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Robert G. Pickel Executive Director and Chief Executive Officer ISDA

Overview of the ISDA Credit Support Documentation and Brazilian Collateral Issues Hotel Inter-Continental Sao Paulo, Brazil August 6, 2002. Robert G. Pickel Executive Director and Chief Executive Officer ISDA. Basics of Collateralization. Risk Reduction Market and Regulatory Forces

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Robert G. Pickel Executive Director and Chief Executive Officer ISDA

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  1. Overview of the ISDA Credit Support Documentation and Brazilian Collateral Issues Hotel Inter-Continental Sao Paulo, BrazilAugust 6, 2002 Robert G. Pickel Executive Director and Chief Executive Officer ISDA

  2. Basics of Collateralization • Risk Reduction • Market and Regulatory Forces • Disadvantages of Other Methods - Guarantees, Credit Insurance or Bond, Letter of Credit, Triple-A Subs • Drawbacks • Operational systems and legal support • Costs of collateral and support may be significant • Legal risk : applicable law and procedures may vary from jurisdiction to jurisdiction

  3. ISDA Credit Support Documents -- A Time of Change • Lessons of 1997-1998 • Reduce time frames • Revise dispute resolution process • Broaden the role of ISDA documents • Opportunity to make structural changes • Simplify architecture • Reduce size of document • Result: 2001 ISDA Margin Provisions and forms of Amendment to existing credit support documents

  4. Background and Structure of 1994 ISDA Credit Support Annex (NY Law) • Bilateral, mark-to-market form • Cash and securities posted as collateral • Parties can add other forms of credit support • Computation and delivery, substitution and return mechanics • Annex also covers: • Dispute resolution • Holding and using collateral; Distributions • Events of Default; Rights and Remedies • Representations; Expenses

  5. Background and Structure • Part of Schedule to ISDA Master • Underlying assumption that NY law applies; NY law ISDA Master • Paragraph 13 of ISDA Credit Support Annex is equivalent of the Schedule to the ISDA Master Agreement

  6. 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) Confirmations (long form) • Definitions: for use in documenting Transactions • 2000 Definitions (replace the 1991 Definitions (as amended by the 1998 Supplement) • 1999 Credit Derivatives Definitions (plus three Supplements published in 2001) • 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) • 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 1995 Credit Support Deed (Security Interest – English Law) 1996 Credit Support Annex (Japanese Law) • Confirmations (short form) • Incorporate Definitions • Specify economic terms of each transaction • Include Transaction-specific modifications • Protocols: amending Master Agreement • 2001 Euro Protocol • 2000 EMU Protocol (Greece) • 1998 EMU Protocol

  7. Paragraph 1 Interpretation (a) Definitions and Inconsistency (b) Secured Party and Pledgor

  8. Paragraph 2 Security Interest • Grant by Pledgor of first priority security interest thereon and right of set-off • Immediate release of security interest and lien upon Transfer of Posted Collateral to Pledgor

  9. Credit Support Obligations Worksheets and Examples The following worksheets and examples demonstrate the mechanics used in Paragraph 3 of the ISDA Credit Support Annex to calculate Credit Support Obligations (including Delivery Amounts and Return Amounts), based on the following three steps: • Identify all relevant defined terms (assigned vs. calculated); • Establish numerical inputs for all “assigned” defined terms; and • Do the arithmetic to derive all “calculated” defined terms.

  10. Delivery Amount Worksheet “Assigned” Defined Terms Secured Party Pledgor (Party B) (Party A) 1. Exposure A. [ ] B. n/a 2. Independent Amount A. [ ] B. [ ] 3. Threshold A. n/a B. [ ] 4. Min. Transfer Amount A. n/a B. [ ] 5. Value of Posted Credit A. [ ] B. n/a Support “Calculated” Defined Terms Secured Party Pledgor (Party B) (Party A) 6. Credit Support Amount A. n/a B. 1A + 2B - 2A - 3B 7. Delivery Amount A. n/a B. 6B - 5A, iff 7B (4B)

  11. Delivery Amount WorksheetExample 1 “Assigned” Defined Terms Secured Party Pledgor (Party B) (Party A) 1. Exposure A. 500 B. n/a 2. Independent Amount A. 0 B. 250 3. Threshold A. n/a B. 100 4. Min. Transfer Amount A. n/a B. 50 5. Value of Posted Credit A. 250 B. n/a Support “Calculated” Defined Terms Secured Party Pledgor (Party B) (Party A) 6. Credit Support Amount A. n/a B. 500 + 250 - 0 - 100 = 650 7. Delivery Amount A. n/a B. 650 - 250 (iff (50)) = 400

  12. Delivery Amount WorksheetExample 2 “Assigned” Defined Terms Secured Party Pledgor (Party B) (Party A) 1. Exposure A. 500 B. n/a 2. Independent Amount A. 700 B. 300 3. Threshold A. n/a B. 200 4. Min. Transfer Amount A. n/a B. 50 5. Value of Posted Credit A. 300 B. n/a Support “Calculated” Defined Terms Secured Party Pledgor (Party B) (Party A) 6. Credit Support Amount A. n/a B. 500+300 - 700 - 200 = (100) = 0 7. Delivery Amount A. n/a B. 0

  13. Return Amount Worksheet “Assigned” Defined Terms Secured Party Pledgor (Party B) (Party A) 1. Exposure A. [ ] B. n/a 2. Independent Amount A. [ ] B. [ ] 3. Threshold A. n/a B. [ ] 4. Min. Transfer Amount A. [ ] B. n/a 5. Value of Posted Credit A. [ ] B. n/a Support “Calculated” Defined Terms Secured Party Pledgor (Party B) (Party A) 6. Credit Support Amount A. n/a B. 1A + 2B - 2A - 3B 7. Return Amount A. 5A - 6B iff B. n/a 7A (4A)

  14. Return Amount WorksheetExample 1 “Assigned” Defined Terms Secured Party Pledgor (Party B) (Party A) 1. Exposure A. 500 B. n/a 2. Independent Amount A. 0 B. 300 3. Threshold A. n/a B. 600 4. Min. Transfer Amount A. 50 B. n/a 5. Value of Posted Credit A. 300 B. n/a Support “Calculated” Defined Terms Secured Party Pledgor (Party B) (Party A) 6. Credit Support Amount A. n/a B. 500 + 300 - 0 - 600 = 200 7. Return Amount A. 300 - 200 B. n/a (iff (50))=100

  15. Return Amount WorksheetExample 2 “Assigned” Defined Terms Secured Party Pledgor (Party B) (Party A) 1. Exposure A. 500 B. n/a 2. Independent Amount A. 700 B. 300 3. Threshold A. n/a B. 200 4. Min. Transfer Amount A. 50 B. n/a 5. Value of Posted Credit A. 300 B. n/a Support “Calculated” Defined Terms Secured Party Pledgor (Party B) (Party A) 6. Credit Support Amount A. n/a B. 500+300 - 700 - 200 = (100) = 0 7. Return Amount A. 300 - 0 (iff B. n/a (50)) = 300

  16. Paragraph 4 Conditions Precedent, Transfers, Calculations and Substitutions (a) Conditions Precedent - no Event of Default, Potential Event of Default or Specified Condition/no Early Termination Date (b) Transfers - next Local Business Day after demand (c) Calculations - by Valuation Agent as of the Valuation Time for each Valuation Date (d) Substitutions - permitted unless otherwise specified

  17. Paragraph 5 Dispute Resolution • Notify other party and Valuation Agent • Undisputed amount is transferred • Parties consult • If dispute relates to Exposure, obtain Market Quotations • If dispute relates to Value of Credit Support, resolve in manner stipulated in Paragraph 13

  18. Paragraph 6 Holding and Using Posted Collateral (a) Care of Posted Collateral (b) Eligibility to Hold Posted Collateral; Custodians (c) Use of Posted Collateral - Broadly Permitted (d) Distributions and Interest Amount

  19. Paragraph 7 Events of Default • Failure to post/return collateral or to pay distributions or interest when due for 2 Local Business Days after notice • Failure to comply with provisions regarding use of collateral for 5 Local Business Days after notice • Failure to perform any other agreement or obligation under Annex for 30 days after notice

  20. Paragraph 8(a) Secured Party’s Rights and Remedies • Triggered by: (1) Occurrence of Event of Default or Specified Condition with respect to Pledgor; or (2) Occurrence/Designation of Early Termination Date • Exercise of Rights and Remedies (i) rights available under applicable law (NY UCC) (ii) rights under terms of Other Posted Support (iii) right to set off (iv) right to liquidate Posted Collateral

  21. Paragraph 8(b) Pledgor’s Rights and Remedies • Triggered by Occurrence/Designation of Early Termination Date as a result of an Event of Default or Specified Condition with respect to Secured Party • Exercise of Rights and Remedies (i) rights available under applicable law (ii) rights under terms of Other Posted Support (iii) Secured Party obligated to Transfer all Posted Collateral and the Interest Amount (iv) right to set off or withhold payment of remaining amounts

  22. Paragraphs 8(c)/(d) Rights and Remedies • Deficiencies and Excess Proceeds • Final Returns

  23. Paragraph 9 Representations • Power to grant a security interest • Sole owner of or right to transfer Eligible Collateral • Creation of a valid and perfected first priority security interest • No other security interest on any Posted Collateral • Special Representation for U.S. bank or thrift - Appendix F to User’s Guide

  24. Paragraph 10 Expenses • Each party pays its own when performing its contractual obligations • Because the Pledgor remains the “owner” of collateral, continues to be liable to pay taxes and other charges that may be levied on collateral • Costs incurred by Secured Party in liquidating and applying collateral are payable by the Defaulting Party or (if no Defaulting Party) equally by both parties

  25. Paragraph 11 Other Provisions (a) Default Interest - applicable when Secured Party fails to make a timely transfer (b) Further Assurances (c) Further Protections - Pledgor must safeguard all Posted Credit Support (d) Good Faith and Commercially Reasonable Manner (e) Demands and Notices (f) Specification of Certain Matters in Confirmations

  26. Paragraph 13 Elections and Variables • Eligible Collateral/Valuation Percentages • Thresholds • Valuation and Timing • “Specified Conditions” • Dispute Resolution provisions where Value of Posted Credit Support not agreed • Eligibility to hold Posted Collateral; Custodians

  27. Paragraph 13 • Distributions and Interest Amount • Additional Representations • Other Eligible Support and Other Posted Support • Demands and Notices • Other Provisions

  28. 2001 ISDA Margin Provisions The New Structure • Common operational provisions – Part 1 • New York Law: pledge/security interest approach – Part 2 • English Law: title transfer approach – Part 3 • Other jurisdictions – Part 4 • Definitions – Part 5 • Supplement and other Appendices (Forms of Notices)

  29. Issues to Consider • Nature and location of collateral • Nature and location of counterparty • Perfection issues • Tax issues • Recharacterization issues • Collateral Opinion Projects

  30. ISDA Collateral Opinion Projects • ISDA is in the process of obtaining legal opinions relating to creation and perfection of security interests under the New York and English law collateral documents. • Opinions received from: Australia England Italy Singapore Austria Finland Japan South Korea Belgium France Luxembourg Sweden Bermuda Germany Malaysia Switzerland Canada Hong Kong The Netherlands Taiwan Cayman Islands Indonesia New Zealand Thailand Denmark Ireland Portugal U.S.A. • Awaiting final opinions from: Norway South Africa • Opinions commissioned for: British Virgin Islands Scotland

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