Derivative Financial Instruments

We use derivative financial instruments to support our clients' needs and to manage our interest-rate and currency risk. In undertaking these activities, we assume positions in both the foreign exchange and interest-rate markets by buying and selling cash instruments and using derivative financial instruments, including foreign exchange forward contracts, foreign exchange and interest-rate options and interest-rate swaps, interest-rate forward contracts and interest-rate futures.

Interest-rate contracts involve an agreement with a counterparty to exchange cash flows based on the movement of an underlying interest-rate index. An interest-rate swap agreement involves the exchange of a series of interest payments, either at a fixed or variable rate, based on the notional amount without the exchange of the underlying principal amount. An interest-rate option contract provides the purchaser, for a premium, the right, but not the obligation, to receive an interest rate based upon a predetermined notional amount during a specified period. An interest-rate futures contract is a commitment to buy or sell, at a future date, a financial instrument at a contracted price; it may be settled in cash or through the delivery of the contracted instrument.

Foreign exchange contracts involve an agreement to exchange one currency for another currency at an agreed-upon rate and settlement date. Foreign exchange contracts generally consist of foreign exchange forward and spot contracts, option contracts and cross-currency swaps. Future cash requirements, if any, related to foreign exchange contracts are represented by the gross amount of currencies to be exchanged under each contract unless we and the counterparty have agreed to pay or to receive the net contractual settlement amount on the settlement date.

Derivative financial instruments involve the management of interest-rate and foreign currency risk, and involve, to varying degrees, market risk and credit and counterparty risk (risk related to repayment). Market risk is defined as the risk of adverse financial impact due to fluctuations in interest rates, foreign exchange rates and other market-driven factors and prices. We use a variety of risk management tools and methodologies to measure, monitor and manage the market risk associated with our trading activities. One such risk-management measure is value-at-risk, or VaR. VaR is an estimate of potential loss for a given period within a stated statistical confidence interval. We use a risk-measurement system to estimate VaR daily. We have adopted standards for estimating VaR, and we maintain regulatory capital for market risk in accordance with currently applicable bank regulatory market risk guidelines.

Derivative financial instruments are also subject to credit and counterparty risk, which is defined as the risk of financial loss if a borrower or counterparty is either unable or unwilling to repay borrowings or settle a transaction in accordance with the underlying contractual terms. We manage credit and counterparty risk by performing credit reviews, maintaining individual counterparty limits, entering into netting arrangements and requiring the receipt of collateral. Collateral requirements are determined after a comprehensive review of the creditworthiness of each counterparty, and the requirements are monitored and adjusted daily. Collateral is generally held in the form of cash or highly liquid U.S. government securities. We may be required to provide collateral to the counterparty in connection with our entry into derivative financial instruments. Collateral received and collateral provided in connection with derivative financial instruments are recorded in accrued expenses and other liabilities and other assets, respectively, in our consolidated statement of condition. As of both September 30, 2012 and December 31, 2011, we had recorded approximately $1.15 billion of cash collateral received and approximately $1.17 billion and $1.48 billion, respectively, of cash collateral provided in connection with derivative financial instruments in our consolidated statement of condition.

We enter into master netting agreements with many of our derivative counterparties, and we have elected to net derivative assets and liabilities, including cash collateral received or deposited, which are subject to those agreements. Certain of these agreements contain credit risk-related contingent features in which the counterparty has the option to declare State Street in default and accelerate cash settlement of our net derivative liabilities with the counterparty in the event our credit rating falls below specified levels. The aggregate fair value of all derivative instruments with credit risk-related contingent features that were in a net liability position as of September 30, 2012 totaled approximately $641 million, against which we had posted aggregate collateral of approximately $188 million. If State Street’s credit rating were downgraded below levels specified in the agreements, the maximum additional amount of payments related to termination events that could have been required pursuant to these contingent features as of September 30, 2012 was approximately $453 million. Such accelerated settlement would not affect our consolidated results of operations.

Derivatives Not Designated as Hedging Instruments

In connection with our trading activities, we use derivative financial instruments in our role as a financial intermediary and as both a manager and servicer of financial assets, in order to accommodate our clients' investment and risk management needs. In addition, we use derivative financial instruments for risk management purposes as economic hedges, which are not formally designated as accounting hedges, in order to contribute to our overall corporate earnings and liquidity. These activities are designed to generate trading revenue and to manage volatility in our net interest revenue. The level of market risk that we assume is a function of our overall objectives and liquidity needs, our clients' requirements and market volatility.

With respect to cross-border investing, clients have a need for foreign exchange forward contracts to convert currency for international investment and to manage the currency risk in their investment portfolios. As an active participant in the foreign exchange markets, we provide foreign exchange forward contracts and options in support of our clients' needs with respect to their management of currency risk. As part of our trading activities, we may assume positions in both the foreign exchange and interest-rate markets by buying and selling cash instruments and using derivative financial instruments, including foreign exchange forward contracts, foreign exchange and interest-rate options and interest-rate swaps, interest-rate forward contracts, and interest-rate futures. In the aggregate, positions are matched closely to minimize currency and interest-rate risk.

We offer products that provide book-value protection primarily to plan participants in stable value funds managed by non- affiliated investment managers of post-retirement defined contribution benefit plans, particularly 401(k) plans. We account for the associated contingencies, more fully described in note 6, individually as derivatives not designated as hedging instruments. These contracts are valued quarterly and unrealized losses, if any, are recorded in other expenses in our consolidated statement of income.

Derivatives Designated as Hedging Instruments

In connection with our asset and liability management activities, we use derivative financial instruments to manage our interest-rate risk. Interest-rate risk, defined as the sensitivity of income or financial condition to variations in interest rates, is a significant non-trading market risk to which our assets and liabilities are exposed. These hedging relationships are formally designated, and qualify for hedge accounting, as fair value or cash flow hedges. We manage interest-rate risk by identifying, quantifying and hedging our exposures, using fixed-rate portfolio securities and a variety of derivative financial instruments, most frequently interest-rate swaps and options (e.g., interest rate caps and floors). Interest-rate swap agreements alter the interest-rate characteristics of specific balance sheet assets or liabilities. When appropriate, forward-rate agreements, options on swaps, and exchange-traded futures and options are also used.

Fair value hedges

Derivatives designated as fair value hedges are utilized to mitigate the risk of changes in fair value of recognized assets and liabilities. Differences between the gains and losses on fair value hedges and the gains and losses on the asset or liability attributable to the hedged risk represent hedge ineffectiveness. We use interest-rate or foreign exchange contracts in this manner to manage our exposure to changes in the fair value of hedged items caused by changes in interest rates or foreign exchange rates.

We have entered into interest-rate swap agreements to modify our interest revenue from certain available-for-sale securities from a fixed rate to a floating rate. The securities hedged have a weighted-average life of approximately 7.1 years as of September 30, 2012, compared to 7.4 years as of December 31, 2011. These securities are hedged with interest-rate swap contracts of similar maturity, repricing and fixed-rate coupons. The interest-rate swap contracts convert the interest revenue from a fixed rate to a floating rate indexed to LIBOR, thereby mitigating our exposure to fluctuations in the fair value of the securities attributable to changes in the benchmark interest rate.

We have entered into interest-rate swap agreements to modify our interest expense on two senior notes and two subordinated notes from fixed rates to floating rates. The senior notes mature in 2016 and 2021; one pays fixed interest at a 2.875% annual rate and the other pays fixed interest at a 4.375% annual rate. The subordinated notes mature in 2018; one pays fixed interest at a 4.956% annual rate and the other pays fixed interest at a 5.25% annual rate. The senior and subordinated notes are hedged with interest-rate swap contracts with notional amounts, maturities and fixed-rate coupon terms that align with the hedged notes. The interest-rate swap contracts convert the fixed-rate coupons to floating rates indexed to LIBOR, thereby mitigating our exposure to fluctuations in the fair values of the subordinated notes stemming from changes in the benchmark interest rates.

We have entered into forward foreign exchange contracts to hedge the change in fair value attributable to foreign exchange movements in the funding of non-functional currency denominated investment securities. These forward contracts convert the foreign currency risk to U.S. dollars, thereby mitigating our exposure to fluctuations in the fair value of the securities attributable to changes in foreign exchange rates. Generally, no ineffectiveness is recorded in earnings, since the notional amount of the hedging instruments is aligned with the carrying value of the hedged securities. The forward points on the hedging instruments are considered to be a hedging cost, and accordingly are excluded from the evaluation of hedge effectiveness and recorded in net interest revenue.

Cash flow hedges

Derivatives categorized as cash flow hedges are utilized to offset the variability of cash flows to be received from or paid on a floating-rate asset or liability. Ineffectiveness of cash flow hedges is defined as the extent to which the changes in fair value of the derivative exceeded the variability of cash flows of the forecasted transaction.

We have entered into interest-rate swap agreements to modify our interest revenue from certain available-for-sale securities from a floating rate to a fixed rate. The securities hedged have a weighted-average life of approximately 2.0 years as of September 30, 2012, compared to 2.8 years as of December 31, 2011. These securities are hedged with interest-rate swap contracts of similar maturities, repricing and other characteristics. The interest-rate swap contracts convert the interest revenue from a floating rate to a fixed rate, thereby mitigating our exposure to fluctuations in the cash flows of the securities attributable to changes in the benchmark interest rate.

We have entered into foreign exchange contracts to hedge the change in cash flows attributable to foreign exchange movements in the funding of non-functional currency denominated investment securities. These foreign exchange contracts convert the foreign currency risk to U.S. dollars, thereby mitigating our exposure to fluctuations in the cash flows of the securities attributable to changes in foreign exchange rates. Generally, no ineffectiveness is recorded in earnings, since the critical terms of the hedging instruments and the hedged securities are aligned.

The following table presents the aggregate contractual, or notional, amounts of derivative financial instruments entered into in connection with our trading and asset and liability management activities as of the dates indicated:



(In millions)	September 30, 2012		December 31, 2011
Derivatives not designated as hedging instruments:
Interest-rate contracts:
Swap agreements and forwards	$	1,668	$	238,008
Options and caps purchased	80		1,431
Options and caps written	80		1,324
Futures	5,890		66,620
Foreign exchange contracts:
Forward, swap and spot	949,752		1,033,045
Options purchased	11,827		11,215
Options written	11,235		12,342
Credit derivative contracts:
Credit default swap agreements	28		105
Other:
Stable value contracts	35,825		40,963
Derivatives designated as hedging instruments:
Interest-rate contracts:
Swap agreements	3,784		3,872
Foreign exchange contracts:
Forward and swap	3,463		2,613

In connection with our asset and liability management activities, we have entered into interest-rate contracts designated as fair value and cash flow hedges to manage our interest-rate risk. The following table presents the aggregate notional amounts of these interest-rate contracts and the related assets or liabilities being hedged as of the dates indicated:



	September 30, 2012						December 31, 2011
(In millions)	Fair Value Hedges		Cash Flow Hedges		Total		Fair Value Hedges		Cash Flow Hedges		Total
Investment securities available for sale	$	1,205	$	129	$	1,334	$	1,298	$	124	$	1,422
Long-term debt⁽¹⁾	2,450		—		2,450		2,450		—		2,450
Total	$	3,655	$	129	$	3,784	$	3,748	$	124	$	3,872


⁽¹⁾	As of September 30, 2012 and December 31, 2011, fair value hedges of long-term debt increased the carrying value of long-term debt presented in our consolidated statement of condition by $190 million and $140 million, respectively.

The following table presents the contractual and weighted-average interest rates for long-term debt, which include the effects of the hedges presented in the table above, for the periods indicated:



	Three Months Ended September 30,
	2012				2011
	Contractual Rates		Rate Including Impact of Hedges		Contractual Rates		Rate Including Impact of Hedges
Long-term debt	4.13	%	3.20	%	3.58	%	3.17	%
	Nine Months Ended September 30,
	2012				2011
	Contractual Rates		Rate Including Impact of Hedges		Contractual Rates		Rate Including Impact of Hedges
Long-term debt	4.01	%	3.20	%	3.56	%	3.17	%

The following tables present the fair value of the derivative financial instruments, excluding the impact of master netting agreements, recorded in our consolidated statement of condition as of the dates indicated. The impact of master netting agreements is disclosed in note 9.



	Asset Derivatives			Liability Derivatives
	September 30, 2012			September 30, 2012
(In millions)	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Derivatives not designated as hedging instruments:
Foreign exchange contracts	Other assets	$	6,738	Other liabilities	$	6,444
Interest-rate contracts	Other assets	5		Other liabilities	1
Other derivative contracts	Other assets	—		Other liabilities	9
Total		$	6,743		$	6,454
Derivatives designated as hedging instruments:
Interest-rate contracts	Other assets	$	181	Other liabilities	$	300
Foreign exchange contracts	Other assets	7		Other liabilities	7
Total		$	188		$	307



	Asset Derivatives			Liability Derivatives
	December 31, 2011			December 31, 2011
(In millions)	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Derivatives not designated as hedging instruments:
Foreign exchange contracts	Other assets	$	12,210	Other liabilities	$	12,315
Interest-rate contracts	Other assets	1,682		Other liabilities	1,688
Other derivative contracts	Other assets	1		Other liabilities	10
Total		$	13,893		$	14,013
Derivatives designated as hedging instruments:
Interest-rate contracts	Other assets	$	123	Other liabilities	$	293
Foreign exchange contracts	Other assets	3		Other liabilities	37
Total		$	126		$	330

The following tables present the impact of our use of derivative financial instruments on our consolidated statement of income for the periods indicated:



	Location of Gain (Loss) on Derivative in Consolidated Statement of Income	Amount of Gain (Loss) on Derivative Recognized in Consolidated Statement of Income
		Three Months Ended September 30				Nine Months Ended September 30,
(In millions)		2012		2011		2012			2011
Derivatives not designated as hedging instruments:
Foreign exchange contracts	Trading services revenue	$	113	$	170	$	459		$	526
Foreign exchange contracts	Processing fees and other revenue	1		5		(2		)	6
Interest-rate contracts	Trading services revenue	1		43		(87		)	(4		)
Interest-rate contracts	Processing fees and other revenue	—		—		2			—
Total		$	115	$	218	$	372		$	528



	Location of Gain (Loss) on Derivative in Consolidated Statement of Income	Amount of Gain (Loss) on Derivative Recognized in Consolidated Statement of Income						Hedged Item in Fair Value Hedging Relationship	Location of Gain (Loss) on Hedged Item in Consolidated Statement of Income	Amount of Gain (Loss) on Hedged Item Recognized in Consolidated Statement of Income
		Three Months Ended			Nine Months Ended					Three Months Ended			Nine Months Ended
(In millions)		September 30, 2012			September 30, 2012					September 30, 2012			September 30, 2012
Derivatives designated as fair value hedges:
Foreign exchange contracts	Processing fees and other revenue	$	26		$	30		Investment securities	Processing fees and other revenue	$	(26	)	$	(30	)
Interest-rate contracts	Processing fees and other revenue	22			62			Long-term debt	Processing fees and other revenue	(21		)	(58		)
Interest-rate contracts	Processing fees and other revenue	(1		)	(7		)	Available-for-sale securities	Processing fees and other revenue	1			3
Total		$	47		$	85				$	(46	)	$	(85	)



	Location of Gain (Loss) on Derivative in Consolidated Statement of Income	Amount of Gain (Loss) on Derivative Recognized in Consolidated Statement of Income						Hedged Item in Fair Value Hedging Relationship	Location of Gain (Loss) on Hedged Item in Consolidated Statement of Income	Amount of Gain (Loss) on Hedged Item Recognized in Consolidated Statement of Income
		Three Months Ended			Nine Months Ended					Three Months Ended			Nine Months Ended
(In millions)		September 30, 2011			September 30, 2011					September 30, 2011			September 30, 2011
Derivatives designated as fair value hedges:
Foreign exchange contracts	Processing fees and other revenue	$	(306	)	$	(306	)	Investment securities	Processing fees and other revenue	$	306		$	306
Interest-rate contracts	Processing fees and other revenue	(171		)	(161		)	Available- for-sale securities	Processing fees and other revenue	172			158
Interest-rate contacts	Processing fees and other revenue	44			60			Long-term debt	Processing fees and other revenue	(42		)	(56		)
Total		$	(433	)	$	(407	)			$	436		$	408

Differences between the gains (losses) on the derivative and the gains (losses) on the hedged item, excluding any amounts recorded in net interest revenue, represent hedge ineffectiveness.



	Amount of Gain (Loss) on Derivative Recognized in Other Comprehensive Income						Location of Gain (Loss) Reclassified from OCI to Consolidated Statement of Income	Amount of Gain (Loss) Reclassified from OCI to Consolidated Statement of Income						Location of Gain (Loss) on Derivative Recognized in Consolidated Statement of Income	Amount of Gain (Loss) on Derivative Recognized in Consolidated Statement of Income
	Three Months Ended			Nine Months Ended				Three Months Ended			Nine Months Ended				Three Months Ended		Nine Months Ended
(In millions)	September 30, 2012			September 30, 2012				September 30, 2012			September 30, 2012				September 30, 2012		September 30, 2012
Derivatives designated as cash flow hedges:
Interest-rate contracts				$	3		Net interest revenue	$	(1	)	$	(4	)	Net interest revenue	$	1	$	2
Foreign exchange contracts	$	(2	)	(1		)	Net interest revenue	—			—			Net interest revenue	2		2
Total	$	(2	)	$	2			$	(1	)	$	(4	)		$	3	$	4



	Amount of Gain (Loss) on Derivative Recognized in Other Comprehensive Income				Location of Gain (Loss) Reclassified from OCI to Consolidated Statement of Income	Amount of Gain (Loss) Reclassified from OCI to Consolidated Statement of Income						Location of Gain (Loss) on Derivative Recognized in Consolidated Statement of Income	Amount of Gain (Loss) on Derivative Recognized in Consolidated Statement of Income
	Three Months Ended		Nine Months Ended			Three Months Ended			Nine Months Ended				Three Months Ended	Nine Months Ended
(In millions)	September 30, 2011		September 30, 2011			September 30, 2011			September 30, 2011				September 30, 2011	September 30, 2011
Derivatives designated as cash flow hedges:
Interest-rate contracts	$	4	$	8	Net interest revenue	$	(1	)	$	(5	)	Net interest revenue		$	2
Total	$	4	$	8		$	(1	)	$	(5	)		—	$	2