isda ® international swaps and derivatives association, inc. “legal framework for otc derivatives...
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ISDA®
International Swaps and Derivatives Association, Inc.
“Legal Framework for OTC Derivatives in CEE Countries ”
ACI Annual MeetingDubrovnik, Croatia
May 11-13, 2007
Dr Peter M WernerPolicy Director
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Risk reduction through close-out netting:Evidence
• Bank for International Settlements, November 2006
– As of June 2006, total notional amount of all outstanding OTC derivatives was $369.9 trillion
– The total mark-to-market value of these outstanding OTC derivatives was $10.1 trillion (2.7% of notional amount).
– After applying close-out netting, the total mark-to-market credit exposure was $2.0 trillion (0.5% of notional amount), a reduction of 80 percent.
• U.S. Department of the Treasury, Office of the Comptroller of the Currency, 4th Quarter 2006
– For federally chartered U.S. banks, netting benefit as of December 30, 2006 was 83.7 percent
All banks, 1998-2006
US banks, 1996-2006
40
50
60
70
80
90
100
Jun-98 Mar-99 Dec-99 Sep-00 Jun-01 Mar-02 Dec-02 Sep-03 Jun-04 Mar-05 Dec-05
Reduction of mark-to-market exposure
40
50
60
70
80
90
100
Mar-96 Dec-96 Sep-97 Jun-98 Mar-99 Dec-99 Sep-00 Jun-01 Mar-02 Dec-02 Sep-03 Jun-04 Mar-05 Dec-05 Sep-06
Reduction of mark-to-market exposure
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COUNTRY NETTING LEGISLATION AS OF FEBRUARY 2007
Anguilla Adopted
Argentina Under Consideration
Australia Adopted
Austria Adopted
Belgium Adopted
Brazil Adopted
British Virgin Islands Adopted
Canada Adopted
China Under Consideration
The Czech Republic Adopted
Denmark Adopted
England * See Footnote
Finland Adopted
France Adopted
Germany Adopted
Greece Adopted
Hungary Adopted
Ireland Adopted
Israel Adopted
Italy Adopted
Japan Adopted
Luxembourg Adopted
Malta Adopted
Mauritius Under Consideration
Mexico Adopted
New Zealand Adopted
Norway Adopted
Poland Adopted
Portugal Adopted
Russia Under Consideration
Slovakia Adopted
South Africa Adopted
South Korea Adopted
Spain Adopted
Sweden Adopted
Switzerland Adopted
United States Adopted
Footnote: England, Hong Kong, Singapore, Netherlands allow for close-out netting as a matter of general principles of law. No specific legislation had to be enacted.
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• Slovakia:Sections 180 and 192 of the Act on Bankruptcy and Restructuring (No 7/2005 Coll, as amended) defines a close-out netting agreement for derivatives (currencies, interest rates), repos, securities lending and also allows for close-out netting to be governed by foreign law and according to the terms of the contract.
• Romania:Article 2 of Regulation No 31/2006 in connection with Article 2(1) No 12 of the Capital Markets Act defines derivatives in a generic way as options, futures, forwards, swaps and “any other derivative” contract relating to currencies, securities, interest rates, credit ratings, indices etc which may be settled physically or financially. Article 3 of Law No 278/2004 on Banking Insolvency as amended by Government Ordinance No 10/2004 on Bankruptcy of Credit Institutions) allows for the application of “bilateral netting” and also defines netting agreements. Article 2 of Government Ordinance No 9/2004 in connection with Law No 222/2004 implements the EU Collateral Directive and ensures equal treatment of title transfer and security interest collateral arrangements
Netting Legislation in CEE: Precedents
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Netting Legislation in CEE: Precedents • Hungary:
Act CXX of 2001 on the Capital Markets (as amended on 10 June 2004) contains a definition of close-out netting, derivative transactions, repo and reverse repo transactions plus commodities. It amends the Bankruptcy Act to give effect to close-out netting and the single agreement concept. Furthermore, the EU Collateral Directive has been implemented in the meantime as well.
• Czech Republic:Part XI, Article XIV of Act No 257/2004 Coll and Sec 197 of the Act on Conducting Business in the Capital Markets (No 256/2004 Coll, as amended) defines close-out netting in accordance with the terms of any local or foreign law governed contract. Declares that bankruptcy does not have an effect on close-out netting as performed under a netting agreement. Local implementation of the EU Collateral Directive currently being improved.
• Poland:Articles 83-85, 127-128 of the Law on Bankruptcy and Restructuring, 2003 define a “framework agreement” as well as “term financial transactions” and disapply the ability of the receiver to rescind the agreement. The wording of the local implementation of the EU Collateral Directive is unclear in regards of the applicability of interbank netting to financial collateral arrangements
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ISDA’s current agenda for financial law reform
• ISDA netting legislation initiatives• 2006 Model Netting Act and Memorandum on
Implementation of Netting Legislation• ISDA proposal for a European instrument on close-out
netting• European Collateral Directive – review of implementation• Hague Securities Convention• UNIDROIT Project on Intermediated Securities• UNCITRAL projects• Other financial law reform initiatives
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Model Netting Act
• A model netting statute, prepared and published by ISDA - available from the ISDA website at http://www.isda.org
• Originally published in 1996, a revised version was published in 2002• 2006 Model Netting Act published in March 2006• Includes provisions relating to collateral and multibranch netting• Has influenced netting legislation in a number of countries, not
necessarily adopted verbatim, but providing a set of basic principles and useful definitions to be incorporated into appropriate statutory form under local law
• ISDA has also recently published a Memorandum on Netting Legislation (March 2006), with guidance for legislators on implementation of netting legislation, with particular attention to civil code jurisdictions
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ISDA Proposal for a European Instrument on Close-out Netting
• Purpose: – to provide guidance to new EU member states that have not yet adopted netting
legislation– to promote convergence of existing EU regimes for netting on a common set of core
principles• Neither the 1994 Contractual Netting Directive nor Article 7 of the Financial
Collateral Arrangements Directive establish a common set of core principles for close-out netting
• EU Commission Securities Experts Group Report of May 2004 on the Financial Services Action Plan referred to need for minimum standards in this area
• ISDA comment letter of 1 August 2005 on the EU Commission Green Paper on Financial Services Policy
• ISDA comment letters of 3 April and 15 September 2006 to the EU Commission on implementation of the European Collateral Directive
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European Directive on Financial Collateral Arrangements
• Now implemented in all 25 Member States• ISDA review of Collateral Directive implementation,
including the implementation monitor on website• ISDA collateral opinions• Article 10: requirement for report by the Commission
on implementation, due by 27 December 2006• ISDA response of 3 April 2006 to the Commission’s
questionnaire addressed to the private sector, and ISDA’s supplemental comments of 15 September 2006
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Implementation of the European Collateral Directive – key industry concerns
• Scope, particularly in relation to the opt-out to exclude corporates
• Clarification of what it means to “provide” financial collateral, particularly in relation to “control” of intangible claims
• Differential implementation across the EU• Apparent lack of full implementation in one or more Member
States• Article 7 and close-out netting• Article 9 and its relationship to the Hague Securities Convention
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Multiple Agreement Disorder (“MAD”)
• Multiple Masters:1. Waste time2. Cost Money3. Invite documentation backlog4. Increase documentation risk (“Battle of the Forms”)5. Divert management attention6. Potentially increase credit risk (and capital costs)
Solutions: Single Agreement concept (since 1987):ISDA Master Agreement is the basis for 90+% of all global OTC derivatives transactions valued at USD220 trillion (2005)
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• ISDA Master Agreement• Schedule• Trade Confirmations• Credit Support Documentation
• User’s Guides• Legal Opinions from 50 jurisdictions
Overview of ISDA DocumentationOverview of ISDA Documentation
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Basic ISDA Agreement Structure
ISDA Master Agreement plus Schedule
• Governs legal and credit relationship of parties• Includes representations, events of default and covenants• Incorporates Confirmations• Schedule makes elections and changes to standard provisions
Short Form Confirmations Incorporate Definitions Specify economic terms of each
Transaction Include Transaction-specific
modifications
Definitions Contain standard terms and
definitions for documenting particular types of Transactions
Long Form Confirmations Specify economic terms of
each Transaction Include Transaction-specific
modifications
Credit Support Documents
Offering protection against credit risk
ISDA Agreement Structure (2007)
ISDA ®
2002 MasterAgreement
1995 Credit Support Deed (Security Interest-English law)
Definitions: for use in documenting Transactions
2006 Inflation Derivatives Definitions
2005 Commodity Definitions
2003 Credit Derivatives Definitions
2002 Equity Derivatives Definitions
2006 Definitions 1998 Euro Definitions 1998 FX and Currency
Option Definitions 1997 Government Bond
Option Definitions
Credit Support Documents: to reduce credit risk
2001 Margin Supplement (incorporating 2001 Margin Provisions)
1995 Credit Support Annex (Transfer-English law)
1994 Credit Support Annex (New York law)
1995 Credit Support Annex (Japanese law)
Bridges 2002 Energy Agreement
Bridge 2001 Cross-Agreement
Bridge 1996 FRABBA Bridge 1996 BBAIRS Bridge
2002 Master Agreement Protocol
Confirmations Short form
confirmations Master confirmation
agreements
Confirmations Long form
confirmations
Annexes North American Power
Annex North American Gas
Annex GTMA Annex (UK Power) European Gas Annex EU/US Emissions
Allowance Annexes Global Physical Coal Annex
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Section 1 - Interpretation
• Definitions
• Inconsistency
• Single Agreement
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Section 2 - Payment and Delivery Obligations
• Conditions Precedent
• Change of Account
• Payment Netting
• Tax Withholding/Gross-Up
• Compensation
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Section 3 - Representations
• 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
• Purpose/Remedies
• Furnish Specified Information
• Maintain Authorisations
• Comply with Laws
• Tax Agreement
• Payment of Stamp Tax
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Section 5 - Events of Default and Termination Events
Events of Default• Failure to Pay or Deliver (Section 5(a)(i))• Breach of Agreement (Section 5(a)(ii))
– applies to both parties– 30 day grace period (following the giving of notice)
• Credit Support Default (Section 5(a)(iii))– applies to both parties and any Credit Support Provider(s)
• Misrepresentation (Section 5(a)(iv))– applies to both parties and any Credit Support Provider(s)
• Default under Specified Transaction (Section 5(a)(v))• Cross Default (Section 5(a)(vi))