solutions.
Our practical experience of working with duciary managers in the
key European marketsthe Netherlands and the U.K.has given us
invaluable insight into the working of duciary management which, we
believe, will benet our clients.
1. Source: Professional Pension, 6 Nov 2008
chart to the right shows how the relationships
between an underlying pension fund, duciary
manager and custodian could work.
In a duciary management mandate, the
custodian would become an integral part of the
relationship and would provide the necessary
information to all parties to help the trustee
measure and monitor the overall investments.
While duciary management mandates can
vary, many trustees employ a duciary manager
to efciently manage the overall solvency of
their pension fund and/or help them implement
a manager structure. Part of managing the
solvency could mean implementing a liability
matching strategy through the use of derivatives,
such as ination and interest rate swaps.
Monitoring such strategies and managers often
forms a critical part of the duciary managers
responsibilities.
The custodians role in providing services such
as performance measurement, accounting and
independent valuation of OTC derivatives is
just as important when a duciary manager
arrangement is in place, but the custodian needs
to be able to interact with the duciary manager.
The custodians role and the services it needs to
provide are unlikely to change in the near future,
except that there is an additional relationship
to manage (i.e., the duciary manager in its
capacity as the agent of the pension fund).

Our Findings
At this years J.P. Morgans EMEA Pension Fund
and Charities Summit, held in London and
themed Effective GovernanceFocusing on the
Key Issues, a key nding was that the advisory
concept is here to stay, given the increasingly
challenging and complex world pension funds
now face, exerting strong pressures on their own
governance models.
To garner further insight, we surveyed our
audience, a signicant proportion of which were
U.K. pension fund trustees. The key results are
shown below.
The survey showed that the concept of duciary
management is gathering momentum in the
Pension Fund
Trustees
Delegates responsibilities
to duciary manager
Fiduciary Manager
Custodian
Monitoring
Strategic Asset Allocation
Manager Selection
External Asset Manager A
Portfolio Construction
Asset Allocation
Consolidated Reporting
Performance Monitoring
External Asset Manager B
External Asset Manager C
Consultant
THE FIDUCIARY MANAGEMENT MODEL
C
O
N
T
R
A
C
T
U
A
L

R
E
L
A
T
I
O
N
S
H
I
P
* Depending on duciary mandate and the level of trustee delegation, custodian may only deal with duciary manager
Does your pension fund have a duciary management mandate in place?
Yes
27%
No, but its under consideration
26%
No, and it has not been considered
47%
If you answered Yes or No, but its under consideration,
how much of your funds does/would this involve?
All
58%
Part
42%
}
Keeping up with the many changes in the global markets can be a
daunting task. Even in the United States, one of the largest and most
developed capital markets, there are signicant changes underway
that may afect how you conduct business.

Rich Mitterando
GlobeClear Product Manager
Proposed Market
Structure Changes
In reaction to the market events of the last
year and to reinstate condence in the U.S.
nancial market, the Obama administration
recently proposed a nancial regulatory
reform plan that would alter the current
U.S. market structure. Under this proposal,
the Fed would have more power to provide
oversight over nancial institutions as
well as payment and settlement systems.
Though any proposed changes will take
time to be approved and/or implemented,
institutions should take note of some
recently introduced changes designed to
make the settlement process more efcient
and equitable.
1. CHANGES IN FEDWIRE DELIVERY
DEADLINES
On July 1, the deadlines for the
origination of Fedwire eligible
deliveries changed to a rm 3:00 p.m.
Eastern Time (ET) closing. This new
U.S. Settlement
Market Structure
As the largest global capital market during
the last few decades, the U.S. markets have
placed a great emphasis on standardizing
post-execution infrastructure to lower costs
and reduce risks. While many regions have
multiple central securities depositories
(CSDs), the United States relies on just two
main CSDsthe Fedwire Securities System
and the Depository Trust & Clearing Corp
(DTCC)to settle all book-entry equities and
xed income instruments.
J.P. Morgan is one of only two clearing banks
for the U.S. Federal Reserve System. In this
capacity, we settle a large portion of the daily
securities volume and play an important
role in the liquidity and stability of the
market. We also directly participate with
the DTCC, with board-level and working
group representation that helps to shape and
drive improvements to both processes and
infrastructure.

U.S. Market Changes
Afect Clearing & Settlement
practice levels the eld for all market
participants, wherever they are located,
while still allowing for some exibility
in turning around late receipts up to
3:15pm ET, if both counterparties agree
in advance. The new process will help
to ensure our market participants,
particularly those outside the United
States, are treated similarly to domestic
U.S. participants. Overall, we expect this
to result in improved settlement rates
and a more efcient settlement process
for our clients.
2. NEW TREASURIES FAILS FINES
To encourage lending and drive the
U.S. economic recovery, the Fed has
held the federal funds interest rate at
nearly zero. This has created higher
settlement fail rates for U.S. Treasuries.
Highlights
Through GlobeClear, clients can better manage
the complexities of clearing, settlement and
custody. In addition to a single access point,
clients benet from:
Multiple methods to send in instructions,
including SWIFT, Internet, le uploads, and
direct links
Access to reports and automated updates via
SWIFT, Internet and le downloads
Customized reports that can be viewed online,
scheduled to be e-mailed to various users or
sent directly to a printer for additional time
savings
Continuous investment in our technology to
keep ahead of the ongoing market changes,
thus reducing your maintenance costs and
continuously improving your processes
Access to a suite of products that complement
our clearance and custody services, such
as our securities lending ofering, our
comprehensive foreign exchange services and
cash management tools
J.P. Morgans economies of scale, fortress
balance sheet and industry position
To combat this and remedy fails quickly,
the Treasury Market Practice Group
(TMPG) recommended a new charge on
treasuries fails. Implemented on May 1,
the practice calls for the failing party to
make full payment of all fails charges in
the month following the failed trade, as
long as the receiving party has provided
timely notice on the amount due. While
not mandatory for the receiving party
to charge for treasuries fails, the TMPG
strongly encourages this practice to help
reduce future fails.

Your Voice at the Table
As the global markets evolve in the
aftermath of the nancial crisis, we at
J. P. Morgan understand the value of our
role as a lead player in the U.S. market.
J.P. Morgan is at the forefront of industry
discussions, both as a voice for our clients to
the market and in representing the market
to our clients. Our involvement in industry
committees, organizations, working groups,
and boards positions us to help recommend,
monitor and implement. For both changes
outlined above, we worked closely with
members of the TMPG, Securities Industry
and Financial Markets Association (SIFMA),
the Asset Managers Forum (AMF), and
other industry representatives. Our goal is to
develop these best practices and ensure our
clients perspective is heard.
Understanding that clear and regular
communication is even more critical in
times of change, we have consistently
provided clients with customized electronic
market alerts, delivered well in advance of
any changes. In fact, we were one of the rst
in the industry to supply customized reports
to help track and calculate these new fail
charges for our clients.

How Can We Help You?
J.P. Morgans GlobeClear platform has direct
links to the DTCC and the Fedwire, allowing
our clients to benet from some of the best
deadlines in the market while efciently
facilitating same-day turnarounds.
Clients can link their trades and recycle
deliveries, in advance of settlement, thus
optimizing delivery without any last minute
intervention. Our regional client coverage
teams enable us to provide local support no
matter where our global clients are located.
For more information, contact
Rich Mitterando at richard.v.mitterando@
jpmorgan.com or +1-212-623-8198.
Recommended Closing Time Practices:
http://www.newyorkfed.org/tmpg/TMPG_closing_time_proposal_052809.pdf
Frequently Asked Questions:
http://www.newyorkfed.org/tmpg/TMPG_faq_052809.pdf
Treasuries Fail Charges:
http://www.sifma.org/capital_markets/docs/fails-charge-trading-practice.pdf
F
I
N
D

I
T
The market events of last year have thrust the previously
little-known world of over-the-counter (OTC) derivatives
processing into the spotlight. For several years, the industry
has been working to streamline and automate processing, and
to increase the use of industry utilities.
Conrmation Platform
Consolidation
The initial development of
conrmation and workow utilities in
the OTC derivatives market saw different
platforms dominate for different derivatives
instruments. Following the announcement
of the Markit and DTCC strategic
partnership originally in 2008, a common
platform is nally on the horizon. Following
nal regulatory approval, MarkitSERV will
launch an interoperable OTC workow
utility for use across the industry. There is a
great deal riding on its success: MarkitSERV
is already being put forward by the industry
as a potential solution to single-step
novation, automated allocation processing
and interoperable electronic conrmation.
Over time, as the MarkitSERV platform
becomes a reality, the services of existing
industry utilities will evolve. Focus areas for
2009 are likely to include the development
of a common portal, regulatory reporting for
interest rate derivatives, and client access to
central counterparty clearing across credit
and interest rate derivatives. Novation
process reengineering and interoperability
of the utilities for interest rate derivatives
are on the agenda for 2010.

Central Counterparty
Clearing
Central counterparty clearing (CCP)
is a major initiative to reduce counterparty
risk, but with multiple CCPs competing for
business, differences of opinion between
regulators and the industry and debate
between sell-side and buy-side institutions
on the way forward, it is likely to be some
time before the road map is crystallised.
Despite the uncertainty, CCP is already
a reality in the credit and interest
Central Settlement
The onboarding of buy-side
rms to central settlement of credit
derivatives via DTCCs Trade Information
Warehouse (TIW) and CLS Bank (CLS)
2
is
proving challenging. With central settlement
now live for the inter-dealer market, the
focus has shifted to the buy-side. The
October 2008 commitment of 96% of
settlements on DTCC-eligible trades to be
centrally settled by 30 November 2009 poses
a signicant challenge for buy-side rms,
their dealers, custodians, administrators, and
the DTCC itself.
Implementation can represent a signicant
project, even for rms trading low
volumes of credit derivatives. Moving
from a bilateral settlement model where
individual settlement instructions are sent
to custodians, to a central settlement model
where net settlements are determined by the
TIW and messaged to CLS for settlement,
requires change in a number of areas.
These include new logic for the eligibility
of cash ows for central settlement,
withholding settlement instructions, and
prompt conrmation matching to ensure
trades settle on value date. Even though a
rm may itself be ready on their own side,
it remains dependent on third parties such
as custodians, fund administrators and CLS
settlement members to go live.

The recent focus on systemic risk
by governments and regulators has
included a reappraisal of how the OTC
derivatives market operates, resulting in
increased requirements for operational
change in an aggressive timescale for
market participants. Focus areas include
central data repositories, extension of
central counterparty clearing, contract
standardisation, broader authority for the
regulators and investor protection through
tighter controls on OTC trading eligibility.
Critically, these changes are no longer just
the preserve of the major OTC dealers,
and the buy-side community is now under
the spotlight. Many of the commitments
incorporated into the recent Industry
Letter to the Federal Reserve Bank of New
York (Fed Letter)
1
from the Operations
Management Group (OMG) impact all
market participants, including those buy-side
rms that are not direct OMG participants.
OTC derivatives operations managers at
asset management rms are realising that
they can no longer watch and wait, and any
perceived lack of progress by the buy-side
rms is likely to attract the attention of the
regulators, as well as pressure from their
dealer counterparts.

DERIVATIVES COMPASS ARE YOU ON COURSE?
1
2
3
rate derivatives arena, and further
commitments have been made to the
regulators. The LCH-Clearnet SwapClear
service has been clearing interest rate
swaps for the major dealers for nearly
10 years. LCH is now working to extend
the benets of the service to the buy side.
IntercontinentalExchange (ICE) started
clearing U.S. credit default swaps for
dealers last year, and both ICE and Eurex
launched European CDS solutions in July.
The industry has articulated to regulators
a goal to achieve buy-side access to CDS
clearing by 15 December 2009, but a number
of issues remain open, such as the optimal
approach to margin segregation, treatment
of credit events, and the scope of eligible
OTC instruments. Buy-side rms are not
necessarily expected to face the CCPs
directly, but could gain access through either
a prime brokerage model, where trades are
given-up to a single clearing member; or an
executing broker model, where each broker
submits both trade perspectives to the CCP.
The operating model for buy-side rms
may not yet be fully understood, but it is
likely to include the need to determine
CCP eligibility, novate trades and post
daily margin. Therefore, rms should be
asking what this is going to mean for their
counterparty exposure and OTC process
ows.

Hardwiring and CDS
Standardisation
OTC operations managers at
buy-side rms will have already decided
whether to adhere to the 2009 ISDA Big
Bang Protocol to hardwire
3
auction
settlement terms into their CDS contracts
and Small-Bang initiative to extend the
auction mechanics to include restructuring
events.
One of the key aspects of the hardwiring
changes, the establishment of the ISDA
Credit Derivatives Determinations
Committees (DCs), requires rms to change
the way in which they track and manage
credit events which impact their CDS
portfolios. Historically, there has been an
element of subjectivity in determining a
credit event trigger on a relevant underlying
entity. The regional DCs will opine on
potential credit and succession events and
become the authoritative source for trades
incorporating hardwiring terms.
Going forward, market participants are
being strongly encouraged to report all their
CDS trades into a Centralised Repository
by the third quarter of 2009 to increase
transparency to regulators. The rst phase
covers weekly reporting by dealers, but
buy-side reporting and increased reporting
frequency may follow. Similar reporting for
the rates and equity asset classes will follow
in 2010.

The Outsourcing Solution
With so much complex change to execute,
many derivatives operations managers and
executives are considering the outsourcing
solution, even those who for many years
have preferred to keep processes in-house.
Based on a sample of buy-side rms recently
surveyed, 64% believe that there will be more
demand for OTC process outsourcing as a
result of the market turmoil and the likely
enactment of regulatory change.
4
Commonly
cited benets of outsourcing include access
to scarce high-calibre staff, enhanced
capabilities, product complexity and
avoidance of high investment expen diture
on an in-house infrastructure. The ability to
respond to industry changes on a timely basis
should now be added to that list.
To date, valuation and collateral
management functions have more
commonly been subject to outsourcing. In
the future, the industry changes outlined
above may result in outsourcing of
conrmation and settlement management
to providers who can build and maintain
a exible infrastructure to support the
evolving industry landscape. Given the
likely continued evolution of the post-trade
processing space over the next few years,
a strong partnership between client and
outsource provider will be critical to success.

Conclusion
The derivatives processing landscape will
change dramatically in the next 18 months,
including further standardisation, more
aggressive processing targets and changes to
industry utilities.
Whether addressing these challenges
in-house, or via an outsourcing solution,
buy-side OTC managers need to act now
to ensure that their operation remains up-
to-date and compliant with industry best
practice. The changes have already begun,
and theyre not optional.
For a more detailed analysis, please read our
white paper at www.jpmorgan.com/visit/gds.
1. Letter to the Federal Reserve Bank of New York,
Operations Management Group, June 2009, http://www.
newyorkfed.org/newsevents/news/markets/2009/ma090602.
html.
2. The DTCCs Trade Information Warehouse (TIW) contains
an up-to-date record of the majority of credit derivatives
trades and enables reporting and lifecycle management
including cash ow calculation on those trades. DTCC has
built an interface to CLS Bank to facilitate the settlement of
those cash ows calculated in TIW.
3. Hardwiring has the effect of incorporating auction
mechanics and cash settlement terms into a CDS contract
upfront, as opposed to relying on agreement of terms only
on the occurrence of a credit event.
4. Derivatives Outsourcing Competitive Landscape
Investigation, Alpha Financial Markets Consulting, April
2009.
DERIVATIVES COMPASS ARE YOU ON COURSE?
4
HOW TO
GENERATE
GREATER
As institutional investors and asset managers
strive to nd new ways to maximize returns in
an uncertain economic environment, interest in
long/short funds has intensied. If structured
properly, these funds can provide the trifecta
of enhanced returns, asset protection and
transparency.
But theres a catch.
While providers of both prime brokerage and
custody services have entered the market or
expanded their long/short offerings, most are
not structured to service clients efciently and
effectively. Nor do they have deep capabilities
across the entire long/short portfolio and the
investment life cycle. Clients such as asset
managers and pension funds, therefore, face
compromises that make long/short strategies
costly and challenging to maintain, which can
distract them from their
key objective: generating
greater alpha.
The key is to deliver
end-to-end custody,
accounting, administration
and nancing across both
longs and shorts, in a
structure that also provides
protection of assets, says
Michael Minikes, Head of J.P. Morgan Clearing
Corp., which delivers Prime Broker Services.
This is best achieved through the effective
integration of global capabilities across prime
brokerage and operational services under a
single roof. Otherwise, clients are forced to use
multiple providers and will therefore likely
face higher nancing costs, inefcient use of
collateral, and fragmented reporting, operations
and service.
So, when it comes to long/short strategies, what
are the most important considerations?

ALPHA,
SAFELY
Integrating Capabilities
to Support Long and
Short Funds via a
Single Provider
Protection of Assets
Many providers are unable to provide clients
with adequate levels of asset protection for
several reasons. Some lack the structure
to segregate the unencumbered cash and
securities. As a result, clients often resort
to a dual provider approach, splitting
responsibility for the unencumbered assets
and short positions between two providers.
The traditional prime broker model has
historically not held clients unencumbered
assets in separate custody accounts, pooling
them instead into the brokerage account.
Segregating unencumbered assets into a
bank depository assures immediate access to
those assets in the event of a bankruptcy of
a prime broker.
Another important point to consider is
the overall soundness of the institution
with which clients assets reside. Hedge
funds, for example, typically hold their
assets with multiple prime brokers. From
an individual client point of view, it is not
always transparent where these assets sit or
who holds them. Knowing which institution
actually holds the assets and the extent to
which those assets are protected, and the
safety and soundness of that institution, are
fundamentally important.
The best option, from a protection of
assets perspective, is to work with a world-
class commercial bank that has a robust
prime brokerage platform and therefore
can effectively service both unencumbered
assets held in a segregated custody account
and short positions in a brokerage account,
explains Minikes. Even if the institution
falters or fails, the structure of holding
unencumbered assets in custody accounts
provides greater protection of the assets.

Minimizing Costs
When clients split long and short positions
between rms, they incur parallel
accounting, administration and reporting
systemsin a sense, paying twice for
similar services. In addition, it becomes the
clients responsibility to consolidate the two
streams of information and documentation
into a single view. The inefciencies and
cost associated with the dual-provider
approach have led some asset managers and
institutional investors to question long/short
strategies altogether.
Using a single rm streamlines the
administration and can reduce costs
signicantly. This is easier said than done,
says Conrad Kozak, Head of J.P. Morgan
Worldwide Securities Services. Most
providers do not have the operational and
technology infrastructure, let alone expertise
or experience, to service both long and short
positions end to end.
Also, with collateral potentially sitting away
from prime brokers as required, for example,
by the Investment Company Act of 1940,
nancing costs can become expensive.
Finding ways to minimize these costs is
crucial to the viability of a dual provider
strategy. Utilizing a service provider with
the appropriate solutions, such as securities
lending, is critical.

Improving Transparency
The dual accounting and reporting streams
of a two-provider approach also make full
consistency and transparency difcult. Fund
reportingincluding trades, fees, taxes,
collateral, margin reports and returnsfrom
two providers challenges clients to set a
daily NAV and provide timely and accurate
information to investors and regulators.
The same efciencies that reduce costs
when using a single provider will also
increase consistency and transparency, says
Kozak. The ability of a single provider to
produce a consolidated end-to-end view of
both long and short positions means that
critical reports and analyses will be more
timely and complete, and data quality will
be higher.

Streamlined Operations
and Service
The dual-provider approach clearly creates
inefciency. But even many single providers
lack the operational processes and technology
infrastructure necessary for cost-effective,
end-to-end accounting, administration and
reporting. Common reasons can include
inadequate long-term investment in
technology, poorly integrated services, and
lack of experience and expertise.
Among the challenges these issues create
are: slow onboarding, multiple service
touch points, and poor coordination
and issues resolution on the providers
part. In addition, providers without
automated collateral management can
be an operational headache to the client,
currently burdened with this daily, manual
process. An inefcient process could also
leave the collateral accounts over- or under
collateralized at any given time.
Providers need integrated technology
platforms specically engineered to support
the requirements of both long and short
positions, says Sandie OConnor, Global
Head, Financing and Markets Products,
J.P. Morgan Worldwide Securities Services.
A well-designed platform will also enable
strong end-to-end operational processes.
The optimal model includes a single point
of contact across long and short positions,
reports and information delivered through
one platform and tool set, and integrated
collateral management.
J.P. Morgan has recently enhanced one of the
industrys only consolidated offerings for
long/short strategies. The service features
automated collateral movements between
collateral accounts and unencumbered long
custody accounts, reduced nancing costs
through smart securities lending, a single
point of contact for service and consolidated
reports for long and short positions available
through a single portal.
Clients receive a fully integrated offering
based on the capabilities and expertise
in J.P. Morgans Worldwide Securities
Services and Investment Bank divisions.
Both are leaders in their industries, and key
businesses at JPMorgan Chase & Co., one
of the most stable and respected nancial
institutions in the world. Says Kozak, Our
experience is unrivalled: we have delivered
integrated long and short capabilities to more
than 100 accounts for more than a decade.
We apply an integrated, global approach,
providing a single set of services, which
enables our clients to focus on their primary
goal: generating greater alpha, safely.
ALPHA,
SAFELY
Securities lending and its risk/reward prole have
been in the headlines as the credit and liquidity crisis
unfolded over the past 24 months. Market events focused
attention on certain important aspects of the business
for all parties involved.
that can be used to increase portfolio returns or
reduce portfolio expenses. In a basic transaction,
securities are lent short-term, collateralized by
either cash or securities, and should be marked
daily. If securities are held as collateral, the
loan transaction is complete. If cash is taken
as collateral, there is another leg to the loan
transaction, as this cash is reinvested, typically
in short-term money market securities. The
transaction is unwound when the borrowed
securities are returned to the benecial owner
and the collateral returned to the borrower.
In a securities lending transaction, a component
of the benecial owners return is affected by a
particular securitys available supply compared
with aggregate borrower demand. When the
demand for a particular security outstrips its
supply, its intrinsic value increases, making
it more protable for the benecial owner
to lend the security in the market. When a
transaction is collateralized with securities,
the borrower pays the benecial owner a basis
point fee on the market value of the borrowed
security. Again, this fee varies by how much
the borrower is willing to pay to borrow the
specic security. When a borrower pledges
cash as collateral, a rebate rate or yield on the
collateral is negotiated. The greater the demand
for the security being lent, the lower the yield
paid to the borrower on the cash collateral.
Securities that go special or have an extremely
high borrowing demand can obtain negative
rebate rates, requiring the borrower to not only
pledge cash, but also pay a fee to the benecial
owner. The cash received as collateral is typically
First, securities lending is a major driver of
market liquidity, from both the lending of
securities and the investment of cash collateral,
through which the benecial owner generates
alpha. Second, with return comes risk. Benecial
owners typically lend securities through agents
(nancial rms who provide securities lending
services). If the owners accept cash collateral,
they can earn a return from reinvesting the
cash. In doing so, benecial owners also
take on interest rate and credit risk from the
investments; therefore, strong risk management
coupled with transparency is an essential
component of a successful securities lending
program. Third, agent lender indemnication
the protection agent lenders provide to
benecial owners against counterparty
defaulthas real value because broker-dealer
counterparties do sometimes default. Given the
importance of fully understanding all aspects
of securities lending, including market liquidity,
reinvestment risk and value generation, it bears
reviewing how securities lending works and
what risk management techniques are available.
Securities lending monetizes the intrinsic
value of a portfolio of securities. It provides an
opportunity for incremental income (alpha)
MANAGING VALUE GENERATION AND RISK
Securities Lending
Sandie
OConnor
Global Head,
Financing and
Markets Products
invested in high quality short term instruments
under guidelines agreed with the benecial
owner. The difference between the yield paid on
the cash collateral to the borrower and the yield
earned on the investment generates return to
the benecial owner.
Securities lending, like all market activities,
creates a risk/reward trade-off for the benecial
owner, borrower, and agent lender. The
three primary risks in securities lending are:
borrower/counterparty default risk, operational
risk and cash collateral reinvestment risk.
Participants in securities lending can manage
these risks through a variety of controls with
the agent lenders assistance. Agent lenders
typically provide indemnication against
broker dealer default, which they manage by
maintaining collateral at levels greater than
100%, and thereby absorb the counterparty
default risk. Capital strength and effective
collateral management are essential for
agent lenders to fulll their obligation under
an indemnication. Benecial owners that
participate in securities lending programs look
to align themselves with well capitalized, high
quality agents. The indemnication provided
against borrower default was tested by the
Lehman Brothers bankruptcy, and benecial
owners quickly realized that their lending
agent must have the capital to deliver on the
indemnication commitment, as well as the
market skill to unwind and replace collateral
positions as needed.
Operational risk management, too, is an
important consideration when benecial
owners select an agent lender. Operational risk
can be mitigated by agent lenders through a
robust operating framework, global scale and a
comprehensive understanding of transactional
ows.
Cash collateral reinvestment riskin particular
requires vigilant benecial owner oversight
and maximum transparency and control.
Benecial owners who accept cash collateral
increase the leverage of their portfolio through
the investments made with the cash collateral.
For them, securities lending is an investment
overlay strategy which generates incremental
alpha in return for additional risk. When a
benecial owner accepts cash as collateral,
investment professionals should be actively
involved in decisions about the program,
including the investment guidelines, the specic
assets purchased under those guidelines, and the
indicative market pricing of those assets on a
daily or weekly basis even under a typical buy
and hold strategy. Going forward, reinvestment
portfolios will likely be of shorter duration
with more standardized maximum guidelines,
possibly along the lines of 2a-7 funds. When
benecial owners accept cash collateral, they
should also understand how account types
impact control and transparencyseparate
accounts provide more control and transparency
for the cash collateral reinvestments, whereas
commingled funds provide less.
Agent lenders directly contribute to strong risk
management of cash collateral through the
account structure, transparency, performance
reviews and control the agents employ. Agent
lenders should provide robust, frequent
reporting to help benecial owners monitor
the performance of their securities lending
program. An agent lenders ability to provide
independent, detailed credit analysis, rather
than relying on rating agencies alone, creates a
valuable resource to a benecial owner as they
navigate investment decisions. Now more than
ever, strong partnerships between agents and
benecial owners are needed as all parties focus
on enhanced transparency and control.
Risk Management
Techniques Supported by
Agent Lenders

Robust counterparty and issuer credit
analysis
Indemnication against borrower default
Overcollateralization of loans to
borrowers, and robust daily process for
collateral management
Operational exibility to restrict
securities or borrowers when necessary
Diverse universe of borrowers that are
vetted as counterparties, subject to
benecial owner restrictions
Reinvestment of account liquidity based
upon collective agreement between
benecial owner and agent lender
Reporting transparency and ongoing
program reviews by both agent lender
and benecial owner
Separate account management
structure with customized guidelines or
commingled funds for cash collateral
reinvestment
This article was extracted from
a white paper on securities
lending published by J.P. Morgan
Asset Management as part of its
compendium of essays entitled
Post-Modern Asset Management:
The Credit Crisis and Beyond (May
2009). The full whitepaper was also
published in Reserve Management
Quarterly (April 2009).
This year, new DOL rules designed to increase transparency
around how ERISA plans compensate their service providers
take efect. Ironically, most service providers nd the rules
to be anything but clear, prompting confusion and concern
among providers and plans alike struggling to sort them out.
In 2007, the U.S. Department of Labor (DOL)
issued guidance aimed to impose a greater
degree of transparency around how ERISA
plans compensate their service providers.
Effective this year, the new rules affect annual
ERISA reporting requirements for Form
5500, as well as the statutory prohibited
transaction exemption (ERISA 408(b)(2)),
which permits parties-in-interest to provide
services to ERISA plans. Employee benet
plans must le Form 5500 annually with
information about their nancial condition,
investments and operations. The underlying
goal for both revisions was to signicantly
expand the degree of information disclosed
to and reported by ERISA plans around direct
and indirect compensation to their service
providers, and ultimately, to increase overall
transparency.
Ironically, these new transparency rules
have seemed anything but clear to service
providers, the majority of whom are
unsure how to comply with new disclosure
requirements in a form they regularly
le for plans.
1
In a recent industry survey
gauging providers comfort with the now
mandatory rules, nearly 75% of service
providers surveyed indicated that they
would benet from additional time and
guidance in order to properly comply with
the new requirements.
2
According to The
SPARK Institute, a national retirement
policy and legislative reform organization
and sponsor of the aforementioned study,
this confusion may well result in providers
interpreting the rules differently, rendering
reporting results anything but uniform.
Further, providers may be forced to expend
signicant resources on technology and
infrastructure changes that will ultimately
prove to be of little or no value to plan
sponsors.
3

Source of Confusion:
Dening Expenses
What is the source of the confusion? The
distinction between rules for reporting
direct compensation and those for reporting
indirect compensation is a key starting
point. In fact, one of the biggest challenges
that the new rules present to providers is
in understanding how plan expenses are
dened. The 2009 Schedule C denes fees
and compensation as either direct or
indirect, which are further broken down
between monetary or nonmonetary
fees. Some fees may be difcult to identify,
especially if they are lumped into a bundling
arrangement and need to be broken out.
Direct compensation, generally, is the
compensation a plan service provider
receives directly from a plan or plan
sponsor; or put another way, fees paid to
a provider out of the plans pocket. For
example, if a plan pays separately for outside
recordkeeping to a third-party provider, that
would be considered direct compensation.
Indirect compensation is that which
is received by a provider from sources
other than directly from the plan or plan
sponsor, and includes fees paid to the
service provider from mutual funds, bank
commingled trusts in which the plan invests,
and other soft-dollar compensation, such as
research, for example.
Reporting of direct compensation is fairly
straightforward under the new rulesthe
amount of compensation is xed and who
receives it is clear. The confusion seems to
be rooted in how indirect compensation
the primary policy focus underlying the new
rulesmust now be reported.

New DOL Rules Cast Cloud of Confusion
Among Plan Service Providers
Reporting Indirect
Compensation on
Schedule C
Under the new rules, unless indirect
compensation is eligible indirect
compensation, the amount of such
compensation must be reported on Schedule
C. The provider (the entity receiving the
compensation) does not have to report the
actual amount of indirect compensation, but
rather may supply a formula pursuant to
which such compensation is determined. The
plan itself, however, must report an actual
amount, usually an estimate of fees based on
that same formula.
On the other hand, eligible indirect
compensation does not have to be reported,
by either the plan or provider. All that the
new rules require is a statement from the
service provider that it did receive such
eligible indirect compensation.
So what is eligible indirect compensation?
Generally, it includes fees or expense
reimbursement payments charged to
investment funds and reected in the value
of the investment or return on investment
of the participating plan. It may also come
in the form of plan participants nders
fees soft dollar revenue, oat revenue,
and/or brokerage commissions or other
transaction-based fees for transactions or
services involving the plan, but that were
not paid directly by the plan or plan sponsor
(whether or not they are capitalized as
investment costs).
This alternative disclosure option is
available as long as a few criteria are met.
However, a primary source of confusion
regarding the eligible indirect compensation
option concerns the written disclosure
requirements that trigger the classication
overall. For example, a provider does not
ofcially get eligible indirect compensation
treatment unless certain written disclosure
requirements are met. The plan must have
received written materials that disclosed
and described the existence of the indirect
compensation, the services provided in
exchange for the payment of indirect
compensation, the amount (or estimate) of
the compensation or a description of the
formula used to calculate the fees owed,
and the identity of the parties paying
and receiving the compensation. Written
disclosures for a bundled arrangement
must separately disclose and describe each
component of indirect compensation that
would be required to be separately reported
if the provider were not relying on this
alternative reporting option.
The bottom line is if the plan receives
adequate disclosure that meets the rules
written disclosure requirements, it does not
have to report the amount of the eligible
indirect compensation paid to a service
provider on Schedule C, just that such fees
were in fact paid out. Additionally, this
alternative reporting option for eligible
indirect compensation can be used to report
compensation paid or received in separately
managed investment accounts of a single
plan. By its very instructions, Schedule C
states that eligible indirect compensation
includes fees or expense reimbursement
payments charged to investment funds and
reected in the value of the plans investment
or return on investments. The instructions do
not further dene the term investment fund
for this purpose, however, and the DOL has
stated that this term would include separately
managed accounts that contain assets of
an individual plan, as long as the other
conditions for this exemption are met.

Pre-2009
Limited to top 40 service
providers to be disclosed

Only 23 Service Codes to classify
reportable compensation

One total fee/commission
disclosed

Bundled Service Arrangements
fees reported as one fee
2009
No limit; all service providers making with over $5,000 in
fees and/or commissions to be disclosed
Fiduciaries and enumerated service providers with over
$1,000 in indirect fees must also be disclosed
Increased number and denitions of
Service Codes
Bundled Service Arrangements fees reported as one fee
Fees broken down by type:
Direct: Payments made directly by the plan or plan
sponsor for services
Indirect: Received from sources other than directly from
the plan or plan sponsor if received in connection with
services rendered to the plan during the year
Eligible Indirect Compensation
Bundled Service Arrangements fees
reported separately by type:
Direct payments may be reported as direct compensation
Indirect compensation must be reported separately
New section to disclose noncooperative service providers
Pre-2009 vs. 2009
The following summarizes the broad changes that the new rules put into efect versus
pre-2009 rules (Source: Atessa Benets, Inc.).
What Plan Sponsors
Should Do
Because plan sponsors take the ultimate
responsibility for the information reported
on Form 5500, they should make sure
that service providers are aware of the
increased disclosure requirements and are
prepared to disclose both direct and indirect
expenses, beginning with the 2009 plan year.
Additionally, all methodologies should be
discussed in advance with audit rms for
supportand, potentially, ERISA attorneys
for guidance when necessary. As with any
rst-year regulatory changes, additional
planning and discussions with their service
providers, ideally with all parties collectively
represented, is the path to success.
For more information, please contact
Peter Donatio, Executive Director, Fund
Accounting and Administration at 617-223-
9147 or peter.a.donatio@jpmchase.com

1 Source: The SPARK Institute.
2. Ibid.
3. The SPARK Institute: Analysis of Form 5500 Schedule
C Reporting Survey Results, by Larry H. Goldbrum, March
24, 2009.
CASH FORECASTING
The more fragmented an organizations cash, and the more
custodians and brokers involved, the more onerous it can be
to identify and extract individual cash positions to create an
investable balance forecast. The forecast needs to be available
at the very start of the cash trading day when market
liquidity is high and the best rates can be achieved. Yet it
also needs to take into account same-day activity such as
derivatives margin requirements, foreign exchange and cash
aggregation standing instructions.
FOREIGN EXCHANGE EXECUTION
Minimizing idle balances in nonfunctional currencies will
maximize cash investment opportunities. And its clear that
netting all FX requirementsboth trade funding and asset
entitlement-basedcan achieve better pricing. However, it
can be cumbersome to execute the additional transactions
required and to aggregate all FX deal ow in order to take
advantage of available netting opportunities.
CASH CONCENTRATION
An efcient and effective cash mobilization and funding
process for balances held at multiple providers demands
time-critical processing power. It also requires the ability to
both ensure that available liquidity is directed wherever and
whenever it is needed to fund trading activity, and to pre-
position all inbound excess funds for investment.
CASH INVESTMENT
Aggregating investable balances allows for the consistent,
systematic application of investment guidelines across all
funds, and is the key to optimizing yields and controlling
counterparty exposures. This level of yield enhancement
and control requires time-critical, multiregional trading and
settlement expertise; access to trading relationships; broad
THESE ARE JUST SOME OF THE PRESSURES facing
investment managers as they plan their responses to a post-
nancial crisis world. And they apply to the management of
liquidity just as much as they do to investment in securities
and derivatives.
In todays tough market environment, where managers
need to demonstrate a robust approach to their duciary
responsibilities, getting cash management and investment
right is more important than ever. Getting it right, however, is
no easy task. While the key attraction of certain funds to end
investors is their simplicity, the funds trading, settlement and
safekeeping infrastructures can be anything but. The often
complex cash account structures scattered across custodians,
payment banks and prime brokers can be a silent enemy to
efciency, transparency and investment performance.
For many investment managers, a strategic review of
liquidity management can identify costs to strip out, ways
to mitigate operating risks and opportunities to deliver real
additional investment performance. However, the effective
implementation of anything more than a rudimentary
centralized investment strategy when cash balances are
scattered across multiple providers, currencies and funds can
seem like a daunting heavy lift.

The Heavy Lift
Whether investment managers currently monitor and
invest cash themselves, or let those processes rest with their
individual providers, the same market challenge remains:
When operating costs are under pressure, how do you
release more value from your cash balancesand assume
greater control over the liquidity management and cash
investment process?
Deliver investment performance when interest rates are at historic lows
Increase control and reduce operating risks
Focus on new priorities and reduce costs
Releasing the Value of Cash
instrument choices; and a robust and effective process for
monitoring counterparty credit risk.
As if that isnt enough, the impact of all the FX, cash
concentration and cash investment activityincluding
individual fund allocations and exposuresneeds to be
accurately reected in front-ofce trading and investment
accounting records, and ready for the next day.

Releasing Value, Increasing Control
Through a new offering known as Institutional Treasury
Management, J.P. Morgan seamlessly integrates the
individual processes critical to achieving effective liquidity
management. This dynamic, end-to-end solution combines
our market-leading foreign exchange, liquidity management
and agency cash investment capabilities. It helps investment
managers release the value of their cash balances, even if held
across multiple providers.
We work with clients to set parameters for controlled
execution of the cash management process, enabling them
to turn over to us many of the associated time-critical
operational tasks and risks. Despite relinquishing these day-
to-day activities, clients can gain greater visibility and control
over the entire process, and can more effectively dene and
implement their cash strategy.
J.P. Morgan is uniquely qualied to do this heavy lifting.
As a provider of middle- and back-ofce processing for
investment managers, we have the information and
infrastructure to create a unied cash position as a basis
for cash forecasting, centralizing FX execution, cash
concentration and cash investment.
However, investment managers do not need to use
J.P. Morgan as their investment operations provider to be able
to take advantage of this capability. The Institutional Treasury
Management model can also be driven by J.P. Morgans
custody records, augmented with information provided by
the investment manager at the start of the day.
Institutional Treasury Management offers many benets:
Centralized FX execution, which maximizes netting
opportunities and minimizes idle balances in
nonfunctional currencies.
Cash concentrated into major functional currencies to
optimize investable balances and minimize single provider
concentration risk.
Improved risk-adjusted investment returns resulting
from better rates applied to consolidated cash balances.
Consistent application of tailored investment guidelines
by global, expert trading desks, and the ability to
implement changes in investment policy quickly, as
required.
Access to the research capabilities of J.P. Morgan
Asset Management for the monitoring of investment
counterparty credit quality.
Increased transparency through integrated reporting,
coupled with investment accounting feeds, to ensure that
rates, performance, exposures and accruals can be tracked
at all levelsfrom individual cash account through to total
group portfolio.
Fully automated processing, helping to reduce execution
errors and operating costs.
The opportunity to mobilize other cash typescorporate
balances, subscription and redemption oat, etc.and to
invest them in the same structures with the same level of
control.
J.P. Morgan is dedicated to working with clients to design a
customized framework to help them improve performance
and meet everyday business challenges. From forecasting
and FX to cash concentration and investment, Institutional
Treasury Management gives investment managers a practical
way to deliver the sustainable value of cash, and ensure
that liquidity management both supports and enables their
strategic business goals.
Institutional Treasury Management: A Four-Step Process
Cash Forecasting
Builds a reconciled, intraday
cash forecast to drive the daily
treasury management process.
Foreign Exchange
Centralizes FX execution,
maximizes netting
opportunities and reduces
idle balances in nonfunctional
currencies.
Cash Concentration
Mobilizes and centralizes
major currencies to maximize
investable balances and
minimize concentration risk.
Cash Investment
Optimizes cash yields and
controls counterparty
exposures through centrally
managed investment
guidelines, active monitoring
of counterparties and
consolidated reporting.
Managing credit risk remains a top priority of
nancial institutions and corporations, thrown
into sharp focus by recent market events. As
participants in OTC derivative transactions
come under increasing pressure to mitigate
counterparty risk, many have returned to the
original risk management tool: collateralization.
The use of collateral in OTC derivatives has
grown dramatically over the past eight years.
While it is unclear how potential regulatory
changes will impact this trend, the number
of collateralized derivative trades is expected
to show consistent growth. Demands for
more frequent reconciliation and access to
pricing utilities are adding new levels of
complexity to the additional volume. These
trends create a clear need for more advanced
collateral management platforms to replace the
increasingly stressed and outmoded spreadsheet-
based systems.

The Impact of Regulatory
Changes on Use of Collateral
The widely anticipated regulatory changes
are likely to have some impact on the use of
collateral in OTC derivatives trading. A move
toward central clearing for standardized OTC
instruments, for example, would eliminate
the need for some trades to be collateralized
bilaterally. As the vast majority of OTC
positions are not standardized, however, such
measures would be unlikely to seriously reduce
collateral use.
Ahead of such regulatory change, the nancial
industry has taken a proactive stance towards
mitigating counterparty risk. In its June letter to
the Federal Reserve, International Swaps and
Derivatives Association (ISDA) dened three
key pillars for collateral management:
To rapidly put in place robust Portfolio
Reconciliation practices to detect signicant
trade population and valuation differences
C
o
l
l
a
t
e
r
a
l

R
i
s
i
n
g
Managing Counterparty
Risk with OTC
Derivatives Collateral
Management
Rapid Growth
in the Use
of Collateral
to Manage
Counterparty Risk
Both the number of collateralized OTC
trades and the total volume of collateral
in circulation increased steadily from
2003 through 2008. According to a
survey by the International Swaps and
Derivatives Association (ISDA), the
percentage of trades collateralized rose
from 30% to 59%, while the collateral
volume grew 60%. This trend rapidly
accelerated as recent events increased
the focus of counterparty risk. Estimated
collateral in circulation will increase
86% this year to $4 trillion (greater
than the GDP of Germany). While this
may well represent a near-term peak,
an upward drift in the use of collateral is
expected.
that could give rise to disputed collateral calls.
The Fed 16 dealers have already made strides
towards reconciling portfolios on a daily basis.
To set out a Roadmap for Collateral
Management focusing on independent
amount risk issues; electronic
communications that will standardize
margin calls; portfolio reconciliation;
CSA review; and the development of best
practices for collateral management. Many
of these recommendations are on track for
implementation by year-end.
To develop a new Collateral Dispute
Resolution process for the industry.

Collateral Management
Is Growing in Complexity
as Well as Scale
While mitigating counterparty risk, several
of the ISDA recommendations place greater
demands on collateral management systems.
Daily portfolio reconciliations alone necessitate
more robust collateral management capabilities.
Over time, the ability to sustain continued
growth and understand counterparty risk on a
global basis will require greater interoperability
-- signicantly reducing the ability of collateral
systems to remain in silos. Ultimately, these
interconnections will promote enterprisewide
collateral management.

Moving Toward Interoperability
and Standardization
Recognizing that community solutions are
inherently stronger than private solutions,
there is a strong move towards the use of peer-
to-peer platforms in portfolio reconciliation.
These platforms provide counterparties with
common views of each others data, allowing
desks to conrm trades and resolve valuation
issues. They may also serve as an early
warning system for systemic patterns of trade
population and valuation discrepancies. During
a recent J.P. Morgan OTC Derivatives Collateral
Management Forum held in New York, the
importance of shared data was a key topic of
discussion. With shared data, desks can clean
up the discrepancies stemming from timing and
data source issues, clearing the way to identify
areas of genuine dispute. Standardized margin
messaging would increase automation options
and enhance speed.
The peer-to-peer platforms may also play a role in
resolving discrepancies. In addition to providing
an early-warning system, the platforms ability to
aggregate data from over 70% of all non-cleared
OTC trades provides precedent to assist with
difcult valuation issues.

A Clear Need for More Robust
Systems and Experienced
Management
According to Colm Gaughran, Global Product
Manager for Derivatives Collateral Management
(DCM) at J.P. Morgan, We increasingly see that
spreadsheet-based operations cannot keep up
with increasingly sophisticated demands of OTC
derivatives collateral management. Replacing
such systems, however, requires a substantial
investment from already constrained IT budgets.
A limited pool of qualied professionals further
hinders the ability of many institutions to
upgrade their collateral management systems.
In the face of such challenges, J.P. Morgans
fully-outsourced DCM solution is a proven and
attractive alternative to internal solutions. This
scalable solution offers the ability to reduce
counterparty risk while minimizing new
operational risk. It enables interoperability,
provides links to peer-to-peer utilities, and
even supports the future direction of daily
reconciliation without requiring any substantial
IT investment.
While regulation will clearly evolve, the use
of OTC derivatives as an essential tool to
control investment risk is expected to grow.
Collateralization will continue to play an
increasingly important role in mitigating the
counterparty risk of these transactions. Together,
these imperatives reinforce the need for a
robust, transparent and scalable OTC derivatives
collateral management program.
J.P. Morgans forums bring market participants
together to discuss the latest industry trends
and developments. To learn more about our
Derivatives Collateral Management solution,
please contact: Sales: Darren Measures at 212-623-
5143 or Russell Pudney at 44-(0)-207-777-5888;
Product: Colm Gaughran at 44-(0)-207-777-0473.
Growth of Value of Total
Reported and Estimated
Collateral 2000-2009
($ millions)
2001
2002
2003
2004
2005
2006
2007
2008
2009
n Reported
n Estimated
Source: ISDA, 2009
145
250
289
437
491
719
707
1,017
854
1,209
922
1,329
924
1,335
1,470
2,126
2,600
4,100
The discussions are being held in both international fora,
such as the G-20, as well as at the national level, particularly
in the United States, European Union and United Kingdom.
And, while there is agreement among governments on the
need for changes to regulatory structures, the details of these
changes are proving more complicated.
While the implications for regulatory reform are global,
the decisions are being made at the local level. Politicians
in the U.S. Congress, the parliaments of EU member states
and elsewhere will ultimately decide the fate of many of the
ideas currently being advanced to reshape the regulatory and
supervisory structures that govern the nancial system.
Because of the uncertainty inherent in these political
processes, JPMorgan Chase & Co., our customers, business
partners and investors around the world have to carefully
monitor unfolding events and prepare for different possible
outcomes. JPMorgan Chase & Co.s International Government
Relations team, working out of Washington, New York and
London, with partners across the rms key markets, is
actively engaged in the reform efforts. This summary offers
a brief analysis of the major issues under consideration, and
points out some of the key areas for stakeholders in the global
markets to follow in the weeks and months to come.

Systemic Risk
While systemic risk mitigation is one of the key regulatory
issues on the agenda, achieving satisfactory systemic risk
oversight and regulation remains a challenge.
In the United States, the Obama administration
has proposed to have the Federal Reserve supervise
systemically important institutions, while a Financial
Services Oversight Council (FSOC) made up of the key
nancial regulators is created to ll supervisory gaps,
facilitate cooperation of policy, resolve regulatory disputes
and identify emerging risks. Under this proposal, all large,
interconnected nancial services rms (including hedge
funds, private equity, insurance, broker-dealers and banks)
that are systemically important will be labeled Tier 1
Financial Holding Companies (FHCs) and will be subject
to consolidated supervision by the Federal Reserve. Tier
1 FHCs will have higher capital requirements and more
robust supervision of liquidity and risk management
structures. The administration has also proposed wider
resolution authority, with the FDIC generally still
appointed as conservator/receiver and some authority
being extended to the SEC.
These proposals have garnered signicant pushback from
legislators in both U.S. political parties and even from other
regulators. Their primary criticism is that these reforms
place too much power in the Fed, which some see as having
been ineffective in the current nancial crisis, and which
could potentially be a distraction from its main role of
monetary policy.
In Europe, a proposed new Systemic Risk Board (ESRB)
would be tasked with analyzing information relevant to
nancial stability and issuing early risk warnings. The EU
has also proposed a new System of Financial Supervisors
(ESFS) that will serve as a coordinator of the national day-
to-day supervisors. The key issue in the EU appears to be
whether this gives Brussels enough authority to handle
cross-border supervision.
Globally, the Financial Stability Board (FSB) has
released principles for cross-border cooperation on
crisis management. These include developing common
support tools, encouraging the development of wind-
down procedures and sharing information on systemic
implications.

The global nancial crisis has sparked unprecedented eforts to reform
and modernize regulatory and supervisory structures.
TheChanging Global Regulatory Environment
Consumer Protection
Another key issue in the debate is ensuring adequate
protections for consumers. On this issue, the Obama
administration has proposed the creation of a Consumer
Financial Protection Agency (CFPA) that would have broad
authority, including enforcement powers, to ensure that
consumer protection regulations over nancial products are
written fairly and enforced vigorously. The proposed CFPA
is designed as an independent agency with stable and robust
funding to serve as the sole rule-maker for consumer nancial
protection statutes. Supporters believe it will reduce gaps in
supervision and enforcement, improve coordination with
states and promote consistent regulation of similar products.
The CFPA would also approve so-called plain vanilla
products, which nancial institutions would be required to
offer consumers.
This controversial proposal has led to signicant debate.
Members of the U.S. Congress, as well as outside stakeholders,
are questioning the need for a new agency, as well as the
breadth and scope of the consumer protection powers
vested in the federal government under the administrations
proposal. While the White House and several key leaders
in Congress seem intent on establishing a CFPA, there is
signicant ongoing discussion about the agencys powers,
particularly concerning preemption, enforcement and the
ability of the government to dene products that lenders
must offer.

Regulating the Unregulated
Global proposals also address areas of the markets that have
historically been either lightly regulated, such as the over-
the-counter derivatives markets, or unregulated, such as
hedge funds.
Entities: In the United States and in Europe, there are
proposals to require hedge funds, private equity and other
private pools of capital, and venture capital rms to register
with regulators. In Europe, this has raised signicant debate.
The EU has also gone further, requiring capital standards
for larger rms and mandating that funds outside the EUs
jurisdiction meet standards set by the EU (with a three-year
grace period) if they want to
market their products in the EU.
Products: Under the Obama plan,
all standardized OTC derivatives
would be cleared through a
central counterparty (CCP), while
customized derivatives would
be subject to higher capital and
margin requirements. In Europe,
the key focus has been on credit
default swaps (CDS), with a mandate that EU entities be
cleared through EU-based central counterparties. This push
to standardize and clear derivatives transactions has been
supported by the industry and is largely in line with the
thinking of the G-20, which has asked the industry to develop
a standardization plan.
However, these proposals have raised a number of concerns
for the end users of derivatives as well as the institutions that
facilitate the transactions. In the United States, proposals
that sought to require end users to face a CCP faced intense
criticism. As a result, the House Financial Services Committee
announced a moderated agreement that does not impose a
CCP requirement. An outstanding concern among end users
is the extent to which capital requirements for customized
products are signicantly higher and consequently increase
the costs of hedging activity. At the international level, some
countries are contending that portions of the European plan
are nationalistic and could pave the way to protectionism.
TheChanging Global Regulatory Environment
While there is agreement
among governments on
the need for changes to
regulatory structures, the
details of these changes are
proving more complicated.
Over the last 10 years, Europe has witnessed a radical
overhaul of nancial regulation. The Lisbon strategy,
launched in March 2000, aimed to make Europe the most
dynamic and competitive knowledge-based economy in
the world. Why? Because Europe was lagging the United
States and the position was worsening: in 1995, European
output per hour was 94% of the U.S. level and by 2003 it
had declined to 85%. In 2002, euro area per capita GDP was
a full 30% lower that of the United States. The European
Commission (EC) thus began a series of legislative measures
designed to improve European capital markets and contribute
to the achievement of Lisbons lofty goals.
Nearly 10 years on, we are emerging from a nancial crisis
worse than most of us have ever seen. The incoming Swedish
presidency of the EU stated in June that it wanted a new,
more focused and more efcient Lisbon strategy for growth
and jobs. While the ink is barely dry on many of the nancial
reform measures, the nancial crisis is prompting global
regulatory changes. Much has been achieved, but that could
be at risk if change is ill-conceived.
One of the biggest European success stories is UCITS,
1

a major and lasting testament to the vision of the single
European market. The UCITS
2
framework has evolved since
1985, now recognized far beyond Europes borders. Indeed,
most in the asset management industry would agree that
UCITS has become a major brand in its own right.
We must preserve...the integrity of the UCITS Kitemark,
ensuring at all times that investor protection is not
compromised, said EU Internal Markets Commissioner
Charlie McCreevy in March 2008.
The UCITS framework was last amended under the auspices
of what is known as UCITS III, which widened the range of
eligible assets to include, for example, derivatives and money
market instruments. Widening its scope has proved to be
a boost to the asset management industry, enabling more
sophisticated investment strategies and encouraging new
entrants, such as hedge funds.
Now, UCITS IV sets out to promote efciency
3
and address
some of the structural shortcomings of the market. UCITS
THREAT OR OPPORTUNITY?
REGULATION OF COLLECTIVE FUNDS
IV should complete a cycle of adjustment and change that
readies European regulated mutual funds to become the
global standard
4
for collective investment. It will go into
effect in July 2011.
The Directive itself, known as Level 1, has been passed by
the European Parliament. Level 2 implementing measures
will ll in more of the detail, but its fair to say most in the
asset management community welcome this set of changes,
perceiving them as an opportunity and a good example of
enabling regulation.

Overview of UCITS IV
UCITS IV will provide:
A framework for fund mergers on a cross-border basis
Master feeder arrangements from 85% to 100%
investment
Electronic regulator-to-regulator notication
Simplied prospectus replaced by Key Investor
Information
Improved co-operation between national supervisors
Management Company Passport
FUND MERGERS
The framework for fund mergers recognises both cross-
border and domestic mergers. However, the complex issue of
taxation is not addressed, and this is likely to be a stumbling
block. However, it should encourage fund groups to
rationalise their ranges and potentially eliminate duplication.
MASTER FEEDER
This may be the most effective of all the Directives
provisions in the short term, although it may lead to a
resurgence of the fund proliferation
5
phenomenon. A
minimum of 85% of a feeder must be invested in the master
and the other 15% may be invested in derivatives for hedging
purposes only.
6
This structure calls for agreements on
information sharing between depositaries and auditors of the
participating entities.
MANAGEMENT COMPANY PASSPORT (MCP)
This proposal was the subject of much political wrangling.
Under the original UCITS directive, a fund, its depositary
and its management company had to be located in the same
member state. The MCP should permit a management
company in a member state to manage the asset of a UCITS
in another member state. The management company must
comply with the requirements of the member state of the
UCITS itself.

The Road Ahead
Much remains to be done to reinforce UCITS success.
A recent Think Tank Report
7
made a series of
recommendations, includingcruciallya call for mutual
funds to be the cornerstone of future pan-European
retirement savings products. This could take European
mutual funds into a new phase of signicant growth,
mirroring the impact of 401(k) on the U.S. mutual fund
industry. The aging population in Europe is one of the biggest
challenges Europe faces, and urgent action is called for. The
very simplicity and transparency of mutual funds should
make them a natural contender for leadership in addressing
this challenge.
However, UCITS IV is on its way against a difcult backdrop,
given the fallout from the nancial crisis.
One recent piece of draft legislation is the draft Directive
on Alternative Investment Fund Managers. This set of
proposals has caused an outcry from a wide spectrum of
the industry. The draft catches managers of all non-UCITS
collective investment undertakings, including hedge and
private equity funds. While few would doubt there are good
intentions embedded in the
draft (e.g., investor protection
and improved transparency),
there are legitimate concerns
that many alternative managers
may be driven out of Europe
altogetherthey are, after all,
mobile and play on the world
stagebut that would be a
heavy price to pay. In addition,
it is not clear that non-EU hedge funds would continue to be
available to European institutional investors such as pension
funds and insurersagain an undesirable outcome.
In addition, although the Directive is aimed at the regulation
of alternative managers, provisions concerning depositaries
have implications for UCITS and the Commission is
consulting on plans to align the requirements. Many trade
associations are concerned that changes to depositary rules
could have serious negative consequencesin particular,
signicantly increased costs and reduced investor returns,
as well as a potential reduction in the choice of markets
available to institutional and retail investors. Lobbying at the
national and EU levels is seeking to make the Directive
a more workable one that does not threaten the industry
and indirectly harm investors. Serious thought needs to be
given to how these changes will impact the diverse product
models across Europe and their investors.
It is vital that all the advances that have been made in
European nancial market reform over the past few years
not be lost: a measured approach is called for, and one that
carries the industry and the interests of investors at its heart.
1. UCITS: Undertakings for Collective Investment in Transferable Securities.
2. Council Directive 86/611/EC.
3. Around two thirds of Europes mutual funds have assets of less than 50
million.
4. UCITS are ve times smaller than U.S. mutual funds and twice as expensive
to manage.
5. Europe has over 30,000 mutual funds; the United States has 8,900.
6. The feeder can calculate its total derivatives exposure by combining its own
exposure either on a look-through basis with the actual exposure of the master,
or with an assumed maximum exposure based on the fund rules of the master.
7. Building Long-Term Savings in EuropeThe Case for Europe.
One of the biggest European
success stories is UCITS, a
major and lasting testament
to the vision of the single
European market.
Sheenagh
Gordon-Hart
Executive Director,
Head of Regulatory
Strategy and
Research
to create a global framework for
automation throughout the funds order
life cycle. This extends into the hedge
fund sector, where the SWIFT Sharp
initiative is central to the industrys
drive for automation.
With these core components in place,
J.P. Morgan is leveraging them to deliver
end-to-end automation and control.
This dramatically increases efciency
and reduces risk for mutual funds and
hedge funds, from order placement
through conrmation, settlement and
asset servicing.
This removes the dependency on
fax-based communication that is still
widespread in the fund processing life
cycle.

Zero Tolerance for Faxes
As an industry, we have been trying to
remove faxes from the trade life cycle
ever since they were introduced, but they
are remarkably resilient. You can remove
them from one part of the processing
The case for automation is simple and
compelling:
Automation is a (arguably the)
fundamental driver for control and
efciency.
Control equals risk mitigation.
Efciency equals improved margin.
A simple hypothesis, but it is a useful
starting point from which to examine
automation as a catalyst for signicant
change.

Funds Automation
Investing in funds lacks the automation
and standardisation that have evolved
over time in the equities settlement
space, but now there are real
opportunities for global automation of
funds orders. The industry adoption
of SWIFTNet (ISO 20022) messages,
the overhaul to settlement practises
in the U.K. funds market, the opening
up of the NSCC charter to non-U.S.
institutions and the automation offered
by funds platforms are all aligning
At the risk of stating the obvious, the market conditions we have faced over the past
12 months have been unprecedented, and one needs to look hard for any positives to
have come out of this period. One positive result is that global custodians are, again,
leading the charge in the drive for automation.
Custodians to Drive Automation in
the Quest for Control and Efciency
Lee C. Adams
Executive Director,
J.P. Morgan Global Custody Services
chain, client segment or region and they
pop up somewhere else.
The importance of removing faxes was
once again brought into sharp relief
last year with the collapse of Lehman.
To react quickly to seismic movements
in the market, it is imperative that
automated methods of communication
be employed, facilitating electronic
receipt, monitoring, transmission and
management.
To rid ourselves of faxes we need to
understand why they are still being
used, given that the risk and cost of
using them is self-evident. Following
is the supposed case for the defence of
faxes (together with the case against in
italics):
1. Faxes are exible (e.g., if an
instruction does not t a standard
template, a fax can be used to cover
the nuances). This increases the
potential of an instruction being
misinterpreted.
2. Faxes can be easily routed to a
specic address (pointing at a fax
machine on a desk). Instructions
should be centralised in a secure,
controlled environment.
3. Faxes are a cheap form of STP. Auto-
fax capability enables the sender to
create the illusion of STP by adding
manual processing by the fax receiver.
At J.P. Morgan, we are committed to
secure, electronic communications
between all participants, zealous in our
drive to remove faxes by:
Proactive adoption of market
standards which promote STP,
and using appropriate tools such
as SWIFT STaQS to monitor and
optimise STP levels.
Providing a wide range of options
for STP to our clients, including
our Web-based banking platform
(J.P. Morgan ACCESS
SM
) and
comprehensive SWIFT support
(including SWIFT Lite to provide
online SWIFT messaging for low-
volume users).
Working in partnership with clients
to facilitate the conversion to
appropriate electronic methods.
With the options of proprietary and
SWIFT-provided platforms readily
available, it is difcult to imagine
framing an argument for the continued
use of faxed trade instructions. The
goal of zero tolerance for faxes is
a tall order, but the risk associated
with fax processing should make
them unacceptable in any transaction
processing environment. The focus
must be on properly implementing the
wide range of options that now exist, to
the point where zero fax is a statistic
rather than an aspiration.
J.P. Morgan
Global Custody Services
J.P. Morgan provides custody and
securities servicing solutions to the
worlds leading institutional investors,
including mutual funds, insurance
companies, pension funds and banks.
Assets under custody are currently
valued at USD 13.7 trillion. With 25
regional operational, technology and
customer service centers, providing
clients with the full range of custody
and securities servicing products
across all time zones, services are by
underpinned by state-of-the-art client
reporting and systems capabilities.
By taking a solution-based approach to
global custody, J.P. Morgan helps clients
maximize processing efciency within
a robust, controlled, automated and
information-rich environment. With
ofces in each region of the world and
a network of subcustodians covering
more than 90 markets, J.P. Morgan helps
clients meet the challenges of cross-
border investing and actively promotes
global standards for efciency and risk
management.
Best Practices
High-prole hedge fund fraud has changed the
level of due diligence key investors will perform
prior to making signicant allocations to single
manager and fund of hedge fund managers.
Industry best practices have always stressed
the need for alternative investment managers
to engage a reputable third-party administrator.
Today, there is increased scrutiny on ensuring
the administrator is performing the necessary
level of service to meet investor demands and
promote condence that the fund manager is in
line with industry best practices.
We are experiencing a shift in the nature of
what constitutes hedge fund best practices in
the areas of fund administration. The recent
fraud cases are pressuring hedge funds to
engage third-party administrators to provide
a more comprehensive fund administration
services. The objective is to instill investor
condence through working with a reputable
service provider that is independently
reconciling activity, substantiating fund assets
and pricing fund assets. Hedge fund managers
and their investors are looking to perform
more detailed due diligence on third-party
administrators to ensure the service provider
has the ability to provide required level of
service to meet best practices.
Third-party hedge fund administration is
now the focal point of discussions between
hedge fund managers and their investors.
for
Third-Party
Hedge Fund
Administrators
The core services most fund administrators offer
involve the following:
reconciliation and substantiation of cash,
trades and positions to all prime brokers and
other counterparties
pricing of holdings including OTC derivatives
fund level accounting and striking of NAV on
dealing dates
maintenance of investor registry, preparation
and distribution of investor statements
performing AML/KYC for onshore and
offshore entities on investor base
The functions listed above are dependent
on a host of operational workows needed
to be executed properly on a daily basis. As
complexity increases, these workows can
become quite onerous, especially in the areas
of reconciliation and fund-level accounting. For
example, how many side pockets does a master
fund have or how many OTC counterparties
does the administrator need to reconcile
to in addition to traditional prime broker
relationships?
As recently as a few months ago, the industry
deemed it acceptable for hedge funds to self
administer or engage a third-party administrator
to perform a water downed version of
administration such NAV Lite. Clearly, the
investor community is now questioning these
once accepted practices. Hedge fund managers
are reacting quickly and forming strategic
partnerships with third-party administrators
to expand the scope of services provided to
their funds. Self-administered funds are now
performing more detailed due diligence prior to
selecting an administrator.
This can start with analyzing the nancial
strength of the administrator and its culture
around fostering a strong control environment.
Managers and investors are examining whether
the administrators nancial stability is viable
to mitigate any risk of having to convert the
books and records due to the insolvency of
the administrator. One element that receives
particular attention is the control environment
and the framework around how business
risks are managed. This goes beyond merely
conrming the administrator has a SAS 70 in
place. Managers and investors have begun to
interview accounting, operations and investor
services managers in an effort to understand
how client deliverables are prepared, reviewed
and distributed to clients. In addition, it is critical
to understand how key operational functions, such
as cash movements at the fund level are originated,
validated and conrmed.
A major concern for self-administered funds is
releasing or losing control of many core processes,
especially in the area of investor services. To
address this concern fund managers can agree
a responsibilities matrix in partnership with
the administrator to clearly dene what tasks
will remain with the manager and what will be
outsourced to the administrator. For example,
performance-related questions, or investor inquires
regarding the monthly statement, in many
instances are directed to the manager and not the
administrator.
The fund manager should be focused on identifying
how the administrator is organized functionally and
who it will be interacting with on a daily basis
meaning, are there multiple points of contact or
a single contact for escalating any service-related
issues. In addition, the managers are increasingly
reviewing the proles of the individuals that will
be assigned to their relationship. To ensure work
experience and tenure within the industry is
adequate to meet service-level requirements specic
to the hedge fund manager.
From an infrastructure and technology perspective,
self-administered funds typically will look to
continue to run most functions in-house and run
a parallel set of books and records. As hedge funds
move away from a self-administration environment,
it is important to understand how the administrator
will capture trading activity, reconcile data and
also source pricing. The manager should strive to
leverage existing infrastructure and create workows
that can assist the administrator in increasing the
ability to STP most trading activity on a daily basis.
Engaging a third-party administration relationship
should be considered a partnership. In essence, the
administrator is truly an extension of the clients
middle and back ofce, and the ability to leverage
respective technology platforms can improve the
monthly frequency of NAV turnaround.
There is increased scrutiny on ensuring the administrator is
performing the necessary level of service to meet investor
demands and promote condence that the fund manager is
in line with industry best practices.
In June, the House Education and Labor Committee announced a bill (H.R. 2989) that, among
other provisions, provides (limited) dened benet (DB) plan funding relief. Here we review
the key elements of the bill, as well as recent IRS guidance related to the bill.
Allow Sponsors to Reelect a Smoothed
Yield Curve for 2010
The combination of new, stricter Pension Protection Act
(PPA) DB funding requirements and the fourth quarter 2008
nancial downturn (and related decline in asset values) has
put considerable stress on many DB plan sponsors. And,
obviously, that stress is in addition to the stress put on those
sponsors businesses generally by the nancial crisis.
In March, the Internal Revenue Service stated that it will
allow, for 2009, the use of spot rates for any of the ve
applicable lookback months (rather than only for the month
preceding the valuation date) to value 2009 dened benet
plan liabilities. Under this approach, calendar year plans can
use the October 2008 PPA full yield curve for 2009 valuations,
signicantly reducing 2009 funding requirements. For many
sponsors, this rule xes DB funding concerns for 2009.
At the time H.R. 2989 was introduced, however, it was not
clear if the IRS would allow a switchback to smoothing for
plans that used October 2008 spot rates to value liabilities
for 2009. H.R. 2989 would have provided for such a
House Education and Labor Committee
Proposes DB Funding Legislation
switchback, one time, in 2010. Since then, plan sponsors got
that additional relief. In late September, the IRS announced
that sponsors will be allowed, for 2010, to switch back
to 24-month valuation interest rate smoothing. Doing so
could be benecial in a couple of ways. First, smoothing
generally enhances predictability, reduces volatility and
increases companies ability to plan. And second, in this
particular case, smoothing will allow consideration, again
(in the 24-month average), of the super-high October and
November 2008 interest rates.

Reasonable Interpretation for 2009
The IRS has proposed rules implementing new PPA DB
funding requirements, but it is not known when those rules
will be nalized. There are a number of controversial areas,
and a number of areas where practitioners generally regard
the approach taken by the IRS as impractical. In Notice
2008-21, the IRS allowed (with certain limits) sponsors
to adopt a reasonable interpretation of PPA rules for
compliance in 2008.
Brian
Donohue, FSA
Managing Director,
Compensation and
Benet Strategies
Heres the key language:
For plan years beginning during 2008, taxpayers must
follow applicable statutory provisions and can rely on the
proposed regulations for compliance with those statutory
provisions. Taking into account [certain specic rules
provided in the notice], the Service will not challenge
a reasonable interpretation of an applicable statutory
provision under [new PPA funding rules] or [new PPA
funding-based benet restriction rules] for plan years
beginning during 2008.
With regulations still not nalized, a question remains about
compliance in 2009. H.R. 2989 would, in effect, extend this
reasonable interpretation treatment to include 2009. It also
provides that the effective date of nal regulations can be no
earlier than 2010.

Investment Expenses Not Part
of Target Normal Cost
Included in the Worker, Retiree, and Employer Recovery
Act of 2008 (WRERA) was a requirement that a plans
target normal cost should be increased by the amount of
plan-related expenses expected to be paid from plan assets
during the plan year. After WRERA passed, a number of
practitioners raised questions about the application of this
provision, pointing out that investment-related expenses
have not historically been included as part of normal cost
and, further, may not be explicitly reected in trust returns
for some investments, potentially producing inconsistent
recognition of these costs for different investments. In
essence, while explicit investment-related expenses would
show up in current year funding requirements as part of
the target normal cost, implicit expenses would generally
be amortized over seven years. H.R. 2989 would provide
clarication that the WRERA provision intended to increase
normal cost by plan-related administrative expenses only.

Expanding the 4010 Gateway
PPA changed the rules for ERISA section 4010 reporting.
The old rule provided for a ling if at the end of the
preceding plan year the aggregate unfunded vested
benets of the DB plans of a controlled group of
corporations (considering only those plans which were
underfunded) exceeded $50 million. PPA replaced
that rule with a requirement for a 4010 ling if in the
preceding plan year the funding target attainment
percentage of a plan maintained by the contributing
sponsor or any member of its controlled group is less
than 80%.
H.R. 2989, essentially, adds to the new PPA test the old
pre-PPA test: that is, under the bill, you have to make a
4010 ling if you would have had to under either the
old test or the new one. The result: under the bill more
companies will have to make 4010 lings.
The combination of new,
stricter Pension Protection
Act (PPA) dened benet
funding requirements and the
fourth quarter 2008 nancial
downturn (and related decline
in asset values) has put
considerable stress on many
plan sponsors.
Collateral management has rapidly taken center stage for
nancial institutions seeking to efectively manage risk.
The nancial turmoil of 2008 highlighted the importance
of collateral management as an essential tool for managing
counterparty risk concerns associated with market activity.
Market Turmoil
Drives Growth
The use of collateral has grown
exponentially (often into new sectors)
as institutions ed unsecured activity
for more secure havens. According to
the 2009 ISDA Margin Survey, collateral
in circulation against OTC derivatives
grew year-on-year by 86% to an
astonishing U.S. $4.1 trillion.
At the same time, the various
disciplines comprising collateral
management now endure far closer
scrutiny. Liquidity and price volatility
of assets are keenly watched, as old
assumptions were market-tested in
2008often with surprising results.
Long-held preferences for xed income
securities were challenged when
liquidity left the market, while money
market funds, the traditional home
for cash collateral, proved unreliable
when many broke the buck. Frequent,
severe market uctuations limited
the effectiveness of haircuts, often
predicated on historical volatility
models that were suddenly invalid.

Implementation Brings
Challenges
Whether embracing or extending the
use of collateral, institutions are nding
that creating an integrated strategy is
one thing, but implementing it well to
achieve stated goals is quite another.
In its purest form, collateral is simply
an exchange of risk. Counterparty
exposure (or the possibility of default)
stems from the legal, operational,
and settlement risks associated
with collateral management. A well-
managed collateral program provides a
mechanism for controlling the newly-
exchanged risk, in contrast to the
counterparty default risk which cannot
be controlled.
For a certain period of time, those new
risks can be supported internally. At
some point, however, the institution
faces a critical choice: whether to invest
in the tools and technology necessary
to manage a collateral program that
has grown beyond spreadsheets and
Expanding Role, Increasing Complexity
manual processes/tracking, or whether
to engage a partner who can not only
support current needs but also provide
the infrastructure, expertise and
innovation to handle future growth and
expansion.
Several factors play into this decision:
the required technological and stafng
resources, the ability to sustain growth,
and the cost-benet analysis of building,
buying or outsourcing. Partnering with
a collateral agent is often the most
timely and cost-efcient solution for
an institution that expects its use of
collateral to increase.
If current trends continue, the
extension of credit that collateral
provides will spur additional business,
with collateral increasingly used to
defray the credit and counterparty risks
associated with transactions. Collateral
agents such as J.P. Morgan provide the
technology, infrastructure and expertise
that allow nancial institutions to focus
on their core activities, condent that
their agent is tightly controlling the
operational environment to efciently
manage process, cost and risk.
For further information regarding
J.P. Morgans Collateral Management
services in Australia, please contact Blair
Harrison +612 9250 4925 or e-mail
blair.harrison@jpmorgan.com
About JPMorgan Chase & Co.
J.P. Morgan Chase & Co. (NYSE: JPM), is a leading global nancial services rm with assets
of $2.0 trillion and operations in more than 60 countries. The rm is a leader in investment
banking, nancial services for consumers, small business and commercial banking, nancial
transaction processing, asset management, and private equity. A component of the Dow Jones
Industrial Average, J.P. Morgan Chase & Co. serves millions of consumers in the United States
and many of the worlds most prominent corporate, institutional and government clients
under its J.P. Morgan, Chase, and Washington Mutual brands. Information about J.P. Morgan
Chase & Co. is available at www.jpmorganchase.com.
J.P. Morgan is the marketing name for the investment banking business and certain commercial
banking businesses conducted by JPMorgan Chase & Co. and its subsidiaries worldwide.
JPMorgan Chase Bank, N.A. is a member of the FDIC. J.P. Morgan Securities Inc. (JPMSI) is a
member of the New York Stock Exchange and other national and regional exchanges, JPMSI is
also a broker-dealer with the National Association of Securities Dealers, Inc. and is a member
of SIPC. Worldwide Securities Services is a division of JPMorgan Chase Bank, N.A. Global
Derivatives Services, Hedge Fund Services, Financial Computer Software and Private Equity
Fund Services are all products and services offered by JPMorgan Chase Bank, N.A. J.P. Morgan
Tranaut is the marketing name for J.P. Morgan Tranaut Fund Administration Limited, which is
wholly owned by JPMorgan Chase Bank, N.A.
We believe the information contained in this publication to be reliable but do not warrant
its accuracy or completeness. The opinions, estimates, strategies and views expressed in this
publication constitute our judgment as of the date of this publication and are subject to change
without notice. This material is not intended as an offer or solicitation for the purchase or sale
of any nancial instrument. JPMSI or its broker-dealer afliates may hold a position, trade on
a principal basis or act as market maker in the nancial instruments of any issuer discussed
herein or act as an underwriter, placement agent, advisor or lender to such issuer.
In the United Kingdom (UK) and European Economic Area: Issued and approved for distribution
in the U.K. and the European Economic Area by J. P. Morgan Europe Limited. In the UK, JPMorgan
Chase Bank, N.A., London branch and J. P. Morgan Europe Limited are authorized and regulated
by the Financial Services Authority.
J.P. Morgan Asset Management does not make any express or implied representation or warranty
as to the accuracy or completeness of the information contained herein, and expressly disclaims
any and all liability that may be based upon or relate to such information, or any errors therein
or omissions there from. This material must not be relied upon by you in making a decision as
to whether to invest in the opportunities described herein. Prospective investors should conduct
their own investigation and analysis (including, without limitation, their consideration and review
of the analyses referred to herein) and make an assessment of the opportunity independently and
without reliance on this material or J.P. Morgan Asset Management.
In addition, prospective investors are strongly urged to consult their own legal counsel and
nancial, accounting, regulatory and tax advisers regarding the implications for them of
investing in these opportunities.
J.P. Morgan Asset Management is the marketing name for the asset management businesses of
JPMorgan Chase & Co. Those businesses include, but are not limited to, J.P. Morgan Investment
Management Inc., J.P. Morgan Investment Advisors Inc., Security Capital Research & Management
Incorporated and J.P. Morgan Alternative Asset Management, Inc.
Editor-in-Chief
Lahni Venable
Copy Editor
Doug McGrath
Contributors
Kimberly Bayer
Orla Kelly
Beth Mead
Ashley Ridenhour
Caren Rossi
Kerry Scire
Adele Small
Marketing Executive
Kate Aurora
Marketing, Media and Business
Communications Executive
Jennifer Hanley
2009 JPMorgan Chase & Co.
All rights reserved.
Approved by the Forest Stewardship Council.
Printed in the U.S.A.
For more information, visit: www.jpmorgan.com/wss
Cert no. SW-COC-002360
J.P. Morgan: A View Forward
Across the globe, institutional investors, alternative asset managers, broker
dealers and equity issuers count on our industry leadership, innovative
products and technology platforms to service their funds and investments.
As markets uctuate and evolve, we are your steady partner helping our
clients mitigate risk, increase efciencies and make informed decisions. In an
increasingly complex marketplace, look to J.P. Morgan for strategic vision and
experience few can match.
Alternative Investment Services
Clearance Services
Custody
Depositary Receipts
Foreign Exchange
Fund Accounting & Administration
Futures & Options
Liquidity Management
Performance Measurement & Analytics
Securities Lending
Transition Management
Trustee & Fiduciary Services
The products and services featured above are ofered by JPMorgan Chase Bank, N.A., a subsidiary of JPMorgan Chase & Co. JPMorgan Chase Bank, N.A. is registered by the FSA for investment business in the
U.K. JPMorgan is a marketing name for Worldwide Securities Services businesses of JPMorgan Chase & Co. and its subsidiaries worldwide. 2009 JPMorgan Chase & Co. All rights reserved.
For more information, please visit jpmorgan.com/wss or contact:
New York Christopher Lynch at chris.e.lynch@jpmorgan.com
London Francis Jackson at francis.j.jackson@jpmorgan.com
Hong Kong Laurence Bailey at laurence.bailey@jpmorgan.com
JPM Thought 9.09 8.5x11.indd 1 8/31/2009 1:36:23 PM

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