Klassifizierung angeben: "Streng vertraulich", "Vertraulich", "Intern", "Öffentlich" Klassifizierung angeben: "Streng vertraulich", "Vertraulich", "Intern", "Öffentlich" CONTRACTS AND FINANCE Introduction and ISDA Master Agreement for Economic Capital and Structured Finance/ Advanced Masters of Finance UNI ZH Date:Zurich, 12 June 2006 Author:Beat Gabathuler

Beat Gabathuler/Contracts and Finance/31 May Overview The 1992 and 2002 ISDA Master Agreement The most important Provisions

Beat Gabathuler/Contracts and Finance/31 May Preliminary Questions  Creditworthiness of counterparty (Credit/Business Issues)  Jurisdiction where counterparty is set up and organised (Legal Issue)  Type / Status of counterparty (Private law versus Public law)  1992 or 2002 ISDA Master Agreement  or local Framework Agreement

Beat Gabathuler/Contracts and Finance/31 May Preliminary Questions  Capacity Power to enter into Derivatives Transactions  Authority Authority to represent counterparty and execute binding Contracts  Suitability of a specific transaction for an individual client

Beat Gabathuler/Contracts and Finance/31 May Specified Entity, Part 1 (a)  Third parties or generic groups which one or both of the parties to an Agreement want to join in to Section 5(a)(v)- (vii) and Section 5 (b)(Events of Default/Termination Event)  Any Default under Specified Transaction, Cross Default, Bankruptcy and Credit Event Upon Merger under another agreement between that Specified Entity and one of the parties of this Agreement  Occurrence of Defaults or Termination Events by a Specified Entitiy also constitutes an Event of Default or Termination Event for the related party  Draw in those entities where the assets are!

Beat Gabathuler/Contracts and Finance/31 May Specified Transaction, Part 1 (b)  Section 14 of the ISDA Master Agreement (Swaps, Forwards, Options)  Specified Transactions are OTC-derivatives between the parties, its Credit Providers, or Specified Entities  Definition of Specified Transaction can be broadened (Repo Transactions; Securities Lending Transactions)  A Default under a Specified Transaction is an Event of Default under the Master Agreement

Beat Gabathuler/Contracts and Finance/31 May Cross Default, Part 1(c)  With a Cross Default a Non-defaulting Party can trigger its termination rights under its ISDA Master Agreement with a Defaulting Party when: It is aware of a default by that Defaulting Party In a debt agreement elsewhere (Specified Indebtedness) with a third party Which amount is above the Threshold Amount determined in the ISDA Master Agreement

Beat Gabathuler/Contracts and Finance/31 May Specified Indebtedness, Part 1(c)  Section 14 of the ISDA Master Agreement  Borrowed money  Definition can be broadened to any obligation vis-à-vis any third party

Beat Gabathuler/Contracts and Finance/31 May Threshold Amount, Part 1(c)  Parties must agree on appropriate default threshold  Fixed sum such as e.g. USD 10m or a small percentage of shareholder's equity (from 2% up to 4%)  Smaller amount for KMUs, small pension funds or private individuals  Greater amount for huge companies, banks and conglomerates

Beat Gabathuler/Contracts and Finance/31 May Credit Event Upon Merger, Part 1 (d)  Termination Event which will close out all Transactions if triggered  Occurrs if a party participates in a merger (or enters into a similar type of transaction) and the "resulting entity" is "materially weaker" after such event  Bank will insist that a Credit Event Upon Merger should apply to its counterparty but often not to itself  2002 ISDA Master Agreement greatly expands the Credit Event Upon Merger Termination Event

Beat Gabathuler/Contracts and Finance/31 May Automatic Early Termination, Part 1 (e)  Parties elect in the Schedule whether Automatic Early Termination is to apply in case of bankruptcy  Automatic Termination needed if Insolvency Laws provides for immediate termination if party goes bankrupt  Legal opinions to countries recommend selection of either applicability or non-applicability

Beat Gabathuler/Contracts and Finance/31 May Payments on Early Termination Part 1(f) (1/3)  1992 ISDA Master Agreement Two Payment Methods Election -First Method (only non Defaulting Party can benefit)  Cherry Picking -Second Method (full two-way payments; irrespective who defaulted) Two Payment Measures Election -Market Quotation -Loss

Beat Gabathuler/Contracts and Finance/31 May Payments on Early Termination Part 1(f) (2/3)  Market Quotation versus Loss Market Quotations more objective and transparent (at least for liquid vanilla transactions)  average of received quotes from Market Makers Loss (determined by Non-Defaulting Party) -Includes hedge cost -More appropriate where it would be difficult to obtain a quote for transaction(s) / portfolio -Simpler valuation -Fallback of Market Quotation is Loss

Beat Gabathuler/Contracts and Finance/31 May Payments on Early Termination Part 1(f) (3/3)  2002 ISDA Master Agreement No election: Close-out Amount is now standard clause Mixture of objective data sources (e.g. volatilities and yield curves) and subjective calculation/determination by the Non-Defaulting Party Unpaid amounts, legal fees and out of pocket expenses are to be excluded in determination of Close-out Amount

Beat Gabathuler/Contracts and Finance/31 May Termination Currency, Part 1 (g)  Currency into which all Transactions are converted on close-out  USD, EURO or Sterling – depending upon the domiciles or preferences of the parties  2002 ISDA Master Agreement depending upon chosen law (English law: Sterling; New York law: USD)

Beat Gabathuler/Contracts and Finance/31 May Additional Termination Events, Part 1(h)  Additional Termination Events come in all shapes and sizes Impossibility (Performance; Settlement is not possible) Force Majeure (Act of God!, Strike, Governmental Edicts) Change of Ownership (Take-over) Downgrading (as determined by Rating Agencies)

Beat Gabathuler/Contracts and Finance/31 May Agreement to Deliver Documents, Part 3  Part 3(a) – Agreement to deliver tax, forms, documents or certificates Elective: list tax forms required in order to give Payer Tax Representation (e.g. W-8BEN)  Part 3(b) – Agreement to deliver other documents Elective: Signatory book, Annual and half year annual reports, Letter of appointment of process agent No board resolution between banks No legal opinion if not necessary

Beat Gabathuler/Contracts and Finance/31 May Process Agent, Part 4 (b)  Receives writs or termination notices or other such legal documentation (Legal Proceedings)  If party is neither incorporated in England nor in New York (head quarter): London or New York branch of bank (Counterparty) Law Debenture Corporation PLC and English/N.Y. Law firms or "Party B appoints no Process Agent. Party B represents that, if, in case of any dispute arising out of or in connection with this Agreement, Party A so requests…"

Beat Gabathuler/Contracts and Finance/31 May Multibranch Party, Part 4 (d)  Many Banks have more than one office through which they enter into OTC Derivatives Transactions  Specify the identity of those branches through which they wish to enter into OTC Derivatives Transactions under the Agreement (Global Book Positions)  Enlarged Netting effect (Multibranch Netting)

Beat Gabathuler/Contracts and Finance/31 May Calculation Agent, Part 4 (e)  Term not defined in the ISDA Master Agreement but may be found in the 2000 ISDA Defintions  The Schedule requires that the parties designate a "Calculation Agent"  Banks are almost always designated as the Calculation Agent because of its financial sophistication in the OTC derivatives area

Beat Gabathuler/Contracts and Finance/31 May Governing Law, Part 4 (h)  Section 13 (a) of the ISDA Master Agreement  Laws of the State of New York or English law

Beat Gabathuler/Contracts and Finance/31 May Set-off, Part 5  Set-off has always been recognized as important in the OTC derivatives area  Cancelling out of mutual debts and credits, thus...  Expansion to include affiliates  2002 ISDA Master Agreement Set-off is not Netting!

Beat Gabathuler/Contracts and Finance/31 May CONTRACTS AND FINANCE Introduction to the ISDA Master Agreement Beat Gabathuler Zürcher Kantonalbank Head Documentation Trading Products Phone: +41 (0)44 /