PLI’s Fundamentals of Swaps & Other Derivatives 2016

Derivatives Documentation: Overview of the ISDA Architecture

Confirmations and ISDA’s Credit Support Annexes

October 24, 2016

New York

GuyLaine Charles

Teigland-Hunt LLP

New York

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What is a Confirmation?

Typically, there are no product specific terms in the

ISDA Master Agreement.

Confirmation is the document memorializing the trade.

Master Confirmations contain all the terms relevant to a

particular product to be traded which allows parties to

simply agree on the economic terms whenever a trade

is entered into.

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What are the Definitions?

Product specific terms that are incorporated by reference

in the Confirmations.

Product Definitions Booklets

2014 ISDA Credit Derivatives Definitions

2011 Equity Derivatives Definitions

2006 ISDA Definitions

2005 ISDA Commodity Definitions

2002 Equity Derivatives Definitions

1998 FX and Currency Option Definitions (plus Annex A)

1997 Government Bond Option Definitions

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Single Agreement

All Transactions are entered into in reliance on the fact that the Master Agreement and all Confirmations form a single agreement between the parties (collectively referred to as this “Agreement”), and the parties would not otherwise enter into any Transactions.

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5

Multiple Transactions under a Single

ISDA Master Agreement

ISDA

Master Agreement

Schedule

2002 ISDA Equity

Derivatives Definitions

Confirmation

(Currency Option)

Confirmation

(Equity Option)

1998 FX and Currency

Option Definitions

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ISDA’s CREDIT SUPPORT ANNEXES

Today ISDA’s Credit Support Annexes (CSA) are widely used to set forth

details of parties’ mutually agreed collateral arrangements for non-cleared OTC

derivatives.

ISDA’s 2015 Margin Survey shows the following:

90% of all non-cleared OTC derivatives trades are subject to collateral

agreements.

The number of active collateral agreements supporting non-cleared OTC

derivatives transactions was 136,936 at end of 2014 – and approximately 80% are

documented using ISDA’s CSAs.

The remaining 20% include bespoke margin agreements, long-form

confirmations with collateral terms and jurisdiction-specific agreements.

Parties elect types of collateral to be posted, how much, how often, where, etc.

With respect to collateral types, cash represents 76.6% of collateral received, while

government securities constitute 13.4% of collateral received.

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What is the Credit Support Annex?

Annex to the Schedule to the ISDA Master Agreement.

Parties may choose to enter into a CSA or not.

Provides a contractual framework under NY law to allow

parties:

Collateralize their obligations;

Identify type of collateral that will be acceptable; and

Establish their rights and remedies with respect to the credit

support provided.

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The Credit Support Annex

in the ISDA Master Agreement Structure

ISDA

Master Agreement

Schedule

Transaction

Confirmation

ISDA Definitions

Booklet

Credit

Support Annex

Paragraph [13]

of CSA

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Benefits/Drawbacks of Collateralization

Benefits of Collateralization

Counterparty Credit Risk Mitigation

Drawbacks of Collateralization

Operational systems and legal support

Costs of collateral and infrastructure

Legal risk: applicable law and procedures may vary from jurisdiction to jurisdiction

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Introduction

to ISDA’s Library of Credit Support Documents

ISDA’s existing credit support documentation:

1994 Credit Support Annex (Security Interest – New York Law)

1995 Credit Support Annex (Transfer – English Law)

1995 Credit Support Deed (Security Interest – English Law)

1995 Credit Support Annex (Security Interest – Japanese Law)

2001 ISDA Margin Provisions

2013 Standard Credit Support Annex

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Introduction

to ISDA’s Library of Credit Support Documents

ISDA’s new credit support documentation:

2016 Credit Support Annex for Variation Margin (Security Interest – New York Law)

2016 Credit Support Annex for Variation Margin (Title Transfer – English Law)

2016 Credit Support Annex for Variation Margin (Loan – Japanese Law)

2016 Phase One Credit Support Annex for Initial Margin (Loan – Japanese Law)

2016 Phase One IM Credit Support Deed (Security Interest – English Law)

2016 Phase One Credit Support Annex for Initial Margin (Security Interest – New York Law)

Parties are free to use other pledge or security agreements; however, the ISDA CSAs are most widely used.

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New York CSA – General Purpose

Bilateral, mark-to-market form

Includes standard terms regarding:

Grant of security interest in collateral

Method for determining a party’s “Exposure” to the other party

Parties’ obligations to deliver/release credit support

Rights, remedies and duties of parties with respect to credit support supplied

Identifies types of collateral/credit support that are eligible

Cash, treasury securities are typical; other forms possible

Credit terms can be customized (in Paragraph 13) for each party

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Paragraph 5: Dispute Resolution

Addresses disputes regarding calculations of Exposure and Value of Credit Support

Undisputed amount must be transferred pending resolution of dispute

Dispute resolution methods:

Exposure is recalculated by seeking 4 mid-market quotations for Transactions in dispute

Value of Credit Support is recalculated using procedures specified in Paragraph 13

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Paragraph 6: Holding and Using Posted Collateral

Eligibility to Hold Posted Collateral; Custodians

Secured Party may be entitled to hold collateral directly (subject to conditions in Para. 13).

If it fails to satisfy conditions, transfer to Custodian may be required.

Alternatively, parties may require Custodian to hold collateral at all times.

Use of Posted Collateral (“Right to Rehypothecate”)

Secured Party may sell, pledge, rehypothecate, invest, use, commingle or otherwise dispose of Posted Collateral (subject to Para. 13 and other conditions).

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Paragraph 6: Holding and Using Posted Collateral (cont’d)

Note: Section 724 of Dodd-Frank requires a swap dealer to segregate initial margin (aka “Independent Amounts” or “IA”) if requested by a counterparty.

ISDA has published a standardized triparty account control agreement to facilitate implementation of IA segregation arrangements.

“ISDA Amend” now offers electronic platform for making segregation elections and acknowledging annual dealer notices re: segregation.

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Purpose of Paragraph 13 of CSA

Paragraph 13 (“Elections and Variables”) = negotiated portion of the CSA

Allows parties to:

Specify relationship-specific provisions and elections

Amend, add to standard terms of the Credit Support Annex

Common negotiation points:

Collateral Thresholds

Independent Amounts

Minimum Transfer Amount

Transfer Timing

Valuation Agent

Dispute Rights

Parties’ rights to hold collateral vs. obligation to use a custodian

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ISDA Collateral Opinion Projects

ISDA has obtained legal opinions relating to creation and perfection of security interests under

New York and English law collateral documents.

Annual updates of these opinions are available to ISDA members.

To date 53 collateral opinions received from: Anguilla

Australia

Austria

Bahamas

Barbados

Belgium

Bermuda

Brazil

British Virgin Islands

Canada

Cayman Islands

Channel Islands (Guernsey)

Channel Islands (Jersey)

Chile

Columbia

Cyprus

Czech Republic

Denmark

England

Finland

France

Germany

Greece

Hong Kong

Hungary

Iceland

India

Indonesia

Ireland

Israel

Italy

Japan

Luxembourg

Malaysia

Mexico

The Netherlands

New Zealand

Norway

Philippines

Poland

Portugal

Quebec

Scotland

Singapore

South Africa

South Korea

Spain

Sweden

Switzerland

Taiwan

Thailand

Turkey

U.S.A

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Uncleared Margin Rules

Per Section 731 and 764 of the Dodd-Frank Act, regulators have begun imposing both initial and variation margin requirements on all swaps that are not cleared by a registered derivatives clearing organization.

CFTC has set margin requirements for non-banks with respect to swaps.

Prudential Regulators (Fed, FDIC, OCC, etc.) have set margin requirements for banking entities with respect to swaps and security-based swaps.

SEC has proposed margin rules for non-banks with respect to security-based swaps, but has not yet finalized its rules.

ISDA has published the 2016 Credit Support Annex for Variation Margin (Security Interest – New York Law) to address the new regulatory requirements with respect to variation margin (“VM CSA”).

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Key Differences between Existing New York Law CSA and

VM CSA Provision Existing CSA VM CSA

Transaction Scope/Netting Set

• Generally all transactions under an ISDA Master Agreement are covered unless specifically carved out.

• A single CSA covers both IA and VM. • All trades under the ISDA Master

Agreement constitute a “netting set” for the purposes of determining net exposure.

• Adds the term “Covered Transactions” which includes only transactions agreed to between the parties.

• Covered Transactions constitute a “netting set” for the purposes of determining net exposure under the VM CSA (this can include legacy trades or not).

• Other CSAs may exclude Covered Transactions.

Margin • Transfer amounts take into account IA and VM.

• Transfer amounts only take into account VM.

Thresholds • The parties may agree to a collateral threshold amount, which would apply to both IA and VM.

• There is no collateral threshold amount applicable for VM. The term “Threshold” does not appear in the VM CSA.

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Key Differences between Existing New York Law CSA

and VM CSA ccxvcvxcvx Provision Existing CSA VM CSA

Transfer Timing • Before notification time: by close of business on the next local business day.

• After the notification time: by close of business on the second local business day.

• Default notification time: 1:00PM NY.

• Before notification time: by close of business on the same local business day.

• After the notification time: by close of business on the next local business day.

• Default notification time: 10:00AM NY (this is to allow for same day transfers).

Offset against Other CSAs

• N/A • Allows the parties to elect to offset opposite flows of margin that is not segregated and not prohibited from offset.

Ineligibility of Collateral

• Parties can post any collateral agreed to. • If posted collateral is no longer regulatory compliant it will cease to be Eligible Credit Support (VM) and will have a value of zero by the later of (i) the date the collateral is no longer compliant and (ii) the 5th LBD after the SP has provided notice of lack of compliance.

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Key Differences between Existing New York Law CSA and

VM CSA Provision Existing CSA VM CSA

Dispute Resolution • Notification of a dispute w/r/t a Delivery Amount or a Return Amount must be made not later than the COB on the LBD following the date the demand is made.

• Notification of a dispute w/r/t a Delivery Amount (VM) or a Return Amount (VM) must be made not later than the COB on the date the Transfer is due.

Interest • Interest earned on Cash collateral is to be transferred to the Pledgor in accordance with Par. 13. If not transferred to the Pledgor, will become Posted Collateral and subject to the security interest.

• Interest Transfers can be netted by the Interest Payer against any Delivery Amount (VM) or Return Amount (VM) (in the form of Cash collateral) owed to the Interest Payer (VM).

• Parties can also elect “Interest Adjustment” and Interest Amount (VM) will, if positive, increase the SP’s collateral and if negative, decrease the amount of collateral held by the SP.

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Key Differences between Existing New York Law CSA and

VM CSA Negotiated Terms Existing CSA VM CSA

Valuation of Collateral for Margin Calculation

• As agreed by the parties. • As agreed by the parties but haircuts cannot be less than required under the relevant margin rules.

Minimum Transfer Amount

• The minimum transfer amount can be any amount as agree by the parties.

• Can be an amount agreed between the parties, subject to regulatory maximum (e.g. USD500,000 across VM and IM under the CFTC and Prudential regulations).

Eligible Collateral • Any collateral as agreed between the parties.

• Eligible collateral must be compliant with the relevant margin rules.

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Teigland-Hunt LLP

127 West 24th Street, 4th Floor

New York, NY 10011

Tel: 212-269-1600

Direct email: gcharles@t-hllp.com

www.t-hllp.com

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