T H E U S E O F F I N A N C I A L D E R I V A T I V E S I N L A T I N A M E R I C A

Transcription

1 S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L T H E U S E O F F I N A N C I A L D E R I V A T I V E S I N L A T I N A M E R I C A Etienne Lacroix etienne.lacroix@jpmorgan.com (1) October 2011

2 T H E U S E O F F I N A N C I A L D E R I V A T I V E S I N L A T I N A M E R I C A Introduction This presentation will attempt to illustrate the evolution of the usage of financial derivatives in global markets and in select Latin American countries (when data is available) Given that they represent the majority of the traded volume globally, we will concentrate in three of the most active derivatives markets: FX, Interest Rates, and Commodities. We will delve into what are the reasons driving companies and countries to enter into financial derivative transactions and what the evolution in the use of Financial Derivatives has been in the region We will conclude by outlining our prognostics with regards to the future of the industry and our opinions on possible developments 1

3 T H E U S E O F F I N A N C I A L D E R I V A T I V E S I N L A T I N A M E R I C A Agenda Derivatives - What Are We Talking About? 2 The Use of Financial Derivatives 5 Implementing Risk Management Policy 21 Annex A: Basic Derivative Product Descriptions 31 Annex B: JPM Commodity Capabilities 36 2

4 D E R I V A T I V E S - W H A T A R E W E T A L K I N G A B O U T? What Are We Talking About When We Say Derivatives Basic Facts about Derivatives Basic Definition: Financial Contract whose value depends on the level of another variable or underlying Users: Investors (Pension Funds, HF, Mutual Funds, Central Banks, Retail, etc.) Corporate (Multinationals, local companies, Producers, etc.) Sovereign Entities Instruments: Swaps, Forwards, Futures (Fixing a future uncertain cash flow) Options (the Right but not the obligation to buy or sell) Exotics (any other non-standard payoff) Tenor: Depends on market and underlying, from very short tenor to +15 years Derivative Markets: FX Interest Rates Commodities Credit Others: Hybrids, Weather related (Rainfall, Temperature, etc.) Market Place: Organized Exchanges (such as the CBOT or NYMEX) Over-the-Counter ( OTC ) bilateral trade with counterparty Objectives: Speculation Hedging 3

5 D E R I V A T I V E S - W H A T A R E W E T A L K I N G A B O U T? Basic Overview of Financial Derivatives Fixing Future Cash Flows through Futures, Forwards or Swaps Futures, Swaps and Forwards are financial contracts that allow the user to fix an uncertain future cash flow Why uncertain? Because the future price level is not known yet and will depend on many unforeseeable factors. Examples: Libor rate in 180 days or in 5.2 years Imports on March , denominated in EUR or JOY Copper exports to happen during 2H12 10 Year Treasury Level relevant for a new bond issuance in 2 months time By using Forwards or Swaps these future uncertain cash flows can be fixed, thus fully known in advance Benefits vs. Risks: Price Certainty versus Opportunity Cost Other risks: Legal risks Operational risk (execution, transfers, etc) Counterparty risk, etc. (bankruptcy of counterparty) Financial Options In contrast to Swaps (or Forwards), options provide an asymmetric payoff (downside and upside are not similar) For the right to participate in a certain price movement, the buyer has to pay a premium in order to avoid being exposed to the opposite price movement By combining different option types (Calls, Puts) different profiles could be obtained, depending on needs, views, etc. Exotics (non-standard payoffs very common) 4

6 T H E U S E O F F I N A N C I A L D E R I V A T I V E S I N L A T I N A M E R I C A Agenda Derivatives - What Are We Talking About? 2 The Use of Financial Derivatives 5 Implementing Risk Management Policy 21 Annex A: Basic Derivative Product Descriptions 31 Annex B: JPM Commodity Capabilities 36 5

7 T H E U S E O F F I N A N C I A L D E R I V A T I V E S Derivative Use across Sectors is Very High for Fortune 500 Companies Worldwide Source: ISDA News Release April 23,

8 T H E U S E O F F I N A N C I A L D E R I V A T I V E S Firms are Increasingly Using Derivatives Markets to Hedge Financial Risks Current usage of derivatives Do not use derivatives 6% Source: 2009 ISDA survey for Global Fortune 500 companies Use derivatives 94% Commentary Historically, a significant number of large companies have been utilizing financial instruments for risk management purposes Based on an ISDA survey conducted in 2009, 94% of top large companies currently use derivatives (up from 92% in 2003) Over the course of the last 5 years, the total outstanding notional amount has increased significantly Mix from swaps to options has increased of late with a drop in option volatility Current derivative usage by the world s largest companies % Using FX % Using interest rate % Using commodity 85% 84% 79% 81% 70% 96% 94% 63% 80% 72% 86% 86% 85% 75% 92% 86% 92% 88% 83% 39% 37% 35% 8% 15% Basic materials Consumer goods Financial Healthcare Industrial goods Services Technology Utilities Source: ISDA news release published on April 23,

9 T H E U S E O F F I N A N C I A L D E R I V A T I V E S Disclosed Hedging of North American Mining Companies Disclosed Hedging of North American Mining Companies Peer Max Tenor Disclosed Commodities Exposures Hedged Barrick 60 months Interest Rate Swaps, FX Forwards (AUD, CAD, CLP, EUR, PGK), Base Metals Zero Cost Options Collars (Copper), Energy Swaps (Diesel, Propane, Natural Gas, Electricity) Goldcorp 6-12 months FX Forwards & Options (CAD, MXN), Base Metals Swaps & Zero Cost Options Collars (Copper, Zinc, Lead), Energy Swaps (Heating Oil) Newmont 60 months FX Forwards (AUD, NZD, IDR), Energy Swaps (Diesel), Interest Rate Swaps Kinross 36 months Precious Metals Forwards & Options (Gold, Silver), FX Forwards (BRL, CLP, RUB, CAD, EUR), Energy Swaps (Crude Oil) Agnico-Eagle 12 months FX Forwards (CAD), Base Metals Zero Cost Options Collars (Zinc) IAMGOLD 36 months Precious Metals Zero Cost Options Collars (Gold), FX Options & Forwards (CAD, EUR), Energy Options and Swaps (Heating Oil), Base Metals Options (Aluminum) Hecla Mining 36 months Base Metals Swaps (Zinc, Lead) Jaguar Mining 6 months FX Forwards (BRL), Precious Metals Zero Cost Options Collars (Gold) Capstone Mining 48 months Base Metals Swaps (Copper, Lead, Zinc) Breakwater Resources 12 months Base Metals Options (Copper, Lead, Zinc), Precious Metals Options (Gold, Silver) Century Aluminum 12 months Energy Swaps (Natural Gas), Base Metals Swaps & Zero Cost Options Collars (Aluminum) Alpha Natural Resources 12 months Energy Swaps & Options (Diesel, Natural Gas), Interest Rate Swaps Sources: Third Quarter 2010 Financial Reports of each company 8

10 T H E U S E O F F I N A N C I A L D E R I V A T I V E S Size of Foreign Exchange (FX) OTC Derivatives Market Worldwide Continuous to Grow BIS 2010 Data In the past 10 years the global OTC FX market has more than doubled. While the Spot and Swaps markets still represent the bulk of the trading volume, there has been a significant increase in the Options and Forwards markets as well. Swaps volume has been greater than spot volume every year for the past 12 years, showing how the usage of derivatives is becoming a central part of business transactions and gaining traction as a solution to mitigate risk exposure. Now, let s compare how Latin American markets are tracking the rest of the world OTC FX Markets Worldwide (Billions US$/Day) Spot ,005 1,490 Forwards FX Swaps ,745 1,808 Options Source:BIS 2010 Total 1,527 1,239 1,934 3,324 3,980 9

11 T H E U S E O F F I N A N C I A L D E R I V A T I V E S ISDA Shows Granular Impact of Past Crisis in the Derivative Use, by Category 10 Source: ISDA Market Survey 2010

12 T H E U S E O F F I N A N C I A L D E R I V A T I V E S Where are FX Derivatives Traded? For financial derivatives, transaction costs tend to lower when volume increases, this in turn further increases the traded volume for that asset, creating a virtuous cycle of volume and liquidity. As Latin America has historically not been a center for financial derivative transactions, it has failed to gain traction as a mayor powerhouse in total volume traded. As it can be observed in the pie chart below, geographical areas with far lesser economic size (e.g. Australia, Switzerland and Hong Kong) have significant higher proportions of FX turnover than Latin America. 11

13 T H E U S E O F F I N A N C I A L D E R I V A T I V E S Global Interest Rate Derivatives Use by Instrument Shows Strong Preference to Swaps Source: BIS, Triennial Central Bank Survey, April

14 T H E U S E O F F I N A N C I A L D E R I V A T I V E S The Use of Derivatives has Increased Rapidly in the Last 15 years: Summary 14

15 T H E U S E O F F I N A N C I A L D E R I V A T I V E S The Use of Derivatives has Increased Rapidly in the Last 15 years: Summary 15

16 T H E U S E O F F I N A N C I A L D E R I V A T I V E S ISDA 2010 End User Survey Shows Strong Use of FX, Interest Rate and Commodities During July and August 2010, ISDA conducted a survey of over-the-counter (OTC) derivatives end-users, including nonfinancial corporations, asset managers and other financial institutions295 respondents from North America and Europe who use OTC derivatives participated in the survey. Of these:80% or 234 used interest rate swaps (IRS) 59% or 174 used currency/fx swaps, 27% or 80 used credit default swaps (CDS), 25% or 74 used equity swaps and 32% or 94 used commodity/energy swaps. Respondents were asked their opinions only on those OTC derivatives that they said they have used On a 1 to 5 scale, 62% rate IRS price competitiveness at a 4 or 5 Only 10% of IRS end-users rate it at a 1 or 2 Electronic Trading: A majority of those surveyed (77%) believe electronic trading of IRS is beneficial The majority of surveyed IRS end-users give high remarks to the current level of pre-trade price transparency 71% of IRS end-users rank it same as or better than FX. 69% rank it same as or better than equities. 83% rank it equal to or better than corporate bonds. 87% rank it same as or better than ABS Source: ISDA End-User Survey: Interest Rate Swaps, October

17 T H E U S E O F F I N A N C I A L D E R I V A T I V E S Size of OTC Derivatives in Latin America Latin American derivatives markets have almost tripled in size in the past 12 years but they still represent less than 1% of the global market for derivatives In fact, Latin America share of the world s transactions hasn t changed significantly in the last 12 years. OTC Derivatives Markets in Latin America (Billions US$/Day) FX Rates Total Argentina Brazil Chile Colombia Mexico Peru Total Latam Total World 2,099 1,692 2,609 4,281 5, ,331 2,173 2,698 2,443 2,368 3,940 6,454 7,754 Source:BIS

18 T H E U S E O F F I N A N C I A L D E R I V A T I V E S Mexico FX Market by Product Mexican OTC FX Market Source:BIS

19 T H E U S E O F F I N A N C I A L D E R I V A T I V E S Colombia FX Market Colombia OTC FX Market by Product Colombia OTC FX Market por plazo Source:BIS

20 T H E U S E O F F I N A N C I A L D E R I V A T I V E S Chile: Policy Makers Have Expressed Continuous Interest in the Development of Local Derivative Markets Source: IMF Working paper 19

21 T H E U S E O F F I N A N C I A L D E R I V A T I V E S Macro Hedging on Country Level has Experienced Particular Interest During the Last Decade in Latin America 20

22 T H E U S E O F F I N A N C I A L D E R I V A T I V E S I N L A T I N A M E R I C A Agenda Derivatives - What Are We Talking About? 2 The Use of Financial Derivatives 5 Implementing Risk Management Policy 21 Annex A: Basic Derivative Product Descriptions 31 Annex B: JPM Commodity Capabilities 36 21

23 I M P L E M E N T I N G R I S K M A N A G E M E N T P O L I C Y Some Basic Facts to Consider when Implementing a Risk Management Policy Basic Facts about Risk Management Risk Management should not be a financial-product driven process but rather an analytical, consistent, recurrent and rational decision based part of any Risk Assessment and Mitigation Analysis: Analytical: it performs a full analysis and understanding of the different exposures and their relationships Consistent: hedging decisions are defined within a Risk Management Policy and are not one-off events Recurrent: it recognizes and addresses the dynamic nature of the financial (and other) exposures Rational: decisions are not made randomly The discussion of financial products and their relative advantages / disadvantages will be part of the last stage of the Risk Management Policy (and not vice versa) Floating Portion Floating Portion Tactical Hedging Baseline Hedging - Unhedged - More sophisticated products - Exotics - Usually simple products - Swaps, Options, Collars Factors to consider in any Hedging Policy Leverage Industry Competitive Landscape Financial break-even point Future financing needs Future capex Diversification in product lines Financial Sophistication and understanding Local tax and accounting treatment, etc. 22

24 I M P L E M E N T I N G R I S K M A N A G E M E N T P O L I C Y R I S K M A N A G E M E N T P O L I C Y Key drivers of the Hedging Decision Decision to hedge Business viability risk? Yes Hedge No Meaningful impact to value? Yes Hedge No Are competitors hedging financial risks? Yes Hedge No Do not hedge No Are any exposures at opportunistic levels to hedge? Yes Hedge 23

25 I M P L E M E N T I N G R I S K M A N A G E M E N T P O L I C Y Price ( $ / bbl) Market Moves Greater than Two-Standard Deviations are not Unseen Events in Commodity Markets In Fact, They Have Occurred Repeatedly in the Recent Past WTI Crude Oil Price Performance vs. 2 Standard Deviation Risk Cone (Assuming Jan 2, 2008 Market Data) $ Standard Deviation Potential Move WTI Within a 10-month period, WTI had a +2 and -2 standard deviation move $80 $30 Source: JPMorgan Jan-2007 Apr-2007 Jul-2007 Oct-2007 Jan-2008 Apr-2008 Jul-2008 Oct-2008 Jan-2009 Apr-2009 Jul

26 I M P L E M E N T I N G R I S K M A N A G E M E N T P O L I C Y Exchange Rate USDBRL) The Same is True for FX and Interest Rates Markets Exchange rate USDBRL vs. 2 Standard Deviation Risk Cone (Assuming Jan 2, 2007 Market Data) $2.6 $ Standard Deviation Potential Move $2.2 $2.0 USDBRL Within a 10-month period, BRL had a +2 and -2 standard deviation move $1.8 $1.6 $1.4 Jan-2006 Apr-2006 Jul-2006 Oct-2006 Jan-2007 Apr-2007 Jul-2007 Oct-2007 Jan-2008 Apr-2008 Jul-2008 Oct-2008 Jan-2009 Apr-2009 Jul-2009 Oct-2009 Jan-2010 Apr-2010 Jul-2010 Oct-2010 Jan-2011 Apr-2011 Jul-2011 Source: JPMorgan 25

27 I M P L E M E N T I N G R I S K M A N A G E M E N T P O L I C Y Percentage Forecast Error Analysts Forecasting Commodity Prices Have Shown Low Accuracy in the Recent Past Monthly crude oil price forecast published by a well-known international consulting firm has shown low accuracy when compared versus ex-post (real) prices, not only for long forecast horizons (12-18 months) but also in the short term (1-3 month period). Based on monthly published reports from To base financial decisions on published forecasts could potentially become a dangerous proposal given that historically financial analysts have exhibited low predictive powers, not only in Commodities but across different asset classes 80.00% 60.00% 40.00% 20.00% 0.00% Maximum % % % % % 25% Percentile 75% Percentile Minimum % Source: JPMorgan Month out 26

28 I M P L E M E N T I N G R I S K M A N A G E M E N T P O L I C Y Hedge: Rolling and Layering as a Consistent Way to Lower Overall Cash Flow Volatility How much discretion should your risk policy permit? J.P. Morgan recommends a policy that mandates discipline in hedging forecasted cash flows. The policy could also allow for a measure of discretion within that discipline Discretion on whether Client hedges to the minimum required by its policy or up to the maximum allowed in any given quarter Some discretion on layering trades intra-quarter: When does Client add a layer and how much? Ability to layer further out than required 100% 90% 80% 70% 60% 50% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Layer E Layer D Layer C Layer B Layer A 40% 30% 20% 10% 0% Minimum mandated by policy Q1 (current quarter) Q2 Q3 Q4 Q5 Q6 Layer E Layer D Layer C Layer B Layer E Layer D Layer c Discretion between minimum and maximum mandated by policy 1Q (current quarter) 2Q 3Q 4Q 5Q 6Q Mandatory % Hedged 50% 40% 30% 20% 10% Layer E Layer D Layer E [***] Assumptions: sliding scale minimum base level, decreasing discretionary maximum level, 15-month hedging tenor 27

29 I M P L E M E N T I N G R I S K M A N A G E M E N T P O L I C Y Different Hedging Profiles Produce Different Reductions in Volatilities Rebalancing Effects of Different Consistent Hedging Policies Crude Oil $40.00 $35.00 $30.00 $25.00 $20.00 $15.00 $10.00 $5.00 $0.00 May-96 May-97 May-98 May-99 May-00 May-01 May-02 May-03 May-04 ($5.00) Difference WTI Hedged Profile 1 Hedge Profile 2 Hedge Profile 3 28

30 I M P L E M E N T I N G R I S K M A N A G E M E N T P O L I C Y Different Hedging Profiles Produce Different Reductions in Volatilities Rebalancing Effects of Different Consistent Hedging Policies Crude Oil $ $ $ $90.00 $70.00 $50.00 $30.00 $10.00 ($10.00) Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 ($30.00) Difference WTI Hedged Profile 1 Hedged Profile 2 Hedged Profile 3 29

31 I M P L E M E N T I N G R I S K M A N A G E M E N T P O L I C Y Historical Evolution in the Use of Financial Derivatives in Latin America In the 1980 s few clients used Derivatives to hedge exposures, the exception to this usually in the agricultural space (through Futures in the US) and to some extent FX Forwards, when available During the 1990 s, for several reasons (PC s, networks, education, sophistication pushed by international banks in local markets) a widespread boom took off, across different asset classes, be it FX, Interest Rates, Commodities, etc. From first generation derivatives (standard swaps and options) to second generation and beyond ( exotics, such as barriers, and extendible structures to more complex products, such as credit linked transactions) became quickly available no limit in terms of pricing, booking and marketing capabilities Since the introduction of FAS 133 (and other similar accounting standards) corporate users, when affected, have gone back to more simple structures due to adverse mark-to-market treatment for exotic products In some jurisdictions tax treatment is (still) not fully clear, such as derivative loss deduction in the income statement, or withholding tax issues On average, sophistication has grown strongly across countries and sectors customers that years ago didn t trade any derivatives nowadays trade through Bloomberg electronically swaps (or other electronic platforms) and close other sophisticated trades Trades are being booked locally as well as with offshore entities (Banks), under standardized local and ISDA Master Agreement Sovereign entities have grown in sophistication as well and macro hedges are not uncommon any more (FX, Commodities, Rates) in the region As a general tendency, Derivatives are being used as part of more complex transactions Capital Markets driven bond issuance in other local markets and swapped back into local currency, commodity prepays, tax efficient funding structures, etc. Local Derivatives have become deeper and with longer maturities as well, similar to the ones seen in some mature markets: FX and Rates in Chile, Mexico, Brazil 30

32 T H E U S E O F F I N A N C I A L D E R I V A T I V E S I N L A T I N A M E R I C A Agenda Derivatives - What Are We Talking About? 2 The Use of Financial Derivatives 5 Implementing Risk Management Policy 21 Annex A: Basic Derivative Product Descriptions 31 Annex B: JPM Commodity Capabilities 36 31

33 A N N E X A : B A S I C D E R I V A T I V E P R O D U C T D E S C R I P T I O N S Buying a Fixed Price Swap Key considerations Objective Illustrative example Net Price Unhedged Hedged To lock in a forward price Description Client locks in the price over a predetermined period by buying a fixed price swap from J.P.Morgan The monthly settlement price is the average of each day s settlement in a given month and compared to the swap price If settlement price is higher than the swap price, Client receives the difference between the settlement price and the swap price If settlement price is lower than the swap price, Client pays the difference between the swap price and the settlement price Advantages The Client locks in a price over a designated time period and is protected from any price increase above the swap price Price increases in the physical market are compensated by hedging gains No upfront premium required Disadvantages The Client loses the potential gain from downward price moves below the swap price Price declines in the physical market are offset by hedging losses Client pays difference Market Price Client receives difference Potential gains Potential costs 32

34 A N N E X A : B A S I C D E R I V A T I V E P R O D U C T D E S C R I P T I O N S Buying a Call Option Key considerations Objective Buying insurance to protect against price increases by paying premium upfront Illustrative example Net Price Unhedged Hedged Description A call option creates a cap price in exchange for upfront premium, which reflects the likelihood that the option will be exercised. The farther the strike price is from trading levels, the lower the amount of premium paid upfront. The call option will reference a published price Call Strike Client receives difference The monthly settlement price is the average of each day s settlement in a given month and compared to the option strike price If the settlement price is higher than the strike price, Client receives the difference between the strike price and settlement price. This payment offsets higher prices in the physical market Otherwise, the purchased option expires worthless, but Client benefits from lower prices in the physical market Premium paid Market Price Potential gains Potential costs Advantages Client participates fully in downward price movements while protecting against price increases above the call level Disadvantages There is an upfront cost associated with this strategy. However, this strategy may prove to be more cost effective than locking in a fixed price 33

35 A N N E X A : B A S I C D E R I V A T I V E P R O D U C T D E S C R I P T I O N S Consumer Zero Cost Collar Key considerations Objective To hedge at zero cost and still retain some benefit from lower prices Illustrative example Net Price Unhedged Hedged Description Client buys a call option and finances it by selling a put option for the same time period at zero upfront cost. The put and call options will reference a published price The monthly settlement price is the average of each day s settlement in a given month and compared to the strike levels of the monthly put and call If the settlement price is higher than call strike, the Client receives the difference between the settlement price and the call strike If the settlement price is lower than put strike, the Client pays the difference between the put strike and the settlement price Otherwise, no payments are made Advantages Zero upfront cost method of hedging against upward price moves while maintaining some downside participation Client pays difference Put Strike Call Strike Market Price Client receives difference Potential gains Potential costs Disadvantages If the market price falls below the put strike, the Client will pay the difference Client has upward price exposure from the current swap level to the call strike 34

36 A N N E X A : B A S I C D E R I V A T I V E P R O D U C T D E S C R I P T I O N S Hedge: Recommended Financial Instruments the Risk Spectrum Each of the available hedge alternatives offers different risk profiles Low Risk Medium Risk High Risk Call options Premium Collars Zero-Cost Collars Swaps Enhanced value strategies Written options Guaranteed cap level in exchange for upfront premium Bespoke settlement Full protection against price increase above the cap level Full participation in downward price movements Premium paid to finance hedging Guaranteed cap level partially financed by selling put options for the same time period Cheaper than outright call purchase Maintain some downward participation Downward participation capped at sold put strike price Upward price exposure to calls strike price Guaranteed cap level financed by selling put options for the same time period Zero upfront premium cost Maintain some downward participation Downward participation capped at sold put strike price Upward price exposure to calls strike price Lock in forward price Consumer receives difference between actual price and swap price, if actual price is higher than swap price. Otherwise, pays the difference Full protection from any price increases above the swap price No upfront premium required Forfeits potential participation if prices fall below swap price No upfront cost relative to swap Locks in more favorable price today Unknown potential cash outflow if market prices change significantly Limited participation in downward price movements to the sold put strike price Maximum benefit is upfront premium Downward participation capped at sold put strike price Fully exposed to price increases 35

37 T H E U S E O F F I N A N C I A L D E R I V A T I V E S I N L A T I N A M E R I C A Agenda Page Derivatives - What Are We Talking About? 2 The Use of Financial Derivatives 5 Implementing Risk Management Policy 21 Annex A: Basic Derivative Product Descriptions 31 Annex B: JPM Commodity Capabilities 36 D U P O N T 36

38 A N N E X B : J P M C O M M O D I T Y C A P A B I L I T I E S J.P. Morgan Covers Commodities Across the Supply Chain Research Global Commodities Futures & Options Metals, Bulk Commodities Energy and Power Grains and Agricultural Technical Analysis OTC Metals, Energy and Ags Warehousing Risk Structured Products Long Dated Contracts Listed Futures and Options Specialist Trading Desks Global Clearing Solutions Electronic Trading Energy and Power Coal Electricity Natural Gas Gasoline Crude Oil NGLs Transportation Freight Base Metals Steel Nickel Zinc Tin Copper Aluminium Lead Aluminium Alloy NASAAC Precious Metals Gold Silver Platinum Palladium Agricultural Cattle Dairy Grains Soybeans Wheat Corn Softs Coffee Sugar Cotton Weather Temperature Precipitation Wind Hurricanes Sunshine Crop Yields Environmental Markets Carbon allowances and offsets (e.g., RGGI; EUAs; CERs; VERs) Sulphur Dioxide Nitrogen Oxides Renewable Energy Credits Plastics Ethylene Polyethylene Polypropylene 37

39 A N N E X B : J P M C O M M O D I T Y C A P A B I L I T I E S J.P. Morgan named 2011 House of the Year in Oil, Coal and Natural Gas Oil and Products House of the Year J.P. Morgan won EnergyRisk s Oil and Products House in June 2011 Innovative financing deals with refiners and state-owned enterprises demonstrated J.P. Morgan s continued ability to provide first class solutions to clients J.P Morgan also showed the importance of maintaining strong relationships with clients despite a challenging economic climate Achieved greatest market penetration for over-the-counter energy derivatives Executed several large tailored transactions to meet clients risk management needs U.S. Natural Gas House of the Year J.P. Morgan won EnergyRisk s U.S. Natural Gas House of the Year in June 2011 EnergyRisk highlighted J.P. Morgan s robust deal-making activities and purchase of RBS Sempra s North America gas business Resulting in expansion of the Firm s ability to serve clients through a diverse network of physical assets in North America 70 bcf/d of storage capacity 1.9 bcf/d of transportation capacity 6 bcf/d of gas marketing activities in 2010 J.P. Morgan also continued excellence in executing large, structured transactions and risk managing capabilities Coal House of the Year J.P. Morgan won EnergyRisk s Coal House of the Year in June 2011 The magazine recognized J.P. Morgan for its transformational restructure of its U.S Coal business highlighting: Increase in offerings International integration Alignment with changing market fundamentals Developing export market for thermal coal J.P Morgan also demonstrated growth in product offering to European and Asian clients Increased marketing support, illustrates J.P. Morgan s leadership within the Commodities Industry Particularly over the last three years, it is fair to say that our share of the wallet overall, in terms of flow and structured transactions, has grown dramatically. I think there isn t a meaningful transaction or opportunity out there that we re not participating in or competing for. - Roy Salame, Global Head of Commodities Corporate Sales EnergyRisk; June,

40 A N N E X B : J P M C O M M O D I T Y C A P A B I L I T I E S J.P. Morgan named 2011 Best Commodities House by Euromoney Euromoney Awards for Excellence - June 2011 Diverse platform of financial and physical capabilities across product areas energy, metals, investor products, agriculture etc Strong growth both organically and through strategic acquisitions, multi-year agreements and large structured transactions Integrated RBS Sempra business in 2010 to further develop a strong and diversified platform across multiple commodity product types Acquisition nearly doubled physical and financial power business Expanded our presence in oil, power, gas and metals Expanded global presence Integration of US and Europe Coal and Freight Platform and a long-term physical coal supply agreement into German coal fired power-plant Increased agricultural products presence in emerging market regions Established sales coverage in emerging markets such as Brazil, South Africa and Middle East Undertaken innovative projects to transform the J.P. Morgan Commodities business In February 2011, J.P. Morgan launched the Commodity-related Project Finance business, a joint venture between Commodities and Syndicated and Leveraged Finance Business Moved the Commodities Research function into the business, publishing some of the industry s most thought-provoking analysis Notable Structured Transactions Large syndicated loan facility for a North African producer In July 2011, J.P. Morgan acted as the lead arranger and underwriter for a syndicated pre-export credit facility J.P. Morgan s leading commodity trading capability enabled enhanced tailoring of oil hedges to fit with the client s actual exposure profile Long term, large volume physical Natural Gas purchase with North East producer In February 2011, J.P. Morgan entered into a large volume, 10 year physical index sales agreement with a major North American Natural Gas producer This leverages J.P. Morgan s existing platform in US and Canada, providing the client with a credit worthy base load market and access to potentially higher priced markets J.P. Morgan acquired and restructured five wind power purchase agreements to monetize the assets owned by a large renewable energy client Highlights J.P. Morgan s continued leadership in executing large, structured transactions across commodities LNG delivery to the UK J.P. Morgan executed delivery of Liquified Natural Gas (LNG) across three continents, purchasing the cargo from a large Middle Eastern gas and power company Transaction represents the first import of LNG into the UK from the US in over 50 years 39

41 A N N E X B : J P M C O M M O D I T Y C A P A B I L I T I E S JPMorgan has Recently Won Every Commodity Award in the Industry JP Morgan Named Quality Leader in US Commodities Corporate Energy in 2010 by Greenwich Associates JPMorgan Named Derivatives House of the Year in 2010 by Energy Risk Magazine JPMorgan Named Commodity Derivatives House of 2009 by IFR JPMorgan ranked Most Innovative in Commodities in 2009 by The Banker JPMorgan Named Commodity Derivatives House of the Year in 2009 by Risk Magazine 40