1. Redington
13-15 Mallow Street
London EC1Y 8RD
T. 020 7250 3331
www.redington.co.uk
Sweating your Assets
Karen Heaven– Redington
8 June 2011

2. • Gilt Repurchase Agreement – “Gilt Repo”
• Gilt Total Return Swap – “Gilt TRS”
• “Collateral Upgrade Trade” – also known as Collateral Swap or
Secured Funding Trade
• All are potential opportunities for pension schemes which have
arisen following the credit crunch
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Introduction

3. Gilt Repo and Gilt TRS

4. -1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
30yr Inflation-Linked Gilt Yield 30yr Swap Real Yield Swap Spread
Real Rates
What has happened in the market?
Market-driven Opportunity
(%)
1. Gilt real yield has been calculated as the yield on index-linked gilts: Swap real yield has been calculated as the difference between nominal swap rate and inflation swap rate: Swap spread has been calculated as
Swap Yield minus Gilt Yield
4
30y Real Rates(1)
Lehman Brothers’
collapse
Swaps have historically
yielded higher than Gilts
Late 2008 – Gilt / swap spread becomes
negative and remains so today

5. -1.0
-0.5
0.0
0.5
1.0
1.5
3.0
3.5
4.0
4.5
5.0
5.5
30yr Nominal Swap 30yr Gilt Yield Swap Spread
Market-driven Opportunity....Same for Nominal Rates
Swap and Gilt yields (%)
1. Swap spread has been calculated as Swap Yield minus Gilt Yield
Gilt / Swap Spread(%)
Late 2008 – Nominal Gilt / swap spread
becomes negative and remains so today
Lehman Brothers’ collapse
Nominal Rates
What has happened in the market?
5
Nominal swaps have
historically yielded
higher than Gilts

6. Why Gilt Repo and Gilt TRS?
• Historically , pension schemes have used interest rate and inflation swaps as part of their investment
strategy, with the advantages of:
– Swaps are implemented as an overlay i.e. they are unfunded
– They offer flexibility i.e. a scheme could hedge each individual cash flow if required
– Relative value: swap rates were previously higher than Gilt yields
However, given the current market dislocation, it would be advantageous to get exposure to the Gilt yield
(instead of the swap yield)
• Could buy Gilts, but would need to sell other assets to release cash
– Affects expected return on assets
• Could replace physical equities with synthetic equities (e.g. equity futures) and use the cash released to
purchase Gilts
– A number of pension schemes have done this transaction since 2008
• Another solution is to get exposure to Gilts on an unfunded basis, either via:
– Gilt Repo or;
– Gilt TRS
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7. 7
Comparing Gilts and Swaps
Hedging using swaps Hedging using gilts
Upfront Payment: None Purchase Price
Counterparty Risk: Yes, mostly mitigated with collateral
agreement
UK Sovereign Risk
Separate Out Interest Rate and
Inflation Risk:
Yes More difficult
Real Yield: Historically higher than real yield on
gilts for most maturities; currently
this relationship is inverted
Historically lower than real rate swaps
for most maturities; currently this
relationship is inverted
Basis Risk vs. a Swap Benchmark: No Yes
Basis Risk vs. a Gilt Based Liability
Valuation:
Yes No
Basis Risk vs. a Corporate Bond
Based Liability Valuation
Yes Yes
Adding in Risk/ Return Exposure: Assets of fund can be invested in risky
assets
Synthetic overlay such as equity futures
Position Size Limited By: Need to post collateral against
potential negative mark-to-market
Need to finance purchase price of gilts
Documentation ISDA/CSA N/A

8. •A repo is a transaction where the scheme sells some gilts to a counterparty (1) , and at the same time
commits to repurchase the gilts back at a specified date at a specified price (2)
•Although legal title to the gilts is transferred, the Scheme retains the economic benefits and market risk
of owning them, thereby achieving financing
What is a Gilt Repo
Hedging Nominal Rates
Gilt Repurchase (“Repo”) Agreement
Pension Scheme
Counterparty e.g.
Investment bank
Receives Cash (C)
Sells Gilts
1
Pension Scheme
Counterparty e.g.
Investment bank
Buys Gilts
Pays cash (C + repo interest amount)
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2

9. What is a Gilt Repo
Hedging Nominal Rates
Gilt Repurchase (“Repo”) Agreement
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• Gilt repos are transacted under a “Global Master Repurchase Agreement” (GMRA), the standardised repo
documentation, similar in purpose and function to an ISDA agreement for derivatives
• Counterparty risk is dealt with via over-collateralisation and daily mark-to-market
REPO LIBOR
Overnight 0.55333 0.56813
1 Week 0.55333 0.58775
2 Week 0.55333 0.59750
1 Month 0.55500 0.62500
3 Month 0.58625 0.82625
6 Month 0.64667 1.10500
1 Year 0.77667 1.58250
Source: Bloomberg, 6 June 2010
• From the point of view of the lender of cash, this is a very
secure transaction and therefore current repo rates are
significantly below LIBOR (see table)
• Hence, this offers very attractive financing, with
considerable flexibility over term, for the borrower
• The repo market is deep, liquid and transparent, and, as a
cornerstone of the money markets, the Bank of England
prioritised ensuring that it continued to function during the
worst days of the financial crisis

10. Comparison: Interest Rate Swap vs. Gilt Financed by Repo
Swap
(e.g. 30 yr)
Pay: 6m LIBOR
Rec: Fixed Rate
1.105%1
3.959%1
Gilt Financed
by Rolling
6m1 Repo
Pay: 6m Gilt Repo
Rate
Rec: Gilt yield
0.647%1
4.142%1
45.8bp1 advantage
for 1st 6m
Unknown LIBOR – REPO spread for remainder of transaction
18bp1 advantage on fixed leg for the life of the transaction
1 6m period shown for comparison
with 6m LIBOR. Actual transactions
can be done from overnight to
longer maturities
In the following worked example, gilts financed by repo offer a 18bp advantage on the fixed leg as well as a
45.8bp on the variable leg when compared to swaps as at 6 June 2011.
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Alternative ways
Gilt financed by Repos

11. Total Return Swaps
Hedging Nominal Rates
• A gilt total return swap (TRS) is an over-the-counter (OTC) contract.
• One counterparty (e.g. a bank) agrees to pay the total return (price appreciation + coupons) on a
specified gilt over an agreed period of time, in exchange for receiving a floating payment based on
LIBOR, from another counterparty (e.g. a pension scheme) over the same period of time.
• The Total Return Swap may be on a conventional gilt or index-linked gilt.
Pension Scheme Counterparty
Total Return (price
appreciation + Coupons)
LIBOR +/- Premium
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12. Total Return Swaps
Hedging Nominal Rates
• A gilt TRS is transacted under ISDA documentation (the same documentation that is used for interest
rate and inflation swaps).
• As is the case for interest rate and inflation swap trades, the gilt TRS is marked to market on a daily
basis, with high quality collateral being passed between the two counterparties
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Advantages Disadvantages
Possible regular cash
requirement
Counterparty balance
sheet charge
Rollover Risk
Alternative to repo
Gilt yields higher than
swaps
Unfunded
Advantages/Disadvantage of TRS
• The TRS counterparty (i.e. a bank) will often
buy the gilt and finance it through the repo
market, as described previously.
• Crucially, where the counterparty is a bank,
this transaction will utilise its balance sheet
and hence a charge will likely be incurred to
reflect this.
• Therefore, Schemes who are able and willing
to set up the necessary documentation and
management of repo transactions can
experience better economics than those who
use total return swaps

13. Comparison: Gilt Financed by Repo vs. Gilt Total Return Swap
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Gilt Financed
by Rolling
6m(1) Repo
Pay: 6m Repo Rate
Rec: Gilt yield
0.647%
4.142%
(1) 6m period shown for comparison with 6m
LIBOR. Actual transactions can be done
from overnight to longer maturities
Gilt Total
Return Swap
(e.g. 2 yr)
Pay(2): 6m LIBOR
[+/-X]bps
Rec: Gilt Total
Return
=1.105% -
0.18%
4.142%
Unknown pricing and market capacity of roll-
over every 2 years
Potential cash settlement of
negative total return
(2) Indicative pricing c. Libor – 18bp
Gilt Repo
Gilt TRS

14. 14
Repo Gilt TRS
Liquidity • Excellent for shorter maturities
• Variable for longer maturities
• Considerable variation from bank to bank and
according to market conditions
• Over 1 year significantly more expensive than
less than 1 year
Maturity • Majority of activity is in overnight up to
3 months
• Longer dates out to one year transact
with variable liquidity
• Typically 1 year
• Potentially 2 – 3 years
Roll-over • Expected to be excellent as the repo
market is cornerstone of Bank of
England’s money market operations
• Long maturities may not trade in a crisis
• Pricing at rollover dependent on counterparty’s
capacity and balance sheet charges (TRS
consumes the counterparty’s balance sheet)
• Risk of market liquidity collapsing if there are
renewed banking sector problems
Gilt Repos vs. Gilt Total Return Swap - Considerations

15. 15
Repo Gilt TRS
Transparency • Very good pricing information - on
broker screens
• May be unreliable for long maturities /
in a crisis
• No publicly available pricing sources
• Varies considerably from bank to bank
Documentation • GMRA – similar to ISDA
• Negotiations will involve time and
expense
• ISDA & CSA (existing) – for schemes with this
in place, TRS may be more convenient than
Gilt Repo
Collateral
(subject to
counterparty)
• Gilts
• Daily mark-to-market
• Cash, gilts and in some cases other securities
• Mark-to-market frequency and collateral
thresholds subject to CSAs
Gilt Repos vs. Gilt Total Return Swap - Considerations

16. Collateral Upgrade Trades

17. What is a Collateral Upgrade Trade?
What is a Collateral Upgrade Trade?
• A Collateral upgrade trade is a transaction whereby a Pension Scheme loans Gilts to a bank in return for
less liquid collateral plus a fee.
• This trade can be structured in a number of ways, including:
– A cash investment
– Yield enhancing portfolio swap
• Through a variety of structures:
– Securities Lending Agreements (SLA)
– Total Return Swaps (TRS)
– Collateral Swaps
– Repo-facilities
• Each type of structure has its own advantages and disadvantages, and within the different structures, the
details of the trades are entirely bespoke and are agreed between the bank and the pension scheme.
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18. Why do a Collateral Upgrade Trade?
Why enter into this transaction?
• Pension scheme: to earn additional returns on Gilt portfolio.
– The transaction monetises the “illiquidity premium”. As long-term investors, Pension Schemes do not
necessarily need to hold all of their assets in very liquid instruments (as long as benefit payments and
collateral requirements (e.g. for swaps) can be met).
• Bank: to gain liquidity, which is now at a premium for banks, primarily due to incoming Basel III rules.
Banks may also be unwilling to sell their illiquid assets as the market for some structured assets remains
depressed.
Who is this transaction for?
• Currently for larger pension schemes because :
– Transactions are entirely bespoke , hence negotiating terms with banks can be time-consuming and
costly
– Can only be undertaken on an individual scheme basis; there is no pooled fund format for this
– As a rule of thumb, c.£100m is a minimum transaction size, although greater optionality in the
structuring could be achieved for larger sizes
Illustration
• For simplicity, we illustrate Collateral Upgrade Trades using “Securities Lending Agreements” (SLA); the
most common and simplest structure in which a Collateral Upgrade Trade can be done.
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19. Collateral Upgrade Trade
Diagrammatic Overview - SLA
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Pension Scheme Bank
1. Pension Scheme lends [£200m] of Gilts to bank
2. Investor receives [X bps] in return
3. Bank posts [£220m - £260m] worth of “assets” as collateral
Pension Scheme Bank
Step 2:
4. Dividend/interest from collateral is
returned to bank
5. (Structure dependant) Any “Yield”
from gilts is returned to the Investor
Banks are only seeking to
fund their assets, not sell
them. As such, banks will
want to retain economic
exposure to their
collateral. Banks could do
this in a number of ways,
but one such concept is
shown here.
It is crucial to determine
what types of asset will
form the collateral before
entering into such an
agreement.
Step 1:

20. Collateral Upgrade Trade
Security Lending Agreement – Basic Principals
Securities Lending Agreement (SLA) – Basic Principals
Securities lending involves the legal transfer of securities, such as gilts, to a counterparty (e.g. bank), who will in
turn provide the lender (e.g. pension scheme), with collateral, typically in the form of illiquid assets.
The bank pays the lender a fee (upfront or periodically) and is contractually obliged to return the securities
borrowed from the lender upon maturity.
Depending on the agreement, the bank may transfer back any interest/dividend payments on the gilts to the
lender or incorporate them into the “fee”. Likewise the interest/dividend payments on the collateral is returned
to the bank.
The collateral posted with the pension scheme will usually be subject to a “haircut” i.e. the collateral’s market
value will be higher than the value of the securities lent to the bank – it is “over-collateralised”. The “haircut”
applied to the collateral depends on the quality of the assets posted.
In general securities lending agreements are governed by a Global Master Securities Lending Agreement
(GMSLA).
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21. High Level Benefits and Risks of Collateral Upgrade Trade
Based on Security Lending Agreement
Benefits
• Yield Enhancement: Pension Scheme
receives a negotiated fee.
• Over-Collateralisation: Pension Scheme
holds collateral with a higher market value
than that of the assets (Gilts) it has lent.
• Eventual Return of Assets: Pension
Scheme receives its assets back at
maturity. Same appplies to bank.
Risks
• Counterparty Risk: Borrower might
default
• Collateral Risk: Risk that the value of the
collateral falls below the replacement cost
of the securities that are lent (exact
protocol for collateral is up for
negotiation)
• Collateral Requirements: Investors
involved in other derivatives hold a
reserve of “liquid assets” to service any
potential collateral calls. A new trade
might deplete this reserve.
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22. Collateral Upgrade Trade – Considerations for the Pension Scheme
Collateral Upgrade Trades are entirely bespoke; the following are some of the structuring considerations for a
pension scheme
• Is this type of transaction consistent with your investment strategy and objectives?
• What is the credit rating of the bank you are lending Gilts to?
• What value of Gilts should be lent and for how long?
– Consider impact on liquidity collateral requirements for the whole scheme
• What types of assets are you willing to accept as collateral and why?
– Can they be independently valued?
– Consider risk management implications and action in the event of borrower default.
• How much of one type of collateral are you prepared to accept? What limits should be placed on any single
asset class?
• What level of “over-collateralisation” is required? 110%, 130%? Will it be enough to mitigate large market
fluctuations?
• What other risks are you potentially exposed to in this type of transaction e.g. collateral switching at the
bank’s option?
• What measures can be implemented that help ensure that the value of the collateral held doesn’t decrease?
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23. Sovereign Bonds
•Senior unsecured debt
•Varying levels of credit ratings
depending on issuing government
•Includes quasi-governmental
bonds such as supranational
bonds – issued by institutions such
as the European Investment Bank
and the World Bank
Corporate Bonds
•Senior unsecured debt
•Varying levels of credit ratings
depending on issuing company
•Corporate bonds originate from
varying sectors:
•Financials
•Non-financials
•Telecoms & utilities, etc.
Covered Bonds
•Senior secured debt
•Very similar to asset backed
securities except that the assets
remain on issuer’s balance sheet.
•Bonds are backed by a “covered
pool” of assets:
•Mortgages Loans
•Public Sector Loans
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Securitised Debt & Structured Credit
•Senior/ junior securitised debt
•Predominantly Asset Backed Securities:
•Consumer Credit – backed by underlying
pool of consumer receivables (i.e. auto
loans, credit card payments etc...)
•Commercial Mortgage – backed by
underlying pool of commercial mortgages.
•Residential Mortgages – backed by an
underlying pool of residential mortgages.
Loans
•Senior secured debt, typical examples include:
•Large Cap Loans – loans to large corporations
•SME Loans – loans to small/medium corporations
•Export Credit Agreements (ECA) – quasi government backed loans
used by companies to buy items such as planes.
•Education Loans – consists of loans to Higher Education institutions.
•Private Finance Initiative (PFI) – private financing to Government
procurement and infrastructure projects.
•Social Housing Loans – loans to social housing developers/operators
Examples of Types of Collateral Offered

24. Liquidity and Collateral Considerations
Addition considerations – Collateral Requirements
•Pension funds generally hold a reserve of “liquid assets” to service any potential collateral calls arising from their
existing derivative trades, and separately to pay benefits as they fall due.
•It is therefore crucial for pension funds to understand the implications entering into any funding/liquidity trade
will have on this reserve, as the basis of such trades involves pension funds foregoing access to some of their liquid
assets a for pre-determined time.
0
100
200
300
400
500
600
700
Collateral Requirements Avaliable Collateral
GBPMillions
Collateral Requirements
Conventional Gilts Inex-linked Gilts + Asset Swaps 1 Year VaR of Swaps 1 Year of VaR of Gilts
0
100
200
300
400
500
600
700
Collateral Requirements Avaliable Collateral
GBPMillions
Collateral Requirements
Conventional Gilts Inex-linked Gilts + Asset Swaps 1 Year VaR of Swaps 1 Year of VaR of Gilts
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25. Disclaimer For professional investors only. Not suitable for private customers.
The information herein was obtained from various sources. We do not guarantee every aspect of its accuracy. The information is for your private information and is for discussion purposes only. A variety of
market factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that the parameters and assumptions used in this analysis can be
duplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appear above are not necessarily indicative of future exchange rates, interest rates, or other
reference rates or prices. Neither the information, recommendations or opinions expressed herein constitutes an offer to buy or sell any securities, futures, options, or investment products on your behalf.
Unless otherwise stated, any pricing information in this message is indicative only, is subject to change and is not an offer to transact. Where relevant, the price quoted is exclusive of tax and delivery costs.
Any reference to the terms of executed transactions should be treated as preliminary and subject to further due diligence .
Redington Ltd are investment consultants regulated by the Financial Services Authority. We do not advise on all implications of the transactions described herein. This information is for discussion purposes
and prior to undertaking any trade, you should also discuss with your professional tax, accounting and / or other relevant advisers how such particular trade(s) affect you. All analysis (whether in respect of
tax, accounting, law or of any other nature), should be treated as illustrative only and not relied upon as accurate.
©Redington Limited 2011. All rights reserved. No reproduction, copy, transmission or translation in whole or in part of this presentation may be made without permission. Application for permission should
be made to Redington Limited at the address below.
Redington Limited (reg no 6660006) is registered in England and Wales. Registered office: 13-15 Mallow Street London EC1Y 8RD
THE DESTINATION FOR ASSET & LIABILITY MANAGEMENT
Contacts
Disclaimer
Direct Line: +44 (0) 20 3326 7134
Telephone: +44 (0) 20 7250 3331
Redington
13-15 Mallow Street
London EC1Y 8RD
Karen Heaven
Vice President | Investment Consulting
karen.heaven@redington.co.uk
www.redington.co.uk
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