Transcript International Swaps and Derivatives Association, Inc

International Swaps and Derivatives Association, Inc.
Understanding the
1992 ISDA Master Agreements
Hotel Inter-Continental
Sao Paulo
Brazil
August 6, 2002
Thomas J. Werlen
Rui Fernando Ramos Alves
Luciana Fuser Bittar
Partner
Head of Legal Department
Allen & Overy
Deutsche Bank AG
Head of Legal and
Compliance
Merrill Lynch & Co., Inc.
1984
1985
ISDA
Formed
Code of
1986 Code
SWAPS
of SWAPS
(Standard
Wording,
Assumptions
and Provisions
for Swaps)
1992
- Master Agreement
(Multicurrency-Cross
Border) & (Local
Currency-Single
Jurisdiction)
- U.S. Municipal
Counterparty
Definitions and
Confirmations
- FX and Currency
Option Definitions
and Confirmations
- OTC Equity Index
Option Confirmation
(Long Form)
1986
1987
1989
- Interest Rate and Currency
Exchange Agreement
- Interest Rate and Currency
Exchange Definitions
- Interest Rate Swap Agreement
-
1993
- User’s Guide to 1992
ISDA Master
Agreements
- OTC Bond Option
Confirmation (Long Form)
- Commodity Derivatives
Definitions and
Confirmations
Cap, Collar
and Floor
Addendum
1990
1991
Option
Addendum
Revised
Definitions
(1991
Definitions)
User’s Guide to ISDA
1994
- Credit Support Annex
(New York law)
- OTC Single Share
Option (Physical
Settlement) Confirmation
(Long Form)
1995
- User’s Guide to the
ISDA Credit Support
Annex (New York law)
- Equity Option
Definitions and
Confirmations
- Credit Support Annex
(Transfer - English law)
- Credit Support
Deed (Security Interest English law)
1996
1997
- 1996 Equity Derivative Definitions
- Credit Support Annex (Japanese Law)
- User’s Guide to the Credit
Support Annex (Japanese Law)
- Chinese Character Translations of the
1993 User’s Guide to the 1992 ISDA
Master Agreements
- 1996 ISDA Representation Regarding
Relationship between Parties
- ISDA / BBAIRS Bridge
- ISDA / FRABBA Bridge
1999
- 1999 User’s Guide to the
1995 Credit Support
Annex (English law) and
the 1995 Credit Support
Deed (English law)
- 1999 User’s Guide to the
1998 FX and Currency
Option Definitions
- 1999 Credit Derivatives
Definitions
- Y2K Review
- 1997 Bullion Definitions
- 1997 Credit Swap Confirmation
- 1997 Government Bond Option
Definitions
2000
- 2000 Definitions
- Supplement to the
1993 Commodity
Derivatives
Definitions
- Revised Annex A
to the 1998 FX
and Currency
Option Definitions
- EMU Protocol
(Greece)
1998
- 1998 FX and Currency
Option Definitions
- 1998 Supplement to the
1991 Definitions
- 1998 Euro Definitions
- EMU Protocol
2001
2001 Margin Provisions and User’s Guide
2001 Euro Protocol
Form of Amendment to 1992 ISDA Master Agreements
U.S. Payee Tax Representations
Restructuring Supplement to 1999 Credit Derivatives Definitions
Supplement to 1999 Credit Derivatives Definitions Relating to
Convertible, Exchangeable or Accreting Obligations
- Supplement Relating to Successor and Credit Events to 1999
Credit Derivatives Definitions
- 2001 Cross-Agreement Bridge
- Chinese Character Translation of 1992 ISDA Master Agreement
-
3
Recent Documentation
Developments

2001 Margin Provisions and User’s Guide

2001 Euro Protocol

Supplements to 1999 Credit Derivatives
Definitions

Form of Amendment to 1992 ISDA Master
Agreements

2001 Cross-Agreement Bridge
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ISDA Agreement Structure 2002
Credit Support Documents:
offering protection against
credit risk
 2001 ISDA Margin Supplement
(incorporating 2001 ISDA
Margin Provisions)
• 1995 Credit Support Annex
(Transfer – English Law)
• 1994 Credit Support Annex
(New York Law)
1995 Credit Support Deed
(Security Interest – English Law)
Confirmations (long form)
1992 Master Agreement
(Multicurrency-Cross Border)




Governs the legal and credit
relationship of the parties
Includes representations, events
of default/termination events and
covenants
Incorporates Confirmations
Schedule used to make changes to
standard provisions
•
•
•
•
2001 Euro Protocol
2001 Credit Support Protocol
2000 EMU Protocol (Greece)
1998 EMU Protocol
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2001 Cross-Agreement Bridge
Definitions: for use in documenting
Transactions



1996 Credit Support Annex
(Japanese Law)
Protocols: amending Master
Agreement
October 2001 Form of Amendment to
1992 Master Agreements

Confirmations (short form)



Incorporate Definitions
Specify economic terms of each
transaction
Include Transaction-specific
modifications




2000 Definitions (replace the
1991 Definitions (as amended by the
1998 Supplement)
1999 Credit Derivatives
Definitions (plus Supplements)
1998 Euro Definitions
1998 FX and Currency Option
Definitions (plus revised Annex A)
1997 Bullion Definitions
1997 Government Bond Option
Definitions
1996 Equity Derivatives Definitions
1993 Commodity Derivatives
Definitions (as amended by the
2000 Supplement)
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ISDA User’s Guides

User’s Guide to the 1992 ISDA Master Agreements

User’s Guide to the 1994 ISDA Credit Support Annex

User’s Guide to the 1995 ISDA Credit Support Annex
(Security Interest - Japanese Law)

User’s Guide to the ISDA Credit Support Documents
under English Law

User’s Guide to the 1998 FX and Currency Option
Definitions

User’s Guide to the 2001 ISDA Margin Provisions
NB: various other “Commentaries” are available
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ISDA Master Agreements
1992 and 1987 Versions Compared
Three especially important changes:

Section 1(c) - Single Agreement

Section 2(c) - Netting

Section 6(e) - Payments on Early Termination
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Section 1 - Interpretation
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
Interpretive Priority

Single Agreement
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Section 2 - Payment and Delivery
Obligations
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
Conditions Precedent

Change of Account

(Payment) Netting

Tax Withholding/Gross-Up

Default Interest/Other Amounts
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On-Going (Payment) Netting - Section
2(c)
(Not Close-out Netting)
Party
A
Gross:
$100
Net: $75
Party
B
Gross: $25
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Section 3 - Representations

Purposes: Facilitate Due Diligence
Establish Factual Underpinnings of
Agreement

Remedies: Event of Default/Liquidation
Agreement Measure of
Damages/Other Remedies
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Section 3 - Representations (cont.)

Basic Representations

Absence of Certain Events

Absence of Litigation

Accuracy of Specified Information

Tax Representations

Additional Non-Standard Representations
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Section 4 - Agreements
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
Purpose/Remedies

Furnish Specified Information

Maintain Authorizations

Comply with Laws

Tax Agreement

Payment of Stamp Tax
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Events of Default
Section 5(a)
Section 5(a)(i)
Section 5(a)(ii)
Section 5(a)(iii)
Section 5(a)(iv)
Section 5(a)(v)
Section 5(a)(vi)
Section 5(a)(vii)
Section 5(a)(viii)
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Failure to Pay or Deliver
Breach of Agreement
Credit Support Default
Misrepresentation
Default under Specified Transaction
Cross Default
Bankruptcy
Merger Without Assumption
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Default under
Specified Transaction
Section 5(a)(v)
Specified Transaction (defined in Section 14)

means derivatives transactions outside ISDA

between
PARTY A
Credit Support Provider
Specified Entity
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and
PARTY B
Credit Support Provider
Specified Entity
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Cross Default
Section 5(a)(vi)

Default in respect of borrowed money

Threshold Amount
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Bankruptcy
Section 5(a)(vii)
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
Insolvency-related events

Actual liquidation

Actions by a secured party
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Termination Events
Section 5(b)
Section 5(b)(i)
Illegality
Section 5(b)(ii)
Tax Event
Section 5(b)(iii)
Tax Event Upon Merger
Section 5(b)(iv)
Merger
Credit Event Upon
Section 5(b)(v)
Additional Termination Event
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Netting Legislation as of 2002
Adopted:
1. Australia
2. Austria
3. Belgium
4. Canada
5. Denmark
6. Finland
7. France
8. Germany
9. Hungary
10. Ireland
11. Italy
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Adopted (cont’d)
12. Japan
13. Luxembourg
14. Mexico
15. New Zealand
16. Norway
17. Poland
18. Portugal
19. South Africa
20. Spain
21. Sweden
22. Switzerland
23. United States
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Netting Legislation as of 2002
Pending:
1.
Brazil
Under Consideration:
1. The Czech Republic
2. U.S. Improvements
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ISDA Netting Opinions 2002
1.
2.
3.
4.
5.
6.
Australia
Austria
Bahamas
Belgium
Bermuda
British Virgin
Islands
7. Canada
8. Cayman
Islands
9. Denmark
10. England
11. Finland
12. France
13. Germany
14. Hong
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15. Indonesia
16. Ireland
17. Italy
18. Japan
19. Luxembourg
20. Malaysia
21. Mexico
22. Netherland Antilles
23. New Zealand
24. Norway
25. Philippines
26. Portugal
27. Scotland
28. Singapore
29.
30.
31.
32.
33.
34.
35.
36.
37.
South Africa
South Korea
Spain
Sweden
Switzerland
Taiwan
Thailand
Turkey
The
Netherlands
38. United States
In Draft:
1. Hungary
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Early Termination
TERMINATION MECHANICS: How to Terminate
Reason
Who may terminate
Events of Default


Bankruptcy
Other


Non-defaulting Party or Automatic*
Non-defaulting Party
Termination Event





Illegality
Tax Event Upon Merger
Tax Event
Credit Event Upon Merger
Additional Termination Event
1992 ISDA Master Reference
Sections 6(a) + (b); Pages 8-9
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




either party
Burdened Party
Affected Party
non-Affected Party
non-Affected Party or either party (if
there are two Affected Parties)
*only applies if elected in Schedule
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Early Termination
TERMINATION MECHANICS: Effect of Termination
Event of Default

all Transactions terminated
Credit Event Upon Merger

all Transactions terminated
Additional Termination
Event

all Transactions terminated
(presumption)

only Affected Transactions
Other Termination Events
1992 ISDA Master Reference
Section 6(c); Page 9
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Early Termination Payment
Components
SETTLEMENT AMOUNT: net value of amounts
(based on Market Quotation or Loss) which would
have been payable under each Terminated
Transaction after the Early Termination Date
(“ETD”) had there not been an ETD (this may be
owed by or to the determining party)
Plus
UNPAID AMOUNTS owed to the determining party
on or before the ETD
Less
UNPAID AMOUNTS owed by the determining party
on or before the ETD.
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Timeline
The following diagram gives an example of how certain payments would fall within Unpaid
Amounts and how others would fall within Market Quotation where there are two swaps and
Party B is the Defaulting Party.
Thursday
Monday
Tuesday
Thursday
Monday
Wednesday
Friday
January 7
January 11
January 12
January 14
February 8
February 10
February 12
Swap 1
Payment Date:
Party B
owes $150,000
and fails
to pay.
Party A gives
notice of
failure to
Party B.
Swap 2
Payment Date:
Party A would
have owed
$75,000.
Party B’s
failure to pay
on January 7
becomes
Event of
Default.
Party A
designates
February 10
as the Early
Termination
Date.
Early Termination
Date.
Also Swap
1 Payment Date:
Party B owes
$100,000.
Swap 2
scheduled
Payment Date.
Party A
would have
owed $75,000.
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Timeline (cont’d)
Market Quotation
Unpaid Amounts
includes discounted value of
payment scheduled for February 12,
as well as replacement value (based
on Market Quotations) of all
subsequent payments due under
Swaps 1 and 2.
includes amount Party B failed to pay on
January 7.
includes amount Party A did not have to pay on
January 12 (failure to satisfy condition
precedent that there be no Event of Default or
Potential Event of Default).
includes the payment scheduled for
February 10 (would have been payable on Early
Termination Date).
excludes the payment scheduled for
February 12 even though portion of relevant
calculation period has run as of Early
Termination Date.
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Early Termination Payment
Components
Swap 1
Swap 2
Market Quotation
(determined by Party A) $1,100,000 ($1,400,000)
Unpaid Amounts
payable to Party A
Unpaid Amounts
payable to Party B
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150,000
100,000
-
-
75,000
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Early Termination Payment
Calculation
Sum of Market Quotations
(Settlement Amount)
$1,100,000
(1,400,000)
($300,000)
Plus Unpaid Amounts payable to Party A
150,000
100,000
250,000
Less Unpaid Amounts payable to Party B
(75,000)
(75,000)
($125,000)
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Early Termination Payment
Result
if First Method is chosen:
no payment is due to
either party
if Second Method is chosen: Party A pays $125,000 to
Party B
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Early Termination Payment
Possible Combinations
Events of Default




First Method/Market Quotation
First Method/Loss
Second Method/Market Quotation
Second Method/Loss
Termination Events




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Market Quotation (One Affected Party)
Loss (One Affected Party)
Market Quotation (Two Affected Parties)
Loss (Two Affected Parties)
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Lessons from 1998 Market
Disruptions

Close-out and valuation procedures did not
work perfectly

Market Quotation: difficult to obtain 4
quotations

Loss: difficult to determine when it would be
commercially reasonable to revert to this
method (if Market Quotation elected)
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Close Out Amount

Close Out Amount overriding principle is good
faith and commercial reasonableness.

combines elements of both Market Quotation
and Loss

maximizes flexibility of Non-defaulting Party

does not require strict procedures of Market
Quotation
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ISDA Master Agreement
Illegality and Force Majeure

Illegality: events beyond parties’ control that
result from changes in laws or government
orders: Section 5(b)(i)

Force Majeure Event: events beyond parties’
control that fall outside Illegality but still hinder
or prevent performance of party’s obligations:
Section 5(b)(ii)
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ISDA Master Agreement:
Illegality and Force Majeure

Illegality and Force Majeure Event:
• Subject to waiting period – only becomes
Termination Event once waiting period expires
• Illegality waiting period: three Local Business Days
• Force Majeure Event waiting period: eight Local
Business Days
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...And last but not
(necessarily) least:
Section 7
Section 8
Section 9
Section 10
Section 11
Section 12
Section 13
Section 14
Testimonium
Signature blocks
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-
Transfer
Contractual Currency
Miscellaneous
Multibranch
Expenses
Notices
Governing Law
Definitions
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Multibranch
Swap 1
Party B
(London
Head Office)
Swap 2
Party B
(Paris Branch)
Party A
(Frankfurt)
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ISDA Schedule
Part 5 - Other Provisions to Consider





 impossibility
set-off
 “non-reliance” representation
credit downgrading
 recording of conversations
escrow arrangements
payment deferral
no occurrence of Events of
Default/Termination Events in
specified circumstances
Note: This list is not exhaustive! But consider which are really needed
and whether additional length and complexity of Schedule is worth
possibly prolonged negotiation time and therefore increased
documentation risk while Master Agreement remains unsigned.
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Basic Set-Off - Version 1
PARTY A
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PARTY B
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Set-off (Parties and their Affiliates) Version 2
PARTY A
+
AFFILIATES
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PARTY B
+
AFFILIATES
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Downgrading of Credit Rating
(as an Additional Termination Event)

Reduction in the long-term debt rating by
Standard & Poor’s and/or Moody’s

In the opinion of one Party, the
creditworthiness of the other Party is
materially weaker
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Escrow Arrangements

Time difference or other reasons simultaneous
payment on any day on which both parties are
required to make payments is not possible

Appointment of escrow agent

Earlier payment to be deposited with escrow agent
and irrevocable payment instructions

Costs of escrow arrangement

Interest on deposited payment, if not released to
intended recipient on the same date
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Payment Deferral

Different payment dates for both parties

Material adverse change in the financial
condition of the intended recipient

Payment deferred until the day on which a
payment is due from the intended recipient

Payment of deferred amount + interest
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Impossibility

Natural or man-made disaster, armed
conflict, act of terrorism, other
circumstances beyond control of the parties

Additional Termination Event

New Force Majeure Termination Event
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Non-Reliance Representation
(a)
Relationship Between Parties. Each party will be deemed to represent to the other party on the date on
which it enters into a Transaction that (absent a written agreement between the parties that expressly imposes
affirmative obligations to the contrary for that Transaction):
(i)
Non-Reliance. It is acting for its own account, and it has made its own independent decisions
to enter into that Transaction and as to whether that Transaction is appropriate or proper for it based upon its own
judgment and upon advice from such advisers as it has deemed necessary. It is not relying on any communication
(written or oral) of the other party as investment advice or as a recommendation to enter into that Transaction; it being
understood that information and explanations related to the terms and conditions of a Transaction shall not be
considered investment advice or a recommendation to enter into that Transaction. No communication (written or
oral) received from the other party shall be deemed to be an assurance or guarantee as to the expected results of that
Transaction;
(ii)
Assessment and Understanding. It is capable of assessing the merits of and understanding
(on its own behalf or through independent professional advice), and understands and accepts, the terms, conditions
and risks of that Transaction. It is also capable of assuming, and assumes, the risks of that Transaction; and
(iii)
of that Transaction.
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Status of Parties. The other party is not acting as a fiduciary for or an adviser to it in respect
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