BNP Paribas - More Than You Ever Wanted

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           Marketing Communication – For Institutional Investors Only                                                           17 May 2013

           More Than You Ever Wanted To Know About Equity Repo

                                                       Equity repo rates have fallen to record lows globally: Equity repo rates implied
    Global Equity & Derivative Strategy                from Total Return Swap (TRS) markets and listed futures have moved sharply lower over the
    Gerry Fowler, CFA                                  past 6 months. Put differently, equity-secured funding rates have now reached record highs.
    United States                                      The most significant move has occurred on the SX5E, SPX and Nikkei indices across short
    Anand Omprakash                                    and long term maturity buckets. While the causes of these moves diverge across regions, the
    Jordan Sinclair                                    most common reasons being used to justify the moves are:
    Amitha Kurmala                                       o   Balance sheet and liquidity constraints: Basel III regulation and new European bank
    Europe                                                   levies are forcing banks to deleverage, which adversely impacts illiquid and long term
    Kokou Agbo-Bloua (Head Europe)                           assets, particularly in Europe. Short term roll repo rates have been distorted globally as a
    Wing Chan                                                result of balance sheet window dressing.
    Benoit Le Pape (CB)                                  o   Forward supply & demand: Investors have gradually increased their exposure to
    Pan-Asia                                                 equities and in some markets through leveraged structures such as forwards, swap
    Guillaume Derville                                       instruments and outright equity call options. The currency debasement theme and
    Winner Lee                                               “Abenomics” in Japan have caused large demand for call option structures and the
    Shun Maruyama                                            subsequent distortion of short / mid-term repo.
    Anthony Wong                                         o   Regulation and FTT: Last but not least, on-going discussions around the Financial
                                                             Transaction Tax in Europe have increased the anticipated costs of trading equity cash
    Global Emerging Markets
                                                             baskets relative to TRS.
    Martial Godet
                                                       However, the correction in equity repo rates appears startling in an environment
    Global Directional
                                                       of ample liquidity and unprecedented monetary easing by global central banks that aims to
    Orrin Sharp-Pierson
                                                       lower the cost of funding and yields across asset classes.
    Ankit Gheedia
                                                         o   Hunt for Yield: Investor demand for safe yields across government and corporate bonds
    Global Dividends                                         is driving the cost of funding lower.
    Antoine Deix
    Nadejda Semenova                                     o   Global monetary easing and collateral scarcity: Central banks’ actions have also
                                                             pushed down the yields and available supply of high quality assets causing, falling
    Global Flow Structuring                                  liquidity swap spreads (such as the EUR/USD cross currency basis) and a decline in the
    Thomas Bornhauser                                        Libor-OIS spread. The resulting scarcity in quality fixed income collateral should, in
                                                             theory, benefit ‘high quality’ equity-secured funding.
    United States                                        o   Some structured credit secured funding costs are now lower than those in equity:
    Philippe Combescot                                       High yield, MBS and CLO collateral funding rates have fallen below equity funding rates.
    Roland Nelet                                             This is again a result of the imbalance in supply and demand for quality collateral.
    Europe                                             In this report, we explore investors’ fears and concerns on equity repo rates
    Anne Bailly-Monthury                               and possible triggers for normalization across regions:
    Romain Marsigny
                                                         o   Harmonization on Withholding Tax in Europe (EU Treaty Article 56)
    Etienne Grisey                                       o   Change in hedging of the French “Plan Epargne en Actions” (PEA)
    Pierre Carubia                                       o   Normalisation of forward supply & demand

    This material is prepared by Sales, Marketing                                      SPX 10y repo rate since 2006
    and/or Trading Desk personnel within the                              0.1
    BNP Paribas group of companies
    (collectively “BNP Paribas”) for distribution to
    Institutional or Professional Investors only
    and you should not regard it as research or a                       -0.05
    research report, although it may refer to a                          -0.1
    research report. This material is therefore not                     -0.15
    independent from the proprietary interests of                        -0.2
    BNP Paribas, which may conflict with your                           -0.25
    interests. We are willing to discuss it with you                     -0.3
    on the assumption that you have sufficient                          -0.35
    knowledge, experience and/or professional                            -0.4
    advice to understand and make your own
    independent evaluation of the merits and
    risks of any transactions in the securities
                                                       Source: BNP Paribas
    discussed herein. Additional information is
    available upon request.

This publication is classified as non-objective. Please refer to important information at the end of the report.

                                                      Executive Summary .................................................................................................. 3

                                                      What, When, Where and Who? ............................................................................... 6

                                                         The Case of the SPX Short Term Repo...................................................................... 6

                                                         The Case of the SPX Long Term Repo ...................................................................... 9

                                                         The Case of the SX5E Short Term Repo ................................................................. 11

                                                         The Case of the SX5E Long Term Repo .................................................................. 14

                                                         The Case of Japan Repo.............................................................................................. 16

                                                      Rational and Irrational Fears.................................................................................. 20

                                                         Fear related to balance sheet constraints................................................................. 20

                                                         Fear related to tax on dividends.................................................................................. 23

                                                         Fear related to other regulation................................................................................... 24

                                                         Fear related to structured products ............................................................................ 26

                                                         Cross Asset Repo: Equity vs Fixed Income secured funding .............................. 30

                                                      A Selection of Trading Opportunities ............................................................... 32

                                                         SX5E Forward Repo ‘Heat Map’................................................................................. 32

                                                         NIKKEI Forward Repo Trade with USDJPY 1Y currency swap .......................... 33

                                                         NIKKEI Long Term Exposure Hedge with a carry .................................................. 33

                                                         Solution to improve liquidity profile with repo........................................................... 33

                                                      Appendix: What is a Repo? .................................................................................... 35

More Than You Ever Wanted To Know About Equity Repo                                                                                                                          2
                                                      Executive Summary
                                                      What, When, Where and Who?
                                                      Equity repo rates can be thought of as equity-secured funding rates embedded in
                                                      the price of futures and long dated total return swaps (TRS). Several drivers,
                                                      from regulatory fears to supply & demand imbalances have contributed to a very
                                                      significant and quick move in global repos rates over the past 6 months across

                                                      THE CASE OF EUROPE

                                                      European banks are facing several regulatory headwinds, particularly from
                                                      capital and liquidity constraints (stemming from Basel III and its European
                                                      implementation, CRD-4, and bank levies). Alongside a private sector slowdown
                                                      in Europe, these constraints have contributed to broad balance sheet
                                                      deleveraging. This also started a process of dis-intermediation of equity-secured
                                                      funding where banks are gradually stepping away from balance sheet intensive

                                                      Shrinking bank balance sheets have been a more powerful force on repo rates
                                                      than a reduction in the distortive impact on forward markets from lower
                                                      structured product issuance. The historically high demand for equity-linked
                                                      structured products in Europe used to put downward pressure on repo rates and
                                                      dividend swap prices. In recent years, issuance has been much lower and the
                                                      structural downward pressure on European repo rates has lessened. However,
                                                      the huge reduction in the risk appetite of the banking sector more than offsets

                                                      The enforceability of dividend withholding tax is being challenged in Europe.
                                                      Article 56 of the EU Treaty on the “free movement of capital” has been used by
                                                      UCITS funds (Undertakings for Collective Investments in Transferable
                                                      Securities) and others to sue several EU governments that discriminate between
                                                      domestic and foreign funds with respect to the withholding tax levied on
                                                      dividends paid by domestic companies. France, Italy and Spain decided to
                                                      harmonize their policy by giving foreign entities the same rules as their domestic
                                                      peers whereas Germany decided to levy domestic institutions the tax as well.

                                                      There had been a marked increase in demand for upside exposure to SX5E via
                                                      long dated call options: Investors are now very underweight European equities
                                                      due to the current recession in peripheral countries and political uncertainty
                                                      stemming from the sovereign debt crisis. SX5E long dated call option prices
                                                      have reached record lows as a percentage of spot due to low bond yields (a
                                                      consequence of QE), low implied volatility and dividends yields that have
                                                      rebounded from 2009 low). Investors looking at Europe’s depressed equity
                                                      valuation relative to global peers are using long-dated calls to position for a
                                                      European equities catch-up. As a result, there has been further positive pressure
                                                      on forwards and consequently, negative pressure on repo rates.

                                                      THE CASE OF THE US

                                                      The dislocation in US repo rates started with the short term futures roll toward
                                                      the end of 2012 as banks attempted to reduce the size of their balance sheet.
                                                      Supply & demand have also contributed to the price action observed for medium
                                                      term tenors.

                                                      Asset managers looking to be long the S&P500 Total Return Index (SPTR) and
                                                      also benefit from a potential rise in long-term interest rates have bought long
                                                      dated forwards for large notionals creating a switch from short term TRS to long
                                                      dated forwards. This has pushed repo rates lower.

                                                      However, US insurance companies are structurally buyers of repo (sellers of
                                                      forwards): Variable annuity hedging by US insurance companies requires
                                                      insurers to buy long dated put options, which creates demand for repo. We

More Than You Ever Wanted To Know About Equity Repo                                                                                   3
                                                      expect this recurrent flow to help stabilize the sudden and significant negative
                                                      pressure observed in the SPX repo over the past 6 months.

                                                      THE CASE OF JAPAN

                                                      The Japanese equity reflation theme triggered by “Abenomics” has caused
                                                      significant demand for short to mid-term forwards. Japanese equities have long
                                                      suffered from low price-to-book multiples and depressed returns on equity given
                                                      on-going deflation and the strength of the yen - a consequence from the “lost
                                                      decade”. The implementation of Shinzo Abe’s policies by the new BOJ governor,
                                                      Kuroda, through an unprecedented asset purchase programme, has triggered a
                                                      significant rally in the USDJPY. The weaker yen has had a dramatic positive
                                                      impact on earnings and margin convexity for Japanese companies.

                                                      Foreign hedge funds and asset managers gained tens of billions of dollars of
                                                      notional upside exposure on the Nikkei through call option structures. This
                                                      created significant bank hedging demand for forwards and consequently, selling
                                                      pressure on Nikkei repo.

                                                      However, like Europe, lower structured products (Uridashi) issuance in Japan
                                                      has reduced the historically distortive impact on forwards. Historically, the
                                                      hedging of forward exposure embedded in Uridashi structures has put pressure
                                                      on dividend and repo rates because of the long maturities of the structures.
                                                      However, since 2008, the duration of the new issuance has fallen substantially
                                                      and a large portion of the existing inventory of Uridashi was knocked out during
                                                      the significant rally in the Nikkei this year. The pressure historically exerted by
                                                      structured products has substantially abated as a result.

                                                      Rational and Irrational Fears
                                                      As the US economy entered the Great Depression after the 1929 crash, Franklin
                                                      D. Roosevelt made a famous speech in 1932 and argued that the “only thing we
                                                      have to fear is fear itself”. Historically, uncertainty and lack of visibility have
                                                      caused large dislocations in financial assets. These events have also been great
                                                      investment opportunities as fear and uncertainty dissipate. While some of the
                                                      concerns appear legitimate to justify the magnitude of the dislocation in repo
                                                      rates, we highlight those that may not.

                                                      Fear of balance sheet constraints: New regulations are currently being
                                                      implemented by banks but the impact of the changes will dissipate in time. The
                                                      key aim of regulators is for a well-capitalized banking system that can support
                                                      the economy and the efficient flow of credit to consumers and companies. Once
                                                      achieved, balance sheet deleveraging and capital increases will abate.

                                                      Fear of withholding tax: There is a clear trend toward the harmonisation of
                                                      withholding taxes in the EU as they may contravene Article 56 of the EU treaty
                                                      relating to the “free movement of capital”. The discrepancy between EU states
                                                      should be resolved over time and will remove uncertainty in swap markets.

                                                      Fear of other regulation: Uncertainty over the implementation of the European
                                                      Financial Transaction Tax remains high as the current draft would dramatically
                                                      impair credit markets and financing costs for both banks and non-financial
                                                      institutions according to many reports (eg. ICMA/European Repo Council report).
                                                      Additionally, several high ranking officials including officials at the Bundesbank
                                                      have recently voiced concerns about the current plans.

                                                      Fear of structured products: Our analysis of structured products issuance show a
                                                      decreasing influence on long term forward across global equity indices. Dividend
                                                      swaps used to be subject to the distortive effects of structured products issuance
                                                      given the pressure they exerted on forwards. However, the clear de-correlation
                                                      between repo and dividends corroborates the decreasing impact of structured

                                                      Equity repo relative to fixed income repo: Equity repo rates have now reached
                                                      levels that are more attractive for investors looking for yield than some structured
                                                      credit repo rates (with MBS, High yield or ABS CLOs collateral). The hunt for

More Than You Ever Wanted To Know About Equity Repo                                                                                     4
                                                      yield and collateral scarcity resulting from central bank actions (QE/LTRO),
                                                      political decisions (austerity reducing EGB supply) and regulations (increasing
                                                      capital requirements, CCPs etc) is forcing fixed income secured funding rates to
                                                      fall. Our rates strategists estimate a US$ 2 trillion shortage of AAA/AA collateral,
                                                      which is creating a “collateral squeeze”. This dynamic conflicts with the current
                                                      high cost of funding for high quality equity and is partially a result of near-term
                                                      uncertainty over the regulatory view on the collateral “quality” of equities.

                                                      The Good, the Bad and the Ugly

                                                      The dynamic between equity repo rates varies across regions and the magnitude
                                                      of the dislocation corresponds to the degree of uncertainty and concerns by
                                                      market participants. Therefore, the repo markets that offer the highest
                                                      opportunity also have the highest risks.

                                                      The Good: The SPX repo term structure is flat. The long dated forward demand
                                                      imbalance is likely to be absorbed over time in our view by the structural forward
                                                      selling flows by US insurance companies (that hedge their variable annuity

                                                      The bad: The Nikkei repo rate dislocation is mostly the result of demand for
                                                      short to mid-term upside exposure from global macro funds due to the on-going
                                                      currency debasement by the BOJ. Domestic investors and pension funds are still
                                                      under pressure to increase their equity allocation to equities over time.

                                                      The Ugly: SX5E repo markets are facing a wide range of issues, including
                                                      regulation, dividend withholding tax, balance sheet deleveraging and dis-
                                                      intermediation. The complexity of these issues can explain the steepness of the
                                                      TRS spread term structure. While more risky, European repo also provides a
                                                      great opportunity set and some of the risk already appear to be fully discounted
                                                      in the price.

                                                      A Selection of Trading Opportunities:

                                                      Capture SX5E repo term structure roll down: Buy SX5E 4y repo in 1y,
                                                      through a short position in 5y TRS against a long position in 1y TRS. We show a
                                                      forward repo heat map for roll-down trades.

                                                      Buy SPX long term repo by replacing existing short short-term TRS in S&P500
                                                      with short long-term TRS to lock in attractive repo rates. Alternatively, buy 7 year
                                                      in 1 year S&P500 repo to benefit from the potential mean reversion of long dated
                                                      SPX repo.

                                                      Government Bonds versus Equity Repo: An investor can enter a term repo
                                                      transaction where he lends his existing government bond holdings such as
                                                      Japanese Government Bond (JGB) and receives Japanese stocks in exchange
                                                      as collateral and is paid potentially 25bps in 1y. This would be double the yield of
                                                      a 1y JGB.

More Than You Ever Wanted To Know About Equity Repo                                                                                     5
                                                      What, When, Where and Who?

                                                      The Case of the SPX Short Term Repo

                                                      SPX repo is currently at historical lows across the entire curve. The implied cost
                                                      of short term equity collateralized funding increased significantly since the end of
                                                      last year. The main driver of the move has been attributed to banks looking to
                                                      decrease the size of their balance sheet by selling equity inventory.

                                                       The risk aversion then spread to the rest of the curve, pushing mid-term repo
    Repo dislocation in the US                        lower as well.
    started with short term
    through monthly futures                           SPX Roll Dislocation Analysis
    roll over the past 3 months.
                                                      The past two futures rolls had the most significant impact on short dated SPX
                                                      repo rate. The dislocation was particularly extreme in the last few days before
                                                      the December 2012 futures expiry as market participants who had to roll their
                                                      long SPX Futures positions (buy roll / sell repo) were not able to find enough
                                                      liquidity in the roll market to accommodate their size, leading to a sudden rise in
                                                      roll cost.

                            SPX Dec12-Mar13 Roll                                                SPX Mar13-Jun13 Roll

       -6.5                                                                     -6.2

        -7                                                                      -6.5

   Source: BNP Paribas, Bloomberg                                           Source: BNP Paribas, Bloomberg

                                                      In order to avoid the same experience in March, market participants pre-empted
                                                      the liquidity risks and started to roll their positions sooner, despite fairly poor
                                                      liquidity conditions. This drove the roll market higher.

                                                      While the roll historically has peaked at the early part of the week before expiry,
                                                      it ended up being the preceding week that saw the peak in roll, ie. the second
                                                      week before the March roll.

                                                      The balance sheet purging from banks could explain the decrease in supply in
                                                      the roll market, hence the increase in the roll cost (so decrease of the repo rate)
                                                      observed in the last 2 rolls.

                                                      SPX Futures Open Interest Analysis

                                                      Looking at the evolution and pattern of S&P futures open interest since
                                                      December 2009 expiry, no particular increase in roll volume since the beginning
                                                      of the year can be observed.

                                                      The typical monthly spikes in open interest are usually related to delta hedging
                                                      activity from index option traders.

More Than You Ever Wanted To Know About Equity Repo                                                                                     6
                                                            The portion of the open interest that is rolled to the next maturity amounts to
   Front month futures roll                                 about 3.6 million mini SPX futures contracts, which is lower than the 4 million
   volume is 10% lower than 3                               contracts usually rolled three years ago.
   years ago. The future
   notional rolled on a                                     It is worth bearing in mind that 3.6 million contracts are equivalent to about USD
   monthly basis is equivalent                              300 billion or 2.14% of the S&P 500 floating market cap (USD 14 trillion).
   to 2% of SPX market cap.
                                                            The second and third futures rolls are negligible relative to the front future. Only
                                                            10 thousand contracts were rolled against 3 million on the front future.

                                                            Of note, the big SPX future still represents 22% of the traded volume.

                                                            The table below depicts the evolution of S&P future Open Interest. We converted
                                                            the big S&P future open interest into an E-minis equivalent:

                                                                                                            SPX Futures Open Interest
                                                                            7,000,000                                                                               Big





                                                                                                   Dec/09   Jun/10   Dec/10        Jun/11   Dec/11     Jun/12      Dec/12

                                                            Source: BNP Paribas, Bloomberg

                                                            SPX roll volume dynamic

                                                            Most of the volume on the front roll of the E-minis is traded over the preceding
                                                            two weeks before the expiry. The volume pattern does not provide evidence of
                                                            abnormal activity (particularly for the December 2012 expiry) relative to previous

                                                            Whilst the March 2013 roll started sooner than usual, there was no significant
                                                            change in trading activity. As of early May, we are at 2% of the expected roll
                                                            amount. There have been 45k second month contracts rolled out of a total of 2.8
                                                            million expected.

                       SPX Roll Activity into Expiry                                                            SPX Roll Repo History by expiry 2012/13
                                         Jun-13                                                                                                                                  0.00
                                                                            % roll completed

                                         Mar-13                      70%                                                                                                         -0.10

                                         Dec-12                      60%                                                                                                         -0.20
                                                                                                                                                                                         Roll Repo %

                                         Sep-12                      50%                                                                                                         -0.30

                                         Jun-12                      40%                                                                                                         -0.40
                                         Dec-11                      30%                                                                             Roll Sep12/Dec12            -0.50
                                                                     20%                                                                             Roll Dec12/Mar13
                                                                                                                                                     Roll Mar13/Jun13
                                                                                                                                                     Roll Jun13/Sep13
          40     35      30        25   20        15   10   5    0                                            85     75       65       55    45       35      25        15   5    -5
   Source: BNP Paribas, Bloomberg                                                                      Source: BNP Paribas, Bloomberg

More Than You Ever Wanted To Know About Equity Repo                                                                                                                                              7
                                                      Short dated Repo rates implied from futures

                                                      By combining the two sets of information, we can compute the volume weighted
                                                      average equity financing cost of each roll. Put differently, this represents the
                                                      amount the market paid as a whole for 3 month equity financing:

                                                                         Sep-12      Dec-12      Mar-13
                                                      Implied Repo         -0.01      -0.37       -0.47
                                                      The current Jun-13 / Sep-13 repo roll is at -40 bps as of May 15 2013.

                                                       As corroborated by the analysis, market participants have not dramatically
                                                      changed their behavior. They started to roll one to two days sooner than average
                                                      according to the cumulative volume curve. However, it is worth highlighting the
                                                      fact that the implied repo parameter continues to be lower than where it was
                                                      during the last quarterly expiry at the same number of days before the roll date.

More Than You Ever Wanted To Know About Equity Repo                                                                                  8
                                                      The Case of the SPX Long Term Repo

                                                      “Great Rotation” Hedging: Higher rates and higher equities

                                                      The US market has historically been a seller of SPX long-term forwards.
                                                      Insurance companies regularly buy long-dated SPX put options to hedge the
                                                      short volatility exposure embedded in variable annuity riders. Dealers, who
  Positioning for the “Great
                                                      provide them with the liquidity, have usually hedged the resulting short delta
  Rotation” created demand                            exposure by selling long-term forwards.
  for long dated forward and
  caused selling pressure on                          However, the recent dynamic is opposite to the traditional trend. Due to large
  repo.                                               S&P 500 (SPX) long-term forward trades implemented over the past 5 months,
                                                      the implied funding cost to go long the SPX synthetically (via swaps, forwards,
                                                      etc) reached historical highs for long-dated maturities (5Y and beyond).
  Variable annuity hedging
  activity creates buying                             These trades were implemented by large asset managers who used to be long
                                                      SPX via rolling short-dated Total Return Swaps (TRS). They have switched their
  pressure of Repo.                                   short dated exposure into long term SPX forwards in order to take advantage of
                                                      the low interest rates environment and to lock in an attractive financing rate. We
                                                      estimate a total volume of around USD 7 billion traded in long dated forward on
                                                      the SPTR. This was enough to cause strong buying pressure in the long term
                                                      SPX synthetic market and a subsequent dislocation in the SPX long term repo.

                                                      There is an implicit financing cost embedded in the hedging of these products
                                                      and without sufficient and immediate offsetting flows, dealers hedge by keeping
                                                      the underlying security on their balance sheets. In an environment of rising cost
                                                      of capital, we suspect dealers had limited appetite to facilitate the recent trades
                                                      given their duration, thereby causing a sharp increase in the implied equity
                                                      financing cost.

                                                      Until December 2012, the SPX 10-year repo rate had oscillated between +7bps
                                                      and -4bps with an average of +1.3bps over the past five years (see below).
                                                      However, since December 2012, the repo rate collapsed to -40 bps as of May
                                                      15th 2013.

                                                                     SPX 10Y Repo History: A significant dislocation

                                                      Source: BNP Paribas

More Than You Ever Wanted To Know About Equity Repo                                                                                    9
                                                      SPX repo: A structural or a temporary dislocation?

                                                      These long dated trades on SPX forwards provide asset managers with equity
                                                      exposure for the next 10 years. Therefore, there is no structural reason to expect
                                                      asset managers to actively trade their position in the forward market regularly.

                                                      One could then make the case that when long term rates start to move higher in-
                                                      line with their expectations, there could be an unwind of these long dated trades
                                                      and a subsequent switch back to short term equity swap via regular rolling of 1 to
                                                      2y TRS.

       Natural variable annuity                       Furthermore, these trades were very large and were executed over a short
                                                      period of time. As dealers were capacity constrained, they were unable to
       hedging via forward selling                    facilitate these transactions without causing significant market impact, hence the
       should gradually trigger a                     sharp move in price. However, over the medium term, it is reasonable to expect
       normalisation of repo over                     that the repo sensitivity exposure created by these trades gradually absorbed by
                                                      the regular and natural hedging flows resulting in forward selling from insurance

                                                      Finally, in periods of market stress, insurance companies are likely to increase
                                                      the amount of SPX put options they buy while asset managers are unlikely to
                                                      increase their equity exposure. Therefore, one could expect the forward supply
                                                      to increase , which should consequently decrease the magnitude of the repo

More Than You Ever Wanted To Know About Equity Repo                                                                                  10
                                                      The Case of the SX5E Short Term Repo

                                                      Medium and long term repo rates on the SX5E have fallen precipitously over the
                                                      past six months by an average of about 50bps, an amount that can be deemed a
                                                      real shock wave in the world of equity repos. This dynamic was also seen on all
                                                      other European equity indices, namely DAX, CAC, FTMIB and the IBEX, There
                                                      has been truly indiscriminate selling pressure on all European equity indices with
                                                      the SX5E suffering the brunt of the selling pressure.

                                                      We have witnessed back in 2009 a similar behaviour for long term SX5E repo
                                                      which collapsed from +0.30% to -0.40% over a period of 5 months. It was at the
                                                      time driven by the deformation of some structured products that made the
                                                      investment banks very large buyers of long term forwards. The mechanics at
                                                      play right now are quite different as the structured products that caused these
                                                      distortions have now matured and the new ones are being issued in much
                                                      smaller sizes.

                                                      It is interesting to note however that the short term repo (1 month) has been fairly
                                                      stable over the past year, excluding the end of year period. Repo rates in
                                                      December were pushed sharply lower as banks dramatically reduced their
                                                      balance sheets in order to meet year end liquidity and capital requirements. One
                                                      has to consider possible contagion effects of short term repo dislocations on
                                                      longer term maturity buckets.

                          Europe 5Y Repo History                                                  SX5E 1m Repo History

          0.6                                                                      1
                                                                                  0.8                    SX5E Repo 1M
          0.2                                                                     0.4
                                                                SXE               0.2
            0                                                   DAX                0

         -0.2                                                   CAC              -0.2
                                                                FTMIB            -0.4
         -0.4                                                                    -0.6

   Source: BNP Paribas                                                      Source: BNP Paribas

                                                      SX5E Futures Open Interest Analysis

                                                      The portion of the SX5E futures open interest that was rolled amounted to 2.6m
                                                      contracts. The highest amount was reached in September 2011 at 3.5m. The
                                                      previous expiry saw 2m contracts rolled. 2.6m contract is equivalent to about
                                                      EUR 70 bn.

                                                      The 2nd into 3rd future rolls are negligible in terms of volume. The open interest
                                                      on the 3rd future represents less than 1% of the total open interest of SX5E
                                                      futures on average.

More Than You Ever Wanted To Know About Equity Repo                                                                                    11
     SX5E future Open Interest in number of contracts                                                  SX5E cumulative roll volume

     5,500,000                                                                                                                                                     100%
     5,000,000                                                                                                  Jun-13

                                                                                                                                                                                         Percentage (%) of Roll executed
     4,500,000                                                                                                  Mar-13
                                                                                                                Sep-12                                             60%
     3,500,000                                                                                                  Jun-12                                             50%
     3,000,000                                                                                                  Dec-11                                             40%

     2,500,000                                                                                                                                                     30%
                                                                                       40        35        30          25     20      15      10       5       0
                                                                                                                     Number of days until Expiry
   Source: BNP Paribas, Bloomberg                                              Source: BNP Paribas, Bloomberg

                                                      SX5E Futures Roll Volume Analysis

                                                      Most of the roll volume is usually completed over the last 2 weeks before futures
                                                      expiry. The roll started early in September and even earlier in December 2012
                                                      futures expiry. The March13 expiry roll actually occurred rather late compared to
                                                      previous expiries.

                                                      As of early May, we are at 0.5% of the total futures expected to be rolled. Only
                                                      13,000 2nd month contracts were rolled out of a total of 2.6m.

                                                      The repo of the roll based on our marks:

                                                                                   SX5E futures roll by expiry

                                                                                                                                roll sep12-dec12
                                                                                                                                roll dec12-mar13
                                                                                                                                roll mar13-jun13

                                                                                                                                                                        Repo rate implied from roll
                                                                                                                                roll jun13-sep13               0.4





                                                            65    60   55    50   45        40        35        30      25     20    15     10     5       0
                                                                                       Number of days until Expiry
                                                      Source: BNP Paribas, Bloomberg

                                                      It is worth highlighting the mean-reversion of repo rates implied by the futures roll
                                                      for the Mar13-Jun-13 futures roll, shown in green on the chart above, which was
                                                      right before expiry. After moving down from ~0.2 down to 0.4 12 days before
                                                      expiry, the futures roll moved back to -0.2.

More Than You Ever Wanted To Know About Equity Repo                                                                                                                                                           12
                                                      Short dated Repo rates implied from futures

                                                      By combining the two set of information, we can compute the volume weighted
                                                      average equity financing cost of each roll. Put differently, this represents the
                                                      amount the market paid as a whole for 3 month equity financing:

                                                                                  Sep-12       Dec-12      Mar-13
                                                      SX5E Implied Repo             0.05        -0.25       -0.33

                                                      The current Jun-13 / Sep-13 repo roll is at -32 bps (as of May 6th).

                                                      Similar to the roll price action in the SPX, the SX5E roll cost was higher in March
                                                      2013. The repo rate was dislocated earlier and remained so for a longer period.

More Than You Ever Wanted To Know About Equity Repo                                                                                   13
                                                                                     The Case of the SX5E Long Term Repo
                                                                                     Long term repo rates have also significantly fallen, driving total return spread
                                                                                     (TRS) to record highs. This implies that long term equity secured funding costs
                                                                                     are now more expensive than ever before and particularly higher than levels
                                                                                     seen during the midst of the financial crisis in 2008/9.

                                                                                     It is all the more puzzling since liquidity injection by central banks has pushed
                                                                                     liquidity swap spreads, implied volatility and CDS spreads to record lows, thus
                                                                                     causing equities to break out to new highs.

                                                                                                           SX5E TRS spreads by maturity buckets

                                                                                     Source: BNP Paribas

                                                                                     Significant underweight positioning in European equities

                                                                                     The on-going balance sheet deleveraging by European corporates, the economic
                                                                                     recession in the European periphery and the ‘Sysiphean’ political and sovereign
                                                                                     debt crises (Cyprus, Italian elections) have triggered unprecedented outflows out
                                                                                     of European equities into the US markets.

                                                                                     This portfolio rebalancing has put significant pressure on implied volatility
                                                                                     parameters in the SX5E and particularly the level of implied volatility skew.
                                                                                     Option skew is defined as the difference between the volatility of the 90% strike
                                                                                     put option and that of the 110% strike call option. It is a good proxy for investors’
                                                                                     demand for downside put protection.

                                                                                     6M skew levels have fallen to record lows because of a lack of demand for
                                                                                     downside protection. Equity investors became very underweight European
                                                                                     equities and did not need to hedge their European equity exposure as much as
                                                                                     before. However, the demand for upside call options has increased as these
                                                                                     underweight investors and other hedge funds have looked to get exposure to a
                                                                                     rally in European equities cheaply and quickly.

           Equity allocation in global equity portfolios                                                                         SX5E and SPX 6mth skew (90% minus 110%)
                                                                 US        Europe
                                                                                                                          10%              SX5E 6M skew        SPX 6M skew
             Weight in global portfolios

                                                                                                               6M 90-110% Skew

                                           35%                                                                                   8%



                                           20%                                                                                   4%
                                                 03   04   05   06    07   08   09     10   11
                                                                                                                                      05   06     07      08       08        09   10   11   12

   Source: BNP Paribas, EPFR                                                                                 Source: BNP Paribas

More Than You Ever Wanted To Know About Equity Repo                                                                                                                                              14
                                                      This trend was particularly clear during 2H of 2012 after the announcement on
                                                      September 6 , 2012 of the Outright Monetary Transactions (OMT) facility by
                                                      ECB president, Mario Draghi, and his famous speech where he promised to do
                                                      “whatever it [took]” to stabilize the Eurozone liquidity crisis.

                                                      Some rebalancing flows towards European equities via SX5E calls

                                                      In addition, the recent rebound in global equities, particularly SPX, Nikkei, FTSE
                                                      and SMI, has created a renewed interest by investors in getting long SX5E
                                                      exposure, especially given the magnitude of its underperformance relative to
                                                      other indices and low headline valuation multiples (eg. PE, EV/Ebitda ratios).
                                                      This led to significant trades in SX5E long dated call options by institutions.

                                                      The absolute premium of long dated call options in the SX5E has indeed fallen to
                                                      record lows for the follow reasons:

                                                              (1) Interest rates have fallen to record lows given fear of a prolonged
                                                              recession in Europe, driving real rates and inflation expectations down.
                                                              QE and the current ‘hunt for yield’ also contributed.

                                                              (2) Implied volatility levels have fallen substantially given the lack of
                                                              demand for index protection by investors as they became significantly
                                                              under-weight Europe.

                                                              (3) Dividend swap futures have rebounded from the lows of 2008-9 by
                                                              over 50%. That said, it is worth noting that they remain well below their
                                                              pre-2008 peak and the term structure of dividend swap has been
                                                              downward sloping since 2011.

                                                      All of the points above, in conjunction with elevated ‘equity risk premium’ and
                                                      depressed headline valuation multiples, have contributed to long dated option
                                                      demand. There have been trades of several billion dollars worth of option
                                                      notional. Furthermore, these call option trades have put pressure on both
                                                      dividend swaps and repo rates given the buying of SX5E forwards by dealers
                                                      looking to hedge.

                                                      The chart below shows that historically, supply and demand from structured
                                                      products on SX5E forwards have distorted both dividend swap and repo rates
                                                      levels during periods of stress.

                                                      However, repo rates implied by TRS spreads have recently fallen more than
                                                      dividend swaps which have remained flat. This could be explained by more
                                                      trading of dividend swaps as an asset class. Dividend swaps are traded in
                                                      listed futures format as opposed to only OTC. That said, one should also
                                                      bear in mind that SX5E long dated dividends have significantly
                                                      underperformed other markets, namely FTSE, SPX and Nikkei dividends.

                                                                                         SX5E 5y repo rate vs 5y dividend swap (rolling)
                                                                                        170                                                     0.55
                                                                                                                      SX5E 5Y Dividend (LHS)
                                                                                        150                                                     0.35
                                                                                                                      SX5E 5Y repo rate (RHS)
                                                                SX5E 5y dividend swap

                                                                                                                                                        SX5E 5y repo rate


                                                                                        50                                                      -0.45

                                                                                        30                                                      -0.65
                                                                                         May-08   May-09   May-10   May-11     May-12      May-13

                                                      Source: BNP Paribas, Bloomberg

More Than You Ever Wanted To Know About Equity Repo                                                                                                                         15
                                                      The Case of Japan Repo
                                                      Dislocated short-term NIKKEI Financing Costs

                                                      Repo trade history

                                                      After the Lehman crisis (2008 / 2009), liquidity became scarce, forcing investors
                                                      to shrink inventory as much as possible in order to free up balance sheet. They
                                                      replaced their long equity inventory with Total Return Swaps (TRS), which
                                                      resulted in significant selling pressure on NIKKEI repo across the term structure.

                                                      Moreover, the repo sensitivity stemming from the Uridashi products (yield
                                                      enhancement structured products sold to Japanese retail investors) rose
                                                      substantially as NIKKEI index fell and got closer to the Down and In Barriers
                                                      embedded in the Uridashi products. The delta exposure of these structures rose
                                                      as a result causing investment banks, who are long these down and in puts, to
                                                      be short an increasing amount of delta. In order to hedge their exposure, they
                                                      had to buy an equally increasing amount of forward exposure.

                                                      This hedging activity pushed repo rates lower at a quickening pace. As the
                                                      maturity of these Uridashi products were on average between 5 and 7 years,
                                                      they triggered more dislocation on the long end of the curve, than on the short
                                                      term. The term structure of repo became very steep as a result.

                                                      In order to monetizing a very steep term structure, investors put on TRS term
                                                      structure trades by going short long term TRS against a long position in short
                                                      term TRS.

                                                      What we observe today

                                                      Whilst in 2009 the repo dislocation was driven by a liquidity crunch, the drivers of
                                                      the distortions today can be explained by significant one-way demand for NIKKEI
                                                      forwards by global macro investors who are trying to get exposure to the
                                                      Japanese reflation story. Since October 2012, macro hedge funds have been
                                                      very active on the NIKKEI. These investors, who usually focus on rates and FX,
                                                      have found a compelling opportunity to express a higher USDJPY through long
                                                      exposure in Japanese equities using plain-vanilla call and call spreads on the

                                                      The significant increase in the open interest of listed options since January
                                                      corroborates the larger proportion of call options relative to put options shown on
                                                      the chart below is also understated as the bulk of the upside positioning by
                                                      hedge funds has been implemented in the Over The Counter (OTC) market.

                                                      Several tens of billion dollars of NIKKEI option notional in calls and call spreads /
                                                      ratios structures were sold by banks to global macro hedge funds and
                                                      institutional investors. To hedge these flows, these banks bought forwards and
                                                      futures, thereby putting pressure on the Repo.

                                                      Additionally, the dynamic above was made worse by balance sheet constraints:

                                                          o    Banks needed to meet financial liquidity ratios at the end of the fiscal
                                                               year in Japan and therefore switched their excess inventory into futures
                                                               or TRS.
                                                          o    Domestic investors, however, were willing to increase cash balances
                                                               before the year end.

                                                      Despite short term and medium term repos coming under significant selling
                                                      pressure recently, long term repo have been fairly stable. It is worth bearing in
                                                      mind that the NIKKEI flows are now of a shorter duration than before (please
                                                      refer to the section on Uridashi below).

More Than You Ever Wanted To Know About Equity Repo                                                                                     16
                                                                NIKKEI Listed Options Open Interest (in number of contracts)

                                                                                                   Call Open Interest   Put Open Interest


                                                                               Jul-12                 Oct-12            Jan-13              Apr-13

                                                          Source: BNP Paribas, Bloomberg

                                                          The chart above is showing greater open interest for call options than put
                                                          options. However, this discrepancy between the number of calls and puts is
                                                          understated as most of the upside positioning from hedge funds has been Over
                                                          The Counter (OTC).

                                                          NIKKEI vs. TOPIX (TPX) and Japanese market participants

                                                          Historically, NIKKEI has garnered interest from retail investors while TPX was
                                                          mostly used by insurance companies as well as pension funds:

                                                               o    Retail investors enter Uridashi products on NIKKEI. To hedge those
                                                                    positions, banks have to buy back forwards, therefore selling Repo
                                                                    exposure. The NIKKEI repo rate has structurally been negative for
                                                                    several years.
                                                               o    Insurance companies and Pension Funds use TPX index as a hedge.
                                                                    These institutions typically buy TPX put options from banks who need to
                                                                    sell back the forward exposure, thereby buying Repo exposure. TPX
                                                                    repo has structurally been higher than NIKKEI repo as a result.

                                                          As mentioned above, since October 2012, the increasing interest in the
                                                          Japanese reflation theme created short-dated Call or Call Spreads / ratios
                                                          demand on NIKKEI or TPX by global macro hedge funds. Given the significance
                                                          of the size being traded relative to normal average daily volumes, the impact was
                                                          similar in magnitude on short dated repo for both NIKKEI and TPX.
                                                          The NIKKEI repo market is more liquid than the TPX market. The former also
                                                          has relatively tighter bid-offer spreads than the latter. That being said, as TPX
                                                          has been mostly used as a hedging vehicle, it is more likely to see the TPX short
                                                          term repo rebound back to higher levels from the forward selling activity (repo
                                                          buying) from institutions.

                            TPX and NIKKEI 3y Repo                                                              TPX and NIKKEI 6m Repo

                                                Repo 3Y                                     0.6                         Repo 6M
          0.2                                                                              0.45                                                      TPX   NKY
           0                                                                                0.3
         -0.6               TPX      NKY
         -0.8                                                                              -0.45
           -1                                                                               -0.6

   Source: BNP Paribas                                                                  Source: BNP Paribas

More Than You Ever Wanted To Know About Equity Repo                                                                                                          17
                                                      The impact of Uridashi flows on NIKKEI Repo

                                                      The issuance of Uridashi has a lower influence on the level of NIKKEI long term
                                                      repo than in the past. The maturity of the products issued over the past few
                                                      years has indeed been much shorter (1 to 3 years). Moreover, these products
                                                      usually have an early cancellability feature on the upside. Consequently, the
                                                      sharp rally of the NIKKEI over the past 6 months triggered the knock-out of a
                                                      large proportion of the outstanding Uridashi market.

                                                          o    The Uridashi market used to substantially influence the NIKKEI long
                                                               term Repo rate back in 2008. The products issued at the time used to
                                                               be long dated (5y to 7y maturity). Furthermore, when the NIKKEI fell by
                                                               more than 50%, their expected maturities increased and the Down and
                                                               In put options embedded in them were triggered. This caused an
                                                               increase in the maturity and delta exposure that needed to be hedged
                                                               by the banks, creating a dislocation of the NIKKEI long term repo. (Cf

                                                          o    After the 2008-9 financial crisis, the Uridashi market moved toward
                                                               shorter dated maturities (1y to 3y)

                                                          o    The combined effects of lower inventory of long dated Uridashi and the
                                                               issuance of new products with shorter dated maturities have reduced
                                                               the impact of these products on long term repo.

                                                      Japanese Fiscal End of Year & Repo

                                                      The Japanese fiscal year end, in March, also had a distortive influence on the
                                                      short term repo rate. Japanese institutions cleared out their inventories and
                                                      replaced their cash underlying exposure with TRS. With the start of the new
                                                      fiscal year, those flows reversed and we observed a large negative effect on the
                                                      very short term. (cf graph below).

                                                                                     NIKKEI 3M and 1Y Repo





                                                                                 NKY 1Y Repo
                                                                                 NKY 3M Repo



                                                               Source: BNP Paribas

                                                      NIKKEI Index specifics

                                                      The risk of sudden death in NIKKEI is often mentioned. The NIKKEI index
                                                      provision and rules state that, in the eventuality that a company, member of the
                                                      index, defaults, it is immediately replaced by another company. Consequently,
                                                      the profit and loss of a basket of shares could be dramatically different than that
                                                      of a long futures position creating demand for futures at the expense of the
                                                      basket. For example:

                                                          o    If stock X is worth 2% of NIKKEI on date t and defaults on date t+1, X is
                                                               replaced by Y as of date t and the performance of NIKKEI between t

More Than You Ever Wanted To Know About Equity Repo                                                                                   18
                                                               and t+1 is computed with Y instead of X. Effectively, NIKKEI is not
                                                               impacted by the event of default.

                                                          o    However, an investor replicating the performance of NIKKEI by holding
                                                               the basket of shares with the respective weights would suffer a 2% loss
                                                               on his portfolio on the close of date t+1.

                                                      Over the past 10 years, only 2 stocks defaulted while being part of the NIKKEI,
                                                      Kanebo in 2005 and Japan Airlines in 2007. Their index weights were 0.12% and
                                                      0.04% respectively. Prior to the default event, these stocks fell by ~75% and
                                                      ~99% respectively. Since the NIKKEI index is price-weighted, these defaults had
                                                      a fairly subdued impact on the cash vs. futures spread.

                                                      The median weight of a NIKKEI stock is 0.215%. If we assume a 75% drop in the
                                                      stock prior to the default event, the impact on the Cash vs. Futures spread would
                                                      be around 0.05%.

                                                      The reshuffle risk is limited on NIKKEI: All of the 225 stocks within NIKKEI are
                                                      sufficiently liquid. Any stock that defaults and suffers a ‘sudden death’ event is
                                                      taken out of the index and replaced by another liquid one. The repo-ability of the
                                                      existing inventories of the index is not really an issue.

                                                      Japan regulation vs. its European and US peers

                                                      Japanese banks do not have cash liquidity concerns. When it comes to capital
                                                      adequacy, they have fewer constraints than before and as well capitalized
                                                      relative to their US and European counterparts (this is especially significant for
                                                      the 3 mega banks).

                                                      Japanese financial institutions (pension funds or insurance companies) hold TPX
                                                      inventories, and thus have little interest in NIKKEI.

                                                      The end of the Japanese fiscal year has an effect on repo rates as market
                                                      participants are based locally. Domestic institutions have a tendency to reduce
                                                      the size of their balance sheet towards the end of the fiscal year. However, the
                                                      size of their balance sheet typically increases again afterwards. This dynamic
                                                      can explain to some extent the rebound in repo rates observed early April.

                                                      Furthermore, after 2008, a number of forward trading desks closed their
                                                      operations in Japan. This had an impact on repo rates since fewer dealers were
                                                      able to put their balance sheet to work.

More Than You Ever Wanted To Know About Equity Repo                                                                                  19
                                                       Rational and Irrational Fears
                                                          “Only thing we have to fear is fear itself” Franklin D. Roosevelt, 1932

                                                      Uncertainty and fear can drive asset prices to dislocated levels but typically they
                                                      eventually normalize once the sources of the concerns abate as confidence and
                                                      visibility improve.

                                                      The fundamental drivers of Repo in Europe are numerous but can be classified
                                                      into three main categories: balance sheet constraints, withholding tax and other
                                                      regulation such as financial transaction tax and solvency requirements.

                                                      Fear related to balance sheet constraints

                                                      o    Cash availability at European Banks

                                                      Since the outburst of the present crisis, cash has become a scarce and valuable
                                                      resource and banks have been dramatically reducing their consumption of short
                                                      term funding. That being said, we do not see believe constraint is affecting the
                                                      short term repo on the SX5E. Banks have recently had an excess of short term
                                                      cash, as they have very significantly improved their liquidity positions.

                                                      o    Leverage Ratio vs Risk Weighted Assets (RWA) ratio:

                                                      There are on-going discussions for a leverage ratio constraint on top of the RWA
                                                      ratio but nothing is effective yet and at the earliest it would come into force in
                                                      2017. Both will be implemented in the EU with CRR / CRD IV-, which is the EU
                                                      transposition of Basel-III.

                                                      The leverage ratio calculation is based on the ratio of Core Tier 1 capital to
                                                      Assets, while the Risk Weighted Asset ratio is based on a more tangible number
                                                      as it translates the assets into risk based capital irrespective of the pure
                                                      outstanding notionals. Whilst US banks have always been constrained by a
                                                      leverage ratio, they managed to cope with it and finance their business
                                                      development regardless.

                                                      As of today, there are too many unknowns, making it difficult to predict which of
                                                      the two constraints will be relevant. Some of the most material uncertainties
                                                      relate to capital market activities (repos, derivatives). Furthermore, there are also
                                                      talks of the FED imposing a tighter capital ratio (10% instead of 5%). We believe,
                                                      however, that local banks will strongly push back against such a measure.

                                                      Within capital market activities, equity derivatives are much less balance sheet
                                                      intensive than fixed income. It is estimated that for an equivalent level of
                                                      revenues, the security inventory of equity derivatives would be about 3 to 4 time
                                                      smaller than fixed income. Equity derivatives are therefore not expected to face
                                                      material balance sheet constraints. More generally, even within European banks
                                                      conducting significant equity derivatives activities, the equity inventory is
                                                      estimated to represent ca. 1% of the total assets.

                                                      It is important to note as well that the Bank Levy created in the UK in 2010,
                                                      whose amount depends on the size of balance sheet, has a meaningful impact
                                                      on a number of local players.

                                                      Some may even suffer from a double levy, in the case of Germany. The UK
                                                      government has consistently increased the tax rate as it regularly missed its
                                                      target levy; hence putting increased pressure on downsizing local balance

More Than You Ever Wanted To Know About Equity Repo                                                                                     20
                                                      o     Liquidity Coverage Ratio (LCR) and liquidity constraints

                                                      The LCR is the first regulatory attempt at tackling liquidity risk. It has been
                                                      introduced to promote the short term resilience of banks liquidity profiles. It is
                                                      defined as the ratio of the stock of unnumbered High Quality Liquid Assets
                                                      (HQLA) which can be converted into cash with little or no loss in private markets
                                                      during a 30 day liquidity stress scenario as specified by the regulators. On
                                                      January 2013, the rules governing the LCR have been amended. The new
                                                      proposal now incorporates the HQLA Level 2 assets, which can include equities
                                                      but with a 50% haircut. However, in order to qualify, these equities cannot
                                                      represent more than 15% of the inventory of the HQLA.
                                                      Additionally, in order to qualify as HQLA, the equity in question must satisfy a
                                                      certain number of conditions, the most important is:

                                                            (1) It should not have been issued by a financial institution;

                                                            (2) It should be a constituent of a major stock index and must not have
                                                            suffered material declines or repo stress during, a defined 30-day period of
                                                            significant liquidity stress;

                                                      The minimum LCR requirement will only apply starting in 2015 at a level of 60%
                                                      but rising to 100% on 1 January 2018. It is also important to bear in mind that the
                                                      ratio can fall below 100% temporarily during a period of stress.

                                                      Finally, in order to get repo trades compliant with the 30 day stress period, one
                                                      can now trade in market “evergreen” repos in which the maturity is a rolling 30
                                                      days (i.e. callable at any time for a remaining maturity of 30 days). These repos
                                                      trade in the market for roughly an extra cost of 0.15%.

                                                                          BCBS Ca lenda r   2015     2016       2017         2018   2019
                                                          Minumum LCR requirement           60%      70%        80%          90%    100%

                                                      Beyond regulatory constraints, the liquidity risk arising from the transformation
                                                      positions taken by banks is under increased scrutiny by regulators and the banks
                                                      themselves. Both are anticipating the expected regulatory requirements by
                                                      running stress-test based simulations and implementing mitigating actions. As
                                                      some capital market activities include transformation positions, such increased
                                                      scrutiny is leading these activities to increase their term funding.

                                                      o      Pressure on Banks’ funding levels

                                                            The repo is an implied parameter which is derived from the spread of the
                                                            Total Return Swap (TRS). This spread is a function of banks’ ability to repo
                                                            out the shares inventory used to hedge their short TRS position but also of
                                                            their funding capacity (which is different from Euribor 3M flat on the long

                                                            However, we do not consider this argument as the plausible reason for the
                                                            recent fall in long term repo rates because banks’ funding levels have
                                                            decreased substantially over past months, suggesting improving funding
                                                            conditions. This can be observed on the chart below, which displays the
                                                            gradual decline in the 5-year senior CDS spreads for a number of European
                                                            banks. We used CDS spreads as proxy for long term funding stress.

More Than You Ever Wanted To Know About Equity Repo                                                                                        21
                                                                                                European Banks 5yr CDS spreads
                                                             350                                                                                                                         BNP Paribas SA
                                                                                                                                                                                         Barclays Bank PLC
                                                                                                                                                                                         Deutsche Bank AG
                                                                                                                                                                                         Citigroup Inc
                                                             100                                                                                                                         Morgan Stanley

                                                               50                                                                                                                        UniCredit Bank AG

                                                      Source: BNP Paribas, Bloomberg

                                                      Furthermore, Euribor-Eonia basis and 3mth EUR/USD cross currency basis
                                                      swaps have been the most common indicators of liquidity stress within the
                                                      European banking system.

                                                      The two charts below show the evolution of these swaps since 2007 and 2008,
                                                      respectively. As shown by 5y credit default swaps of European banks, there is
                                                      also no evidence of a liquidity stress or shortage in Europe. The tensions seen in
                                                      the second half of 2011 have substantially abated since the implementation by
                                                      the ECB of two Long Term Refinancing Operations (LTRO) in December 2011
                                                      and early 2012. They provided European banks facing liquidity shortages with up
                                                      to EUR 1 trillion of 3yr funds that could be collateralized with a wide range of
                                                      eligible assets.

                           Euribor-Eonia basis (bps)                                                                                  3m EUR/USD swap basis (bps)

   Source: Exane BNP Paribas                                                                    Source: Exane BNP Paribas

                                                      o     Evidence of ‘Balance sheet window dressing’

                                                      For the first time in a while, there seems to be evidence of balance sheet window
                                                      dressing across regions. The 1-month repo for SX5E, SPX and NKY collapsed
                                                      simultaneously at the end of last year (December 2012).

More Than You Ever Wanted To Know About Equity Repo                                                                                                                                                          22
                                                                Global index 1m Repo – Large moves in Dec-12 and Mar-13
                                                                                        SX5E            SPX            NKY






                                                      Source: BNP Paribas, Bloomberg

                                                      This particular price action appears to corroborate the desire for banks to move
                                                      assets out of their balance sheet and replace them with synthetics such as total
                                                      return swaps or futures.

                                                      This phenomenon also occurred in March 2013 for the NIKKEI (green line). The
                                                      month of March in Japan marks the end of the corporate fiscal year.

                                                      Fear related to tax on dividends

                                                      o    Withholding Tax on Dividends and Article 56 of EU Treaty

                                                      There are two opposite forces in Europe currently affecting the levels of net

                                                           1.    Litigation under Article 56 of EU Treaty on “free movement of
                                                                 capital” regarding the Withholding Tax (WHT) applying to UCITS
                                                                 funds: In France, Italy and Spain, the European Court of Justice ruled in
                                                                 favour of an harmonisation of withholding tax between domestic and
                                                                 foreign UCITS funds (Undertakings for Collective Investment in
                                                                 Transferable Securities).

                                                                 This harmonisation only applies again to UCITS funds but is triggering
                                                                 interest from a number of British pension funds (PF) that would like to
                                                                 claim back years on WHT as well. The French government is pushing
                                                                 back, arguing that the British PFs do not compete with French ones,
                                                                 unlike in the fund space.

                                                                 The French government has set aside $6bn as a provision against the
                                                                 payment of WHT, levied from past dividends. There is a state of
                                                                 limitations of 3 years. In order to finance this additional cost, the French
                                                                 government has levied a new tax of 3% on earnings of French

                                                           2.    A recent decision by the German government on 1st March 2013 is
                                                                 moving in the opposite direction. Domestic corporate shareholders with
                                                                 stakes below 10% are treated similarly to foreign corporate
                                                                 shareholders in that they will be subject to a 15% tax on dividends.

                                                      The market is currently torn between moving in two directions and in a situation
                                                      where governments are struggling to reduce their budget deficits, there might be
                                                      a risk that EU governments decide to apply a flat WHT across Europe.

More Than You Ever Wanted To Know About Equity Repo                                                                                       23
                                                      Currently for non-domestic residents, Italy applies a 98.625% tax rate for every
                                                      European fund. In Spain, European funds can receive 99% of dividends. In
                                                      Germany, corporate shareholders only get 85% of dividends.

                                                      o    Scrip dividends and their impact on Repo

                                                      Similar to the market turmoil of 2008, a number of companies in Europe have
                                                      started to use scrip dividends as a way to save cash and pay dividends with
                                                      shares by effectively diluting the existing shareholders.

                                                      The use of scrip dividends has been especially popular in France, Holland and
                                                      Spain. Financials have been very aggressive users of this scheme but its use
                                                      has also spread to a broad range of companies on a recurrent basis. It should
                                                      also be noted that some scrip dividends (the Spanish and Dutch ones in
                                                      particular) are not subject to any taxes (cash dividend are taxed). This benefit
                                                      has caused TRS spreads levels to increase given their impact on repo rates.

                                                      The impact of the scrip dividends on the SX5E comes from the time and intrinsic
                                                      values (mainly for French scrip dividends where there is a discount of up to 10%)
                                                      but this impact remains low, (€0.40 on the €115 2012 SX5E dividend).
                                                      However in 2012, the SX5E dividends paid either in scrip divs that are tax free
                                                      (SAN / BBVA / REP / IBE / PHIA) or from reserves (DTE) amounts to ~18.6% of
                                                      the Dec-12 dividend swap (€115).

                                                      It is an all the more important a figure as those dividends are actually tax free
                                                      and this percentage could fall over the next few years. This could have positive
                                                      implications for TRS spread levels as dealers are likely to require more
                                                      compensation against the risks of higher taxes on their long stock positions.

                                                      However, the beneficial tax treatment of scrip dividends has effectively enabled
                                                      Spanish banks in particular to issue equity rather than consume cash (by paying
                                                      cash dividends), which has been very positive for their capital ratios and liquidity
                                                      levels. Consequently, the tax benefit of scrip dividends (lower tax on stock
                                                      dividends than cash dividends) could last longer than expected.

                                                      Fear related to other regulation
                                                      o    European Market Infrastructure Regulation (EMIR)

                                                      The financial community stresses that regulation is likely to create a second ‘high
                                                      quality collateral trap’ after the LCR. The projected impact varies from 1% to
                                                      100% of market participants depending on the assumptions and the most cited
                                                      figures mention a $1 to $2 trillion additional collateral need. It is therefore very
                                                      difficult to predict a clear impact at this stage, but if anything, it should be positive
                                                      for equity repo as the collateral shortfall might open the doors to equities as
                                                      eligible collateral.

                                                      Mandatory clearing of vanilla transactions

                                                      This might cause more collateral to be posted at Central Counterparty Clearing
                                                      Houses (CCP). However, it is not obvious that the impact will be material, as a
                                                      large portion of equity derivatives are already centrally cleared (because they are
                                                      listed). Moreover, there will be cross margining inside each CCP, so the increase
                                                      of deposit should not be huge compared to today's deposits and volatility of

                                                      Bilateral posting of Initial Margin for non-cleared OTC transactions:

                                                      This should indeed increase the need for high quality collateral, however:

                                                             Final guidelines are not yet published. The target is Sep-13 for a new
                                                             version as the recommendation must be ready for the next G20. ESMA
                                                             will need to publish their proposition after that, delaying further the

More Than You Ever Wanted To Know About Equity Repo                                                                                         24
                                                                This should apply only to counterparties whose notional of derivative is
                                                                above a certain 'threshold' to be defined
                                                                This should not apply before 2015 and there will be a grandfathering
                                                                clause, so only new business will be impacted. It is not a gap event.
                                                                Counterparties will probably work out solutions to reduce their bilateral

                                                      o       Financial Transaction Tax (FTT)

                                                      The European FTT is still at an early stage even if France and Italy have decided
                                                      to move forward on their own. Germany looks reluctant to put in place anything
                                                      too early. According to a report by Exane BNPP entitled “Normalisation is
                                                      delayed but valuation is supportive” 18 April 2013, the FTT initiative is likely to
                                                      negatively impact repo rates and interbank markets. They also believe that it
                                                      could threaten the proper functioning of financial markets in Europe. That said,
                                                      exposing repos to the FTT would be unprecedented.

                                                      o       Bank for International Settlements (BIS)

                                                      The BIS publishes on a semi-annual basis statistics on the Over-The-Counter
                                                      derivatives markets in the G10 countries plus Australia and Spain.

                                                      The goal is to draw a better picture of the activity in global financial markets
                                                      which includes traditional banking and securities statistics. The latest report with
                                                      data ending December 2012 data was published on 8 May 2013.

                                                      Looking at the outstanding amount of OTC equity-linked derivatives, the only
                                                      substantial increase in total contracts actually comes from Europe, which
                                                      increased by $183bn.

                                                                        OTC equity-linked derivatives by equity regions

                                                          In billions of $                 Dec-10     Jun-11    Dec-11    Jun-12    Dec-12
                                                          Total Contracts                     5,635     6,841     5,982     6,313     6,251
                                                          US Equities                         1,565     1,739     1,700     1,903     1,936
                                                          European Equities                   2,793     3,414     2,675     2,646     2,829
                                                          Japanese Equities                    595       712       644       641       460
                                                          Other Asian Equities                 252       346       387       438       322
                                                          Latin American Equities               58        77        68        76       132
                                                          Other Equities                       372       554       509       610       573

                                                      Source: BNP Paribas, BIS

                                                      Looking at the data from another angle, the only product showing an increase in
                                                      outstanding notional is “Forwards and Swaps of a maturity of one year or less”.
                                                      While such an increase could explain the moves seen in short term repo rates for
                                                      the December expiry, it cannot explain the evolution of long term repo rates.

                                                      It will be very interesting to see the publication of the numbers for the June 2013
                                                      period as that data should shed further light on current flows and market

More Than You Ever Wanted To Know About Equity Repo                                                                                     25
                                                                             OTC equity-linked derivatives by maturity

                                                          In billions of $                   Dec-10     Jun-11    Dec-11    Jun-12    Dec-12
                                                          Forwards and Swaps                    1,828     2,029     1,738     1,880     2,045
                                                          Maturity of one year or less          1,009     1,188     1,049     1,142     1,345
                                                          Maturity between 1 and 5 years         628        653       524       589       564
                                                          Maturity oveer 5 years                 190        188       166       149       136
                                                          Options                               3,807     4,813     4,244     4,434     4,207
                                                          Maturity of one year or less          1,640     1,982     2,002     2,149     2,005
                                                          Maturity between 1 and 5 years        1,729     2,347     1,769     1,826     1,766
                                                          Maturity over 5 years                  437        484       473       459       436
                                                      Source: BNP Paribas, BIS

                                                      o       Equities as collateral with Central Counterparty Clearing House (CCP)

                                                      The larger CCPs already accept equities as collateral (Eurex, LCH Clearnet SA).
                                                      LCH Ltd does not accept equities yet, but they are expected to harmonize their
                                                      policy with Clearnet SA. The remaining issues are the following:

                                                                  o    Haircuts (HC) are generally very high (between 20 and 50%, or
                                                                       higher). Posting equity as collateral is therefore too expensive. It is
                                                                       worth noting that Eurex moved in 2010 to lower the HC applicable
                                                                       to equity used to collateralize initial margins from 50% to a formula
                                                                       floored at 20%.

                                                                  o    One cannot guarantee that CCP policy will not change. They
                                                                       reserve the right to change their policy at any point in time. It can
                                                                       therefore be very risky to enter into a term borrow and post the
                                                                       equity collateral to the CCP.

                                                      Counterparties are likely to keep posting the cheapest assets for collateral and
                                                      this could include equity. There is a possibility for equity repo rates to move
                                                      higher if equities are increasingly posted as collateral for bilateral margins.
                                                      However, this is unlikely in the short term in our view.

                                                      Fear related to structured products
                                                      o       Structured Products (SP) Issuance in Europe (figures are based on the
                                                     database and include only the public offers).

                                                                  o    Overall volumes have declined significantly (from €260bn in 2007
                                                                       to €115bn in 2012 have continued to decline in 2013).

                                                                  o    Over the past few years, the proportion of equity linked SPs has
                                                                       increased in percentage terms (around 65% of issuances in 2012),
                                                                       while those linked to minor asset classes have almost disappeared
                                                                       (hybrids, funds, etc…). Looking at the issuance of equity-linked
                                                                       SPs in 2012, more than 50% was on single stocks / basket of
                                                                       single stocks, close to 40% was on indices (with almost 50% from
                                                                       these linked to Eurostoxx 50 Index) and very little was on basket of

                                                                  o    Long dated capital guaranteed structures were very popular after
                                                                       2008 and demand rose significantly then. However, given the
                                                                       increased general risk aversion since then, the proportion of
                                                                       products with maturity below 2 years and a level of capital
                                                                       guarantee below 100% has increased. This is again the result of
                                                                       the current low and falling long term interest rates that are
                                                                       rendering capital guarantee structures less attractive.

More Than You Ever Wanted To Know About Equity Repo                                                                                        26
                                                                                    o          The demand for long term forwards stemming from exotic desks is
                                                                                               falling as a result of falling interest rates.

                                                                                    o          Structured product flows have been one of the key drivers of long
                                                                                               term TRS buying as the exotic desks needed to buy back (hedge)
                                                                                               the forward exposure they implicitly sold through these products.

           EU Structured Products Issuance by asset class                                                 EU Structured Products Issuance by level of capital
                             Issuance split by asset class

     150,000                                                                       FX Rate
     100,000                                                                       Hybrid
                                                                                   Interest Rate

                2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

   Source: BNP Paribas,                                                   Source: BNP Paribas,

                                                                    Forward/Repo exposure from structured product issuance in

                                                                            1-      Split of structured product issuances per level of capital guarantee:

                                                                                    After 2008, there has been a significant increase in the level of capital
                                                                                    guarantee because of a high risk aversion and interest rates that
                                                                                    remained elevated.

                                                                                    Since 2012, however, the proportion of non-capital guaranteed products
                                                                                    has increased because of the collapse in long term interest rates.

                                                                            2-      Below is the delta on the SX5E issued per year (assuming 50% of all
                                                                                    equity underlyings are hedged with SX5E forwards and an average
                                                                                    40% delta on all products). Volumes continued to weaken so far this
                                                                                    year with no specific flows that could justify increased demand for long
                                                                                    term forwards.

               EU Structured Products issuance by maturity                                                  Estimated Delta from new issuances by maturity
                        Issuance split by maturity
                                                                  Long Term (>6 years)
                                                                  Medium Term (>2 and <=6 years)
                                                                  Short Term (<=2 years)




               2003   2004    2005   2006   2007   2008   2009   2010    2011    2012       2013

   Source: BNP Paribas,                                                   Source: BNP Paribas,

                                                                    o        Increasing Dis-intermediation of Repo markets

                                                                    Despite lower overall structured product issuance in Europe, it is worth bearing in
                                                                    mind that banks now have low risk appetites given the higher regulatory
                                                                    constraints on liquidity and capital since 2009. This might trigger a gradual dis-
                                                                    intermediation of the equity secured funding market as other non-bank
                                                                    institutions step in and lend their balance sheet while banks step out and only
                                                                    play an intermediary role.

More Than You Ever Wanted To Know About Equity Repo                                                                                                          27
                                                      This is a trend already observed in the corporate credit markets to a certain
                                                      extent where companies are now increasingly switching out of the loan markets
                                                      and into the corporate bonds / convertible bonds market to raise funds in order to
                                                      finance their business cash requirements, such as capital expenditure
                                                      investments and working capital needs.

                                                      o     “Plan Epargne en Actions” (PEA) as a supply of Long term repo:

                                                      France has a specific tax efficient wrapper for retail investors provided that the
                                                      fund invests at least 75% of its value in European equities. This wrapper has
                                                      been very successful historically and leads to a strong demand for term repo (the
                                                      formula fund is typically long the equity, short the TRS and long an OTC option).

                                                             Plan Epargne en Actions (PEA) – Asset under Management

                                                                                 PEA eligible formula funds






                                                                           DEC-06     DEC-07   DEC-08    DEC-09   DEC-10    DEC-11    DEC-12

                                                      Source: BNP Paribas, Bloomberg, Factset, Autorites des marches Financiers(from 2010 becnhmarked on
                                                      overall fund AUM)

                                                      Since the 2008 financial crisis, CAC repo started to trade at a significant
                                                      premium to SX5E repo (CAC was positive and SX5E negative). This spread
                                                      generated some interesting relative value trading strategies particularly as 35%
                                                      of the components of the Eurostoxx50 index are French shares.

                                                      Over the past 18 months, the picture started to change dramatically as the
                                                      looming Financial Transaction Tax (FTT) made banks more reluctant to enter
                                                      into repo trades given the potential risk of having to incur more friction costs.

                                                      The negative effect is clearly made worse by two other developments. First,
                                                      there has been a substantial reduction in the AUMs of PEA eligible funds as
                                                      most of these funds have matured. Second, long term EUR swap rates have
                                                      fallen to such an extent that they no longer provide a sufficient funding spread for
                                                      the issuance of attractive capital guaranteed products.

                            SX5E vs CAC 5y Repo                                                       Repo vs EU swap rates
      0.80                                                                          0.80                                                            6.00

                                                                                                              Repo 5Y
      0.60                                                SX5E                                                                   SX5E 5Y Repo       5.00
      0.40                                                CAC                       0.40                                         CAC 5Y Repo
                                                                                                                                 EU 5Y Swap (RHS)   4.00
      0.20                                                                          0.20

      0.00                                                                            -                                                             3.00

      -0.20                                                                       -0.20
      -0.40                                                                       -0.40
      -0.60                                                                       -0.60
      -0.80                                                                       -0.80                                                             -

   Source: BNP Paribas                                                          Source: BNP Paribas

More Than You Ever Wanted To Know About Equity Repo                                                                                                 28
                                                      We have seen a few trades of late from some PEA funds that are switching from
                                                      CAC or custom baskets to SX5E baskets as the extra yield pick-up received from
                                                      dislocated repo rate more than offsets the inefficiency of trading non-French
                                                      shares for which PEA funds cannot reclaim the withholding tax levied on
                                                      dividend income.

                                                      This could provide some support to repo rates should other PEA funds follow
                                                      suit. Last but not least, these funds embed a restrike mechanism if the valuation
                                                      of equities falls below a certain level of NAV. At this point, the product must be
                                                      re-strucks thereby creating increasing flows of repo buyers during market sell-

                                                      o    Basel-III and Value-At-Risk (VAR) on Credit Value Adjustment (CVA)

                                                      Under Basel III, a new capital charge has been introduced which is linked to the
                                                      Value at Risk (VaR) on Credit Value Adjustment (CVA) on derivatives. While in
                                                      most instances the formula uses the CDS as an input to the CVA computation, in
                                                      some particular situations, absent a market reference, capital requirement may
                                                      be distorted upwards. Some structured funds may be in such situations. The
                                                      capital requirement arising from the VaR on the CVA charge for the Bank would
                                                      then be in proportion to the actual risks arising from the structure of the fund.

                                                      We are nevertheless confident that only a marginal part of the product offer
                                                      would be impacted, and that market participants will adapt and will find solutions
                                                      ensuring an alignment between actual risk and capital requirements such as
                                                      innovative structures or hedges into listed markets.

More Than You Ever Wanted To Know About Equity Repo                                                                                  29
                                                      Cross Asset Repo: Equity vs Fixed Income secured
                                                      An important market for funding …

                                                      The fixed income repo market is important to the proper functioning of financial
                                                      markets and a crucial source of funding for both financial institutions (i.e. balance
                                                      sheet funding) and corporates (i.e. working capital funding needs). It has also
                                                      been an essential part of the “shadow banking” system.

                                                      A recent study by the International Capital Market Association (ICMA) on the
                                                      potential impact of the Financial Transaction Tax (FTT) on the European Repo
                                                      market makes two interesting points.

                                                      (1) The repo market currently provides a secure home for liquid cash
                                                          investment for institutional and corporate investors who do not have access
                                                          to risk free deposits accounts at a central bank and who have sums of
                                                          money to invest that are too large to be protected by deposit insurance or
                                                          wish to limit the concentration of their credit exposure to commercial banks.
                                                      (2) Collateral is essential to the flow of credit. Repo is the primary vehicle for
                                                          collateralised credit.

                                                      …facing ~EUR 4 trillion of Collateral Shortage driven by global
                                                      central banks’ QE and regulation (Basel-III/CRD 4/Dodd Frank/ CCP)

                                                      In order to improve the impaired transmission mechanism of lower rates to the
                                                      economy and the stimulation of economic activity, the FED and the ECB have
                                                      resorted to large scale asset purchase programmes that have created distortion
                                                      on the availability of quality collateral. As a matter of fact, QE and LTROs have
                                                      caused banks to significantly increase the size of their balance sheets with high
                                                      quality assets (government bonds, MBS and other credit instruments).

                                                                   Central Banks’ Balance sheet close to 25% of GDP

                                                      Source: BNPP Paribas. Bloomberg

                                                      In addition, other sources of regulation are contributing to the current collateral
                                                      scarcity. Demand through initial and variation margins via CCPs is currently
                                                      expected to exceed EUR 200bn in Europe according to BNPP rates strategists.
                                                      Moreover, pension funds and insurance companies will have to post initial and
                                                      variation margin for the first time, which could have a significant impact. Finally,
                                                      Basel III / CRD 4 Liquidity coverage ratio (LCR) and Dodd Frank Sec165
                                                      Liquidity Requirement means that banks that fall under the jurisdiction of these
                                                      legislations will have to increase their holdings in AAA/AA assets by EUR 2

                                                      According to BNPP credit and rate strategists, demand through the overall
                                                      demand for collateral is expected to be in the order of $USD 2 Trillion. That said,
                                                      the use of rolling repo should reduce the absolute demand for high quality asset
                                                      for the LCR.

More Than You Ever Wanted To Know About Equity Repo                                                                                     30
                                                         Equities considered as Liquid Asset under LCR regulation

                                                         It is important to bear in mind that the LCR regulation has been reduced and now
                                                         allows equities alongside corporate bonds down to BBB and mortgage products.

                                                         High Quality Equity Secured Funding now above Structured Credit Repo

                                                         Lower quality fixed income secured funding repo rates are now at levels below
                                                         what one could receive with funding secured by high quality equities (ie.
                                                         companies with largest market capitalisation such as SPX or SX5E). This is in
                                                         particular the case with collateral such as High Yield corporate bonds (HY),
                                                         Investment Grade (IG) Asset Backed Securities (ABS) and Collateralized Loan
                                                         Obligations (CLO). This is unsual as lower quality credit used to trade higher
                                                         than equity secured funding in after the 2008/9 financial crisis.

                                                         The fact that high quality equity repo rates are now trading higher than repo rates
                                                         secured by lower rated credit products (in some cases) can be explained by the
                                                         current collateral scarcity and hunt for yield environment. As a matter of fact, one
                                                         of the consequences of the FED’s $40bn monthly asset purchase programme in
                                                         the Mortgage Backed Securities markets (MBS) was to ease funding stress
                                                         somewhat. Structured finance repo trading volume has also increased, while
                                                         repo rates have fallen somewhat over the past few years.
                                                         A recent paper by Fitch Ratings entitled “Repos: A Deep Dive in the Collateral
                                                         Pool”, August 1st, 2012 shows an interesting analysis of the structured finance
                                                         repo markets trends and highlights the demand from money market funds
                                                         looking for yield. This highlights the effects central banks had on this market.

            USD BNP Paribas Benchmarks - over Libor 3m                                EUR BNP Paribas Benchmarks - over Euribor 3m

                            BNPP Unsecured Bonds      BNPP Covered Bonds                            BNPP Unsecured Bonds    BNPP Covered Bonds
          Maturity                                                                    Maturity
                             (ASW - Interpolated)      (ASW - Interpolated)                          (ASW - Interpolated)   (ASW - Interpolated)

             1Y                          77                   [N/A]                     1Y                   14                      1
             2Y                          58                   [N/A]                     2Y                   44                      3
             3Y                          82                    36                       3Y                   49                      8
             4Y                         101                    41                       4Y                   56                     13
             5Y                         122                    51                       5Y                   61                     15
   Source: Bloomberg, BNPP                                                       Source: Bloomberg, BNPP

                                                         Finally, the table below shows the evolution of repo haircuts across different type
                                                         of collateral in the US (treasury and agency, corporate, structured finance and
                                                         equity). While the levels of most haircuts have reverted back to pre-crisis levels,
                                                         median haircut values for equity remain at the top end of its historical range
                                                         (60% above pre-08 levels), despite US equity implied volatility and US
                                                         investment grade credit default swap spreads having converged back to pre-
                                                         crisis levels.

                                                                       Evolution of Collateral Haircut Across Asset Class

                                                         Source: Fitch Ratings

More Than You Ever Wanted To Know About Equity Repo                                                                                          31
                                                      A Selection of Trading Opportunities
                                                      Given the currently stressed levels of equity repo, we explore trading
                                                      opportunities designed to take advantage of the current term structure.

                                                      There are also interesting opportunities in combining dividend swap, repo and
                                                      rates exposure in one trade.

                                                      SX5E Forward Repo ‘Heat Map’
                                                                Buy 1y TRS and sell 5y TRS to monetize the Repo term structure.

                                                                The roll down analysis below provides an interesting framework to
                                                                identify the best point in the repo term structure to put on TRS calendar
                                                                spreads. The best points identified through this analysis are:

                                                                1y1y, 4y1y, 3y2y, 2y3y, 1y3y and 1y4y for roll down play.

                                                                Methodology: 3y2y means buying 3y repo in 2y and is equivalent to
                                                                selling 5yr TRS and buying 2y TRS.

                                                                             SX5E Repo Forward Heat Map

                                                      Source: BNP Paribas

                                                      Methodology: The forward repo rate R(T1,T2) between maturities T1 and T2 with
                                                      respective repo rates of R1 and R2 is computed using the following formula:
                                                      R(T1, T2) = [ R(T2) x T2 – R(T1) x T1 ] / [ T2 – T1 ]

More Than You Ever Wanted To Know About Equity Repo                                                                                   32
                                                      NIKKEI Forward Repo Trade with USDJPY 1Y
                                                      currency swap

                                                          -    Jun 14 / Dec 14 forward start NIKKEI TRS JPY L3M + 42 bps bid
                                                          -    Jun 15 / Jun 16 forward start NIKKEI TRS JPY L3M + 49 bps bid

                                                      European and US investors can benefit from the current basis swap (see the
                                                      following graph) to enter the trade in a compo USD format. For a variation of the
                                                      same trade, they will benefit from an extra pick up thanks to the currency swap.

                                                          -    Jun 14 / Dec 14 forward start NIKKEI Compo USD:
                                                                TRS USD Libor3M + 77 bps bid

                                                          -    Jun 15 / Jun 16 forward start NIKKEI Compo USD:
                                                          -    TRS USD Libor3M + 114 bps bid.

                                                                                      USDJPY 1Y currency swap

                                                                    Nov-12   Dec-12      Jan-13   Feb-13   Mar-13   Apr-13   May-13








                                                               Source: BNP Paribas

                                                      NIKKEI Long Term Exposure Hedge with a carry

                                                          -    Dec 18 NIKKEI TRS JPY L3M + 47bps
                                                          -    Dec 18 NIKKEI TRS Compo USD USD L3M + 100bps

                                                      An investor interested in hedging his long term Japanese exposure can do so
                                                      with long dated TRS. Under this structure, he would not be required to roll short
                                                      term futures positions on a regular basis. In addition, he will be able to secure an
                                                      extra yield of up to 47bps in JPY and 1.0% in USD.

                                                      Solution to improve liquidity profile with repo
                                                      The dislocated level of the Japanese repo can be used to enhance secured
                                                      transactions through the posting of Japanese equities as collateral.

                                                      This format takes advantage of stressed Japanese repo rates and has been very
                                                      popular with financial institutions in Japan as a way to generate extra yield and
                                                      optimize balance sheet usage.

                                                      This structure can also be implemented with existing government bonds in the
                                                      US or Europe given current General Collateral (GC) repo rates.

                                                      Trade structure basics

                                                      The investor enters into a secured transaction as it lends BNP his JGBs holdings
                                                      for a tenor of 1 year. BNP posts Japanese equities as collateral.

More Than You Ever Wanted To Know About Equity Repo                                                                                    33
                                                      The investor receives an attractive yield pick-up of around 20bps per annum for
                                                      a secured loan (not subject to a mark to market).

                                                      This trade is attractive given the currently dislocated Japanese repo rates.

                                                                              JGBP vs Equities Pricing Table
                                                                                          JGB vs. Equities
                                                                                   Floating Price in %           Fix Price in %
                                                                            Reference    No HC       5% HC      No HC     5% HC
                                                                    6M      JPY L1M +     0.04           0.01   0.15        0.12
                                                                    1Y      JPY L1M +     0.14           0.1    0.25        0.21
                                                                    2Y      JPY L1M +     0.13           0.08   0.27        0.23

                                                               Source: BNP Paribas

                                                      Enhance your return with USDJPY and EURJPY cross currency basis
                                                      swaps: US or EU Bonds Collateralized loan using Japanese stocks

                                                      European and US investors can therefore benefit from USDJPY and EURJPY
                                                      cross currency basis swaps. The negative basis swap offers incremental yield

More Than You Ever Wanted To Know About Equity Repo                                                                                  34
                                                      Appendix: What is a Repo?

                                                      Definition of Equity Repo

                                                        o   Cash & Carry Arbitrage

                                                                    In a risk-neutral world, holding a Bond or an Equity should
                                                                    yield a similar return
                                                                    The Bond return over period T is given by the risk-free rate “r”
                                                                    The Equity return is composed of 3 elements
                                                                           performance return, i.e. for a stock S: ST - S0
                                                                           dividends paid during the period by the Equity
                                                                           fees earned from lending the equity, called “repo”

                                                        o   Forward price calculation: Impact of the repo

                                                                     At t = 0, the Forward Price of maturity T, i.e. the expectation of
                                                                    the level of the spot at time t = T, is

                                                                      FT = S 0 ⋅ exp (r − repo ) * T − ∑ divi ⋅ exp (r − repo ) * (T −ti )
                                                                              r: average risk-free rate between t = 0 and t = T
                                                                              div: implied dividends = dividends paid by the
                                                                               stock(s) between t=0 and t=T
                                                                              repo: implied repo = average (overnight) repo fee
                                                                               between t=0 and t=T
                                                                              S0: Closing level of stock S at t=0

                                                      The Total Return Swap

                                                                    A Total Return Swap (TRS) is a swap where two
                                                                    counterparties exchange at periodic dates the following
                                                                    cash flows

                                                                           the “receiver” (“Long”) receives an Equity Amount,
                                                                           reflecting the P&L of a Long Position in the underlying,
                                                                           equal to the performance of the Equity plus the
                                                                           Dividends paid during the period
                                                                           the “payer” (“Short”) receives a Floating Rate
                                                                           Amount, reflecting the cost of carrying the underlying

                                                                    The TRS spread represents the cost of carrying the
                                                                    underlying. It should hence be equal to “-repo” :
                                                                          the lower the repo, the higher the spread of a TRS

                                                                    Being “Short“ a TRS means being “Long” the Implied Repo

More Than You Ever Wanted To Know About Equity Repo                                                                                          35
                                                      Trading the Implied Repo curve with Total Return
                                                      Swaps *
                                                                      Let’s assume an investor trades a spread of Total Return
                                                                      Swaps :
                                                                             Long a 1Y TRS (i.e. selling the 1Y implied repo) with a
                                                                             spread of +55 bps
                                                                             Short a 6Y TRS (i.e. buying the 6Y implied repo) with a
                                                                             spread of +76 bps

                                                                      What are the cash flows during the first year?
                                                                        Every 3 months:
                                                                           receives the Equity Perf + Dividends from the 1Y TRS
                                                                           and pays the exact same amount for the 6Y TRS
                                                                           pays EURIBOR 3M+55 bps for the 1Y TRS and
                                                                           receives EURIBOR 3M+76 bps from the 6Y TRS
                                                                           Net Cash flow: receives 76 - 55 = 21 bps p.a.
                                                                           No exposure to the spot, the dividend nor the E3M

                                                                      What happens to the mark-to-market if the implied repo moves
                                                                      during the first year?
                                                                             Being short the 6Y TRS means being long the 6Y repo
                                                                             If the long term implied repo goes back up, positive
                                                                             mark-to-market, otherwise, negative mark-to-market

                                                                      What happens to the mark-to-market after the first year?
                                                                           After 1 year the investor is Short a 5Y TRS
                                                                           It is necessary to roll-over the 1Y TRS or to exit the 5Y
                                                                               TRS, being exposed to unwind or roll-over risks

                                                                      Trading a spread of TRS allows to put on a Carry Trade
                                                                      and trade the Implied Repo

                                                      Trade and Mark to Market Examples

                                                        o   Total Return Swap run vs EUR3M

                                                               Tenor        Bid (bp)   Offer (bp)
                                                                 1y            50          55
                                                                 2y            55          60
                                                                 3y            58          63
                                                                 4y            63          69
                                                                 5y            70          76
                                                                 6y            76          83
                                                                 7y            77          85
                                                                 8y            79          90

                                                                      Let assume an investor trades a 1Y / 6Y Total Return Swap
                                                                            “Buy” the 1Y at +55 bps
                                                                            “Sell“ the 6Y at +76 bps

More Than You Ever Wanted To Know About Equity Repo                                                                               36
                                                                   After 1 year, the investor has received 21 bps p.a. of carry
                                                                  (76-55), and is now Short a 5Y TRS

                                                      o   Scenario 1: same term-structure in 2Y

                                                                  Carry P&L during year 1: +21 bps (76 - 55 bps)
                                                                  Bid/offer on the 5Y: 70 / 76 bps
                                                                  2 strategies :
                                                                         Exit the 5Y TRS @ +76 bps : (76 - 76) x 5 = 0 bps

                                                                                         Total P&L = +21 bps

                                                                         Roll-over the 1Y TRS and MtM at mid-level : (76 - 73) x
                                                                           5 = 15 bps
                                                                                        Total P&L + MtM = +36 bps

                                                      o   Scenario 2: flat term-structure at 0 in 1Y

                                                                   Carry P&L during year 1 : +21 bps (76 - 55bps)
                                                                   bid/offer on the 5Y : -5 / 5 bps
                                                                   2 strategies :
                                                                          Exit the 5Y TRS @ +5 bps : (76 - 5) x 5 = +355 bps
                                                                                                  Total P&L = +376 bps
                                                                          Roll-over the 1Y TRS and MtM at mid-level : (76 - 0) x
                                                                            5 = +380 bps
                                                                                                  Total P&L + MtM = +401 bps

                                                      o   Scenario 3: steepening of the term-structure in 1Y

                                                                   Carry P&L during year 1 : +21 bps (76 - 55bps)
                                                                   bid/offer on the 5Y : 77 / 85 bps
                                                                   2 strategies :
                                                                          Exit the 5Y TRS @ +85 bps : (76 - 85) x 5 = - 45 bps
                                                                                               Total P&L = -24 bps
                                                                          Roll-over the 2Y TRS and MtM at mid-level : (76 – 81)
                                                                            x 5 = -25 bps
                                                                                               Total P&L + MtM = - 4 bps

                                                      o   Scenario 4: Rolling over the 1Y TRS every year at 55 bps

                                                                   Carry P&L during year 1 :        +21 bps
                                                                   Carry P&L during year 2 :        +21 bps
                                                                   Carry P&L during year 3 :        +21 bps
                                                                   Carry P&L during year 4 :        +21 bps
                                                                   Carry P&L during year 5 :        +21 bps
                                                                   Carry P&L during year 6 :        +21 bps
                                                                                      Total P&L = + 126 bps

More Than You Ever Wanted To Know About Equity Repo                                                                               37
                                                      Current Trading Bid-Offer Prices for TRS
                                                              SX5E                               NKY TRS                            SPX
                                                              TRS                                                                   TRS

                                                       1y     43/48                     Dec13    31/36                      1y      30/36
                                                       2y     52/57                     Dec14    39.5/45.5                  2y      31/38
                                                       3y     56/62                     Dec15    42/49                      3y      31/38
                                                       4y     62/68                     Dec16    44.5/52.5                  4y      33/40
                                                       5y     69/75                     Dec17    46/55                      5y      33/40
                                                       6y     72/80                     Dec18    47/57                      6y      33/40
                                                       7y     75/85                     Dec19    48/59                      7y      35/45
                                                       8y     77/90                     Dec20    49/61                      8y      35/45
                                                       9y     79/92                     Dec21    50/63                      9y      35/45
                                                       10y    81/94                     Dec22    51/65.                     10y     35/45

                                                      Repo Forward Matrix
                                                             start      1y      2y       3y       4y       5y       6y       7y        8y       9y       10y
                                                             \ end
                                                                 1y             63.49    65.75    71.50    78.62    82.10    85.75     88.35    91.06    94.94
                                                                 2y                      68.00    75.50    83.66    86.75    90.20     92.50    95.00    98.87
                                                                 3y                               83.00    91.50    93.00    95.75     97.40    99.50   103.28
                                                                 4y                                       100.00    98.00   100.00    101.00   102.80   106.66
                                                                 5y                                                 96.00   100.00    101.33   103.50   108.00
                                                                 6y                                                         104.00    104.00   106.00   111.00
                                                                 7y                                                                   104.00   107.00   113.33
                                                                 8y                                                                            110.00   118.00
                                                                 9y                                                                                     126.00

                                                             start     Dec13   Dec14    Dec15    Dec16    Dec17    Dec18    Dec19    Dec20     Dec21    Dec22
                                                             \ end
                                                               Dec13            48.09    49.23    51.60    53.14    54.29    55.56     56.90    58.28    59.69
                                                               Dec14                     50.36    53.36    54.82    55.83    57.05     58.37    59.73    61.13
                                                               Dec15                              56.36    57.05    57.64    58.72     59.96    61.29    62.67
                                                               Dec16                                       57.74    58.28    59.50     60.86    62.27    63.71
                                                               Dec17                                                58.80    60.37     61.89    63.40    64.90
                                                               Dec18                                                         61.96     63.46    64.96    66.46
                                                               Dec19                                                                   64.96    66.46    67.96
                                                               Dec20                                                                            67.96    69.46
                                                               Dec21                                                                                     70.96

                                                             start      1y      2y       3y       4y       5y       6y       7y        8y       9y       10y
                                                             \ end
                                                                 1y             36.00    35.25    37.67    37.38    37.20    41.17     41.00    40.88    40.78
                                                                 2y                      34.50    38.50    37.83    37.50    42.20     41.83    41.57    41.38
                                                                 3y                               42.50    39.50    38.50    44.13     43.30    42.75    42.36
                                                                 4y                                        36.50    36.50    44.67     43.50    42.80    42.33
                                                                 5y                                                 36.50    48.75     45.83    44.38    43.50
                                                                 6y                                                          61.00     50.50    47.00    45.25
                                                                 7y                                                                    40.00    40.00    40.00
                                                                 8y                                                                             40.00    40.00
                                                                 9y                                                                                      40.00

More Than You Ever Wanted To Know About Equity Repo                                                                                                              38
Equity Derivative Strategy Contacts

Global Head
Gerry Fowler                          +44 20 7595 8619

United States
Anand Omprakash                       +1 212 841 2886
Jordan Sinclair                       +1 212 841 3313
Amitha Kurmala                        +1 212 841 3446


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Global Emerging Markets
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Global Directional
Orrin Sharp-Pierson                   +44 20 7595 1128
Ankit Gheedia                         +44 207 595 1215

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Antoine Deix                          +33 1 40 14 06 22
Nadejda Semenova                      +44 207 595 1278

Global Structuring Group Contacts

 Thomas Bornhauser                   +44 207 595 8676


 Bailly-Monthury                     +44 207 595 8876

 Romain Marsigny                     +44 207 595 8832

 United States

 Philippe Combescot                  +1 212 471 3310

 Roland Nelet                        +1 212 471 3239


 Pierre Carubia                      +852 2108 5794

 Etienne Grisey                      +852 2108 5701

2013 Outlook: Epic Distortions                                                                     39



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2013 Outlook: Epic Distortions                                                                                                                  40
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2013 Outlook: Epic Distortions                                                                                                                    41
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2013 Outlook: Epic Distortions                                                                                                                       42
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2013 Outlook: Epic Distortions                                                                                                                         43

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