Understanding the
ISDA Credit Support Annex:
Know Your Rights and Risks
CRAIG ENOCHS
Jackson Walker L.L.P.
International Energy Credit Association
2011 IECA Spring Education Conference
March 20-22, 2011
Hilton Head Island, South Carolina
Discussion Topics
• Overview of the CSA
• Key Provisions of the CSA
•
•
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•
•
•
Security Interest
Credit Support Obligations
Conditions Precedent
Transfer Timing
Calculations of Value and Exposure
Substitutions of Collateral
2
Discussion Topics
• Key Provisions of CSA (cont.)
•
•
•
•
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•
•
Dispute Resolution
Holding and Using Posted Collateral
Events of Default
Certain Rights and Remedies
Representations
Costs and Expenses
Additional CSA Obligations
• Paragraph 13 to the CSA
3
Discussion Topics
• Credit Implications of Dodd-Frank
• Clearing Requirement and End-User Exception
• Segregation of Collateral Securing Uncleared Swaps
• Reporting and Recordkeeping Obligations
• Capital and Margin Requirements
4
Discussion Topics
• Overview of the CSA
• Key Provisions of the CSA
• Paragraph 13 to the CSA
• Credit Implications of Dodd-Frank
5
Overview of the
Credit Support Annex
•
Paragraph 13 contains elections and amendments modifying
Paragraphs 1 through 12
•
Protects against mark-to-market exposure
•
Most often used by sophisticated trading counterparties
•
•
Requires consistent monitoring and back-office systems
Preferred over adequate assurances because allows 100%
collateralization over threshold.
6
Discussion Topics
• Overview of the CSA
• Key Provisions of the CSA
• Paragraph 13 to the CSA
• Credit Implications of Dodd-Frank
7
Security Interest in Posted Collateral
• Paragraph 2: Each Pledgor grants to the Secured
Party a first priority continuing security interest, lien
on, and right of Set-Off against all Posted Collateral.
• When the Secured Party transfers the Posted
Collateral back to the Pledgor, the security interest
and lien shall be released immediately without further
action.
8
Security Interest in Posted Collateral
• Practice Notes:
• Only applies to “Posted Collateral”—not “Posted Credit
Support”.
• “Eligible Collateral” that is posted with a Secured Party is called
“Posted Collateral”.
• Most common Eligible Collateral elected in Paragraph 13 is Cash.
• Security interest would not apply to other forms of credit
support, such as Letters of Credit.
• Primarily aimed at banks which may use Treasuries, bonds,
equities or other assets as collateral.
9
Credit Support Obligations
• Paragraph 3(a): Delivery Amount. Upon a demand
by the Secured Party:
• If on any Valuation Date the Delivery Amount
equals or exceeds the Pledgor’s Minimum
Transfer Amount, then
• The Pledgor Transfers Eligible Credit Support
with a Value at least equal to the Delivery
Amount.
10
Credit Support Obligations
• Paragraph 3(a): Delivery Amount (cont.): If on any
Valuation Date the Delivery Amount equals or
exceeds the Pledgor’s Minimum Transfer Amount:
• Delivery Amount: the amount by which the Credit Support
Amount exceeds the Value of all Posted Credit Support
held by the Secured Party.
• What is the Credit Support Amount?
• Does it exceed the Value of all Posted Credit Support
(e.g., Cash, Letters of Credit, etc.) currently held by the
Secured Party?
11
Credit Support Obligations
• Paragraph 3(a): Delivery Amount (cont.): If on any
Valuation Date the Delivery Amount equals or
exceeds the Pledgor’s Minimum Transfer Amount:
• Credit Support Amount:
• Secured Party’s Exposure, plus
• Pledgor’s Independent Amount, minus
• Secured Party’s Independent Amount, minus
• The Pledgor’s Threshold; provided if such value is
negative, the Credit Support Amount is zero (0).
12
Credit Support Obligations
• Paragraph 3(a): Delivery Amount (cont.): If on any
Valuation Date the Delivery Amount equals or
exceeds the Pledgor’s Minimum Transfer Amount:
• Exposure:
• Defined in Paragraph 12 of CSA
• The amount payable under Section 6(e)(ii) of the ISDA
Master Agreement as if all Transactions terminated as
of the Valuation Date.
• Takes into account all forward mark-to-market
positions.
13
Credit Support Obligations
• Paragraph 3(a): Delivery Amount (cont.): If on any
Valuation Date the Delivery Amount equals or
exceeds the Pledgor’s Minimum Transfer Amount:
• Independent Amount
• Elected by the parties in Paragraph 13
• Collateral “cushion” required to be maintained by
Pledgor in addition to any other Delivery Amount.
• Threshold
• Threshold for each party is stated in Paragraph 13.
• Most often credit ratings matrix that varies by
counterparty.
14
Credit Support Obligations
• Paragraph 3(a): Delivery Amount (cont.): If on any
Valuation Date the Delivery Amount equals or
exceeds the Pledgor’s Minimum Transfer Amount:
• Once you calculate any Delivery Amount, does it exceed
the Pledgor’s Minimum Transfer Amount?
• Minimum Transfer Amount: Designated by the parties in
Paragraph 13.
• Credit evaluation that varies by counterparty and the
anticipated volume of Transactions under the ISDA.
• E.g., $250,000 for larger counterparties, and $100,000
for smaller counterparties.
15
Credit Support Obligations
• Paragraph 3(b): Return Amount. Upon a demand by
the Pledgor:
• If on any Valuation Date the Return Amount
equals or exceeds the Secured Party’s Minimum
Transfer Amount, then
• The Secured Party Transfers Posted Credit
Support with a Value at least equal to the Return
Amount.
16
Credit Support Obligations
• Paragraph 3(b): Return Amount (cont.): If on any
Valuation Date the Return Amount equals or exceeds
the Secured Party’s Minimum Transfer Amount:
• Return Amount: The Value of all Posted Credit Support
held by the Secured Party, minus the Credit Support
Amount.
• What is the Value of all Posted Credit Support (e.g.,
Cash, Letters of Credit, etc.) held by the Secured
Party?
• Does it exceed the Credit Support Amount?
17
Credit Support Obligations
• Paragraph 3(b): Return Amount (cont.): If on any
Valuation Date the Return Amount equals or exceeds
the Secured Party’s Minimum Transfer Amount:
• Once you calculate any Return Amount, does it
equal or exceed the Secured Party’s Minimum
Transfer Amount?
18
Conditions Precedent
• Paragraph 4(a): Conditions Precedent. Each
obligation to Transfer amounts under Paragraphs 3
(Delivery/Return Amounts) and 5 (Dispute
Resolution) is subject to the condition precedent that:
• No Event of Default, Potential Event of Default or
Specified Condition has occurred and is continuing with
respect to the other party; and
• No Early Termination Date for which unsatisfied payment
obligations exist has occurred or been designated under the
Agreement.
• Caution: Ipso Facto
19
Transfer Timing
• Paragraph 4(b): Transfer Timing.
• If a demand is made by the Notification Time, then
Transfers are made no later than close of business
on the next Local Business Day.
• If a demand is made after the Notification Time,
Transfers are made no later than the second Local
Business Day.
20
Transfer Timing
• Paragraph 4(b): Transfer Timing (cont.)
• Practice Notes:
• Notification Time elected by the parties in Paragraph 13
(e.g., 1:00 p.m. EST on any Local Business Day).
• No distinction between various types of Eligible Credit
Support elected in Paragraph 13, including Letters of
Credit.
• Operational Concerns: While Cash may be Transferred
quickly, what about LOC issuances and amendments?
• Does your company need to increase Transfer timing to
avoid breach?
21
Calculations of Value and Exposure
• Paragraph 4(c): Calculations. All calculations of
Value and Exposure will be made by the Valuation
Agent as of the Valuation Time.
• Practice Notes:
•
•
Valuation Agent and Valuation Time specified in
Paragraph 13.
Ensures there is no gaming or manipulation of the
snapshot of index prices used to calculate Exposure, as
such amount may fluctuate throughout the day.
• Note that if the Valuation Agent is always your
counterparty, you are at their mercy.
22
Substitutions of Collateral
• Paragraph 4(d): Substitutions.
• Generally, Pledgor may Transfer substitute Eligible Credit
Support (“Substitute Credit Support”) to the Secured Party
on any Local Business Day by providing notice.
• The Secured Party then Transfers the Posted Credit
Support being replaced back to the Pledgor no later than
the Local Business Day following the date it receives the
Substitute Credit Support (the “Substitution Date”).
23
Substitutions of Collateral
• Practice Notes:
• Substitution terms often amended in the Paragraph 13
elections:
• Secured Party’s consent for any substitution?
• Eliminating the notice requirement?
• Often used by Pledgor to increase liquidity by substituting
a less liquid form of Eligible Credit Support (e.g., Letter of
Credit) for previously-posted Cash.
• The substituted collateral must be a type of Eligible Credit
Support agreed upon by the parties in the Paragraph 13
elections.
24
Dispute Resolution
• Paragraph 5: Dispute Resolution: How can disputes
arise?
•
Calculation of Delivery/Return Amount
• What amount of collateral is a party obligated to deliver
or return?
•
Value of Eligible Credit Support or Posted Credit Support
• What is the Value of the collateral being posted or held?
• May arise when dealing with fluctuating collateral, e.g.
securities.
25
Dispute Resolution
• Paragraph 5: Dispute Resolution (cont.): Procedure
for resolving disputes:
•
Disputing Party gives notice by close of business on the
Local Business Day following the date of the demand or
Transfer (as applicable);
•
The appropriate party will Transfer the undisputed
amount no later than the close of business on the Local
Business Day following the date of the demand or
Transfer (as applicable); and
•
The parties will attempt to resolve the dispute informally.
26
Dispute Resolution
• Paragraph 5: Dispute Resolution: Procedure for
resolving disputes (cont.):
•
If the parties fail to resolve the dispute by the Resolution
Time (elected in Paragraph 13), then:
• For disputes regarding Delivery/Return Amount: The
Valuation Agent will recalculate using undisputed
calculations or mid-market quotations from Reference
Market makers.
• For disputes regarding the Value of collateral: The
Valuation Agent will recalculate the Value as of the date of
the Transfer in the manner set forth in the Paragraph 13
elections.
27
Holding and Using Posted Collateral
• Paragraph 6(a): Care of Posted Collateral.
•
Secured Party is required to exercise reasonable
care to assure safe custody of Posted Collateral,
which means the same degree of care the Secured
Party would use as to its own property.
•
Note that “Posted Collateral” is defined by the
parties in Paragraph 13.
• Typically means Cash.
28
Holding and Using Posted Collateral
• Paragraph 6(b): Eligibility to Hold Posted
Collateral; Custodians:
•
The Secured Party generally may hold Posted Collateral
or appoint a Custodian to hold Posted Collateral.
•
In Paragraph 13, most parties elect specific requirements
and conditions to holding Posted Collateral:
• Not a Defaulting Party
• Only held in the U.S.
• Ratings triggers
29
Holding and Using Posted Collateral
• Paragraph 6(b): Eligibility to Hold Posted
Collateral; Custodians:
•
Why Use a Custodian?
• Usually only preferred when a party doesn’t meet the
conditions to holding Posted Collateral
• Paragraph 13 generally requires that a Custodian be a
“Qualified Institution” by meeting some form of credit
rating and asset standards.
• Custodians take time to establish and can be expensive.
► Dodd Frank Note: Under the Act, a counterparty could
unilaterally require a Custodian irrespective of the CSA.
30
Holding and Using Posted Collateral
• Paragraph 6(c): Use of Posted Collateral.
•
If the Secured Party is not a Defaulting Party or an Affected
Party and no Early Termination Date has occurred, then the
Secured Party has the right to sell, invest, assign, commingle
or otherwise dispose of any Posted Collateral.
•
However, the Secured Party shall be deemed to be holding
such Posted Collateral for purposes of calculating
Delivery/Return Amounts and Disputed Amounts.
► Dodd Frank Note: The Act could restrict a party’s ability to
hold and use Posted Collateral.
31
Holding and Using Posted Collateral
• Paragraph 6(c): Use of Posted Collateral.
•
Practice Notes:
• Rehypothecation of collateral is an important right
that is generally favored.
• In light of recent credit downgrades across the
industry, some counterparties may limit the ability of
a Secured Party to rehypothecate Cash and instead
require the safekeeping of Posted Collateral in a
segregated collateral account.
32
Holding and Using Posted Collateral
• Paragraph 6(d): Interest Amounts.
•
•
•
The Secured Party shall Transfer to the Pledgor the
Interest Amount with respect to Posted Collateral at the
time designated in Paragraph 13, so long as a Delivery
Amount would not be created or increased by such
Transfer.
Any Interest Amount not Transferred shall constitute
Posted Collateral.
Practice Note: The Transfer of the Interest Amount is
negotiated between the parties, usually on a monthly
basis.
33
Events of Default
• Paragraph 7: Events of Default: An Event of
Default occurs under Section 5(a)(iii)(1) (“Credit
Support Default”) of the Agreement if:
•
A party (or its Custodian) fails to make any Transfer of
Eligible Collateral, Posted Collateral or Interest Amount
when required if not cured within two (2) Local Business
Days after receiving notice of same.
34
Events of Default
• Paragraph 7: Events of Default: An Event of
Default occurs under Section 5(a)(iii)(1) (“Credit
Support Default”) of the Agreement if:
•
A party fails to comply with Paragraph 6(c) (“Use of
Posted Collateral”) if not cured within five (5) Local
Business Days after receiving notice of same.
•
A party fails to comply with any other obligation under
the Annex (not otherwise a separate Event of Default) if
not cured within thirty (30) days after receiving notice of
such failure.
35
Events of Default
• Paragraph 7: Events of Default: Any default under
Paragraph 7 of the CSA is an Event of Default under
Section 5(a)(iii) of the Master Agreement:
•
•
•
Right to suspend payments and performance under
Section 2(a)(iii) of the Master Agreement.
Right to suspend Transfers of Eligible Credit Support
under Paragraph 4(a) of the CSA.
Right to designate an Early Termination Date and
liquidate all Transactions under the ISDA.
36
Certain Rights and Remedies
Paragraph 8(a): Secured Party’s Rights and Remedies.
• When do Secured Party’s rights arise?
•
Event of Default as to Pledgor
•
Specified Condition as to Pledgor, or
• Practice Note: “Specified Conditions” are
Termination Events elected by the parties in
Paragraph 13.
•
The occurrence or designation of an Early Termination
Date with respect to the Pledgor
37
Certain Rights and Remedies
Paragraph 8(a): Secured Party’s Rights and Remedies.
• What rights are available? Unless Pledgor has paid all
Obligations then due, Secured Party may exercise any of the
following remedies:
•
•
All remedies available under applicable law;
Any rights and remedies under Other Posted Support
• E.g., Drawing on outstanding Letters of Credit
•
•
Setoff of amounts payable by Pledgor against Posted
Collateral held by Secured Party; or
Liquidate Posted Collateral and apply proceeds to any
Obligations owed by Pledgor.
38
Certain Rights and Remedies
Paragraph 8(b): Pledgor’s Rights and Remedies.
• When do Pledgor’s rights arise?
•
The occurrence or designation of an Early Termination
Date arising from an Event of Default or Specified
Condition with respect to the Secured Party.
•
Practice Note: Pledgor’s rights do not arise until the
occurrence or designation of an Early Termination
Date—not merely upon the occurrence of an Event of
Default or Specified Condition.
39
Certain Rights and Remedies
Paragraph 8(b): Pledgor’s Rights and Remedies.
• What rights are available? Unless Secured Party has paid all
Obligations then due, the following shall apply:
•
•
Pledgor can exercise all remedies available under applicable
law.
Pledgor can exercise any rights and remedies under Other
Posted Support.
• E.g., Drawing on outstanding Letters of Credit
•
Secured Party is obligated to immediately Transfer all Posted
Collateral back to the Pledgor.
40
Certain Rights and Remedies
Paragraph 8(b): Pledgor’s Rights and Remedies.
• What rights are available? Unless Secured Party has paid all
Obligations then due, the following shall apply (cont.):
•
If Secured Party does not Transfer back all Posted Collateral to
Pledgor, then Pledgor may:
• Set-Off amounts payable by Pledgor against any Posted
Collateral held by the Secured Party; and
• If amounts are not Set-Off, withhold payment of amounts
due up to the Value of Posted Collateral until such Posted
Collateral is returned.
41
Certain Rights and Remedies
Paragraphs 8(a) and 8(b): Rights and Remedies
• Practice Notes:
•
These sections recognize that the Non-Defaulting or NonAffected Party should have the right to protect its
collateral if the other party defaults.
•
Rights are different depending on whether the Pledgor or
Secured Party defaults, but both sets of rights and
remedies are equally important to protect a party’s Posted
Credit Support.
42
Certain Rights and Remedies
• Paragraph 8(c): Deficiencies and Proceeds. Secured Party
must Transfer to Pledgor any proceeds and Posted Credit
Support remaining after liquidation, Set-Off and/or application
of funds after all amounts payable are satisfied in full.
•
Pledgor remains liable for any unpaid amounts.
• Paragraph 8(d): Final Returns. When no amounts may
become payable by Pledgor with respect to Obligations under
the ISDA, Secured Party will Transfer all Posted Credit
Support and Interest Amounts back to the Pledgor.
43
Representations
• Paragraph 9: Representations. Each Party represents the
following on the date the CSA is executed and each date the
Pledgor transfers Eligible Collateral:
•
It has the power to grant a security interest and lien on the
Eligible Collateral and has taken all necessary actions to
effect same;
•
It is the sole owner of the Eligible Collateral it Transfers,
and it Transfers such Eligible Collateral free and clear of
liens or other encumbrances;
44
Representations
• Paragraph 9: Representations. Each Party represents the
following on the date the CSA is executed and each date the
Pledgor transfers Eligible Collateral (cont.):
•
Upon a Transfer, the Secured Party will have a valid and
perfected first priority security interest and lien on the
Eligible Collateral; and
•
The performance of its obligations under the CSA will
not result in any other security interest, lien or
encumbrance other than provided to the Secured Party.
45
Costs and Expenses
• Paragraph 10(a): General. Each Party generally
pays for its own expenses in performing its
obligations under the CSA.
• Paragraph 10(b): Posted Credit Support. The
Pledgor shall promptly pay all taxes or charges
imposed with respect to Posted Credit Support held
by the Secured Party upon becoming aware of same
(except taxes with respect to the Secured Party’s use
of Posted Collateral).
46
Costs and Expenses
• Paragraph 10(c): Liquidation/Application of Posted
Credit Support.
•
All reasonable costs and expenses incurred in
connection with the liquidation and/or
application of Posted Credit Support shall be
payable either by the Defaulting Party, or if there
is no Defaulting Party, equally shared by the
parties.
47
Additional CSA Obligations
• Paragraph 11(a): Default Interest. If Secured Party
fails to make any Transfer of Posted Collateral or
Interest Amount, such amount shall accrue interest at
the Default Rate from the date such amount was
required to be Transferred until the date actually paid.
• Practice Note:
• Note that the Default Rate under the ISDA is a
penalty rate, with a higher rate than is paid for
interest on Cash held as Posted Collateral.
48
Additional CSA Obligations
• Paragraph 11(b): Further Assurances. Upon demand by a party,
the other party shall execute or deliver any financing statement,
specific assignment or other document that may be necessary or
desirable with respect to creating, perfecting, enforcing and/or
releasing any security interest or lien granted under the Annex.
• Practice Notes:
•
Beware of language granting to counterparty a power of
attorney to execute security documents on your company’s
behalf.
•
While permitted by Article 9 of the UCC, most companies
require a board resolution or other corporate action to grant a
power of attorney.
49
Additional CSA Obligations
• Paragraph 11(c): Further Protection. Pledgor will
give notice to the Secured Party of, and defend
against, any suits, actions or proceedings relating to
Posted Credit Support Transferred by the Pledgor or
that could adversely affect the security interest and
lien granted under the CSA (unless such suit or action
results from Secured Party’s exercising its rights to
use Posted Collateral).
50
Additional CSA Obligations
• Paragraph 11(d): Good Faith and Commercially
Reasonable Manner.
•
Performance of all obligations and calculations
under the Annex shall be made in good faith and
in a commercially reasonable manner.
51
Discussion Topics
• Overview of the CSA
• Key Provisions of the CSA
• Paragraph 13 to the CSA
• Credit Implications of Dodd-Frank
52
Paragraph 13 Elections & Variables
• 13(b)(ii): Eligible Collateral.
•
Paragraph 13 permits the parties to specify which forms
of collateral shall constitute “Eligible Collateral” under
the Annex, as well as the applicable Valuation Percentage
used in determining the Value of such collateral.
• Practice Note:
•
Most energy commodity counterparties elect for Cash to
qualify as Eligible Collateral, but do not elect for
Treasury Bills, Notes or Bonds.
53
Paragraph 13 Elections & Variables
• 13(b)(iii): Other Eligible Support.
•
Paragraph 13 permits the parties to specify what
collateral may constitute “Other Eligible Support” apart
from any Eligible Collateral.
• Practice Note:
•
Many parties elect for Letters of Credit to constitute
“Other Eligible Support” and provide that the Valuation
Percentage shall be 100% unless (i) an Event of Default
occurs and is continuing, or (ii) fewer than 20 days
remain before expiry of the Letter of Credit, in which
case the Valuation Percentage shall be zero (0).
54
Paragraph 13 Elections & Variables
• 13(b)(iv): Threshold.
•
•
•
Each party specifies its applicable “Independent
Amount”, “Threshold” and “Minimum Transfer Amount”
used in determining its applicable Credit Support Amount
under Paragraph 3.
Such designations are important because they directly
affect whether a party is required to post collateral to the
Secured Party.
The parties also may specify the amount by which
calculations under the CSA will be rounded up or down.
55
Paragraph 13 Elections & Variables
• 13(b)(iv)(A): Independent Amount. Similar to a minimum
collateral amount that a party must maintain at all times under
the Agreement.
• Practice Notes:
• An Independent Amount is in addition to Exposure, so it
effectively represents the amount by which the party
posting an Independent Amount will over-collateralize its
obligations.
• Any request for an Independent Amount should be
reviewed by a party’s credit group.
56
Paragraph 13 Elections & Variables
• 13(b)(iv)(B): Threshold: Directly offsets a party’s obligation
to Transfer a Delivery Amount or Return Amount.
•
•
•
The amount of a party’s Threshold is heavily negotiated
between the parties’ credit departments.
A party that is more creditworthy may receive a higher
Threshold, while a party that is less creditworthy may
receive a lower Threshold.
Thresholds may be a fixed dollar amount, but more
commonly are set forth in a Threshold matrix where
Threshold amounts vary based on a party’s (or its Credit
Support Provider’s) credit rating.
57
Paragraph 13 Elections & Variables
• 13(b)(iv)(C): “Minimum Transfer Amount”: A Delivery
Amount must equal or exceed a Pledgor’s Minimum Transfer
Amount before the Pledgor is required to Transfer collateral.
• 13(b)(iv)(D): “Rounding”: The parties may specify the dollar
amount by which calculated values will be rounded up or
down.
• Practice Notes:
• MTA and Rounding Amounts can be amended to make
collateral obligations more or less onerous.
• Avoid making the MTA and Rounding Amounts identical.
58
Paragraph 13 Elections & Variables
• 13(c): Valuation and Timing.
•
13(c)(i): Valuation Agent.
• Generally, the Valuation Agent is the party making a
demand under Paragraph 3, but the parties may
amend this requirement.
• The Valuation Agent is the party calculating the
Delivery or Return Amount under Paragraph 3 of the
Annex.
59
Paragraph 13 Elections & Variables
• 13(c): Valuation and Timing.
•
13(c)(ii): Valuation Date.
• The parties specify in Paragraph 13 what date shall
constitute a “Valuation Date” for purposes of
determining whether a Delivery Amount or Return
Amount is due.
• Parties often elect that the Valuation Date shall be
each Local Business Day, requiring the parties to
daily monitor whether a Delivery Amount or Return
Amount is due.
60
Paragraph 13 Elections & Variables
• 13(c): Valuation and Timing.
•
13(c)(iii): Valuation Time.
• The parties may select the time when the Delivery
Amount or Return Amount shall be calculated, either:
• By close of business on the Valuation Date, or
• By close of business on the Local Business Day
before the Valuation Date.
61
Paragraph 13 Elections & Variables
• 13(c): Valuation and Timing.
•
13(c)(iv): Notification Time. The parties designate the
time by which a demand for a Transfer may be made
under Paragraph 3.
• When designating the Notification Time, consider how
quickly you can Transfer Cash, issue Letters of Credit or
provide other Eligible Credit Support.
• The CSA’s standard Transfer timing is (i) the next Local
Business Day if demand made by Notification Time, or
(ii) second Local Business Day if after the Notification
Time.
62
Paragraph 13 Elections & Variables
• 13(d): Conditions Precedent and Secured Party’s Rights and
Remedies.
•
The parties may specify certain Termination Events which
shall qualify as “Specified Conditions” with respect to either
party under the CSA.
•
Specified Conditions arise when parties desire to exercise
remedies under Paragraphs 8(a) and 8(b).
•
Because Specified Conditions give rise to collateral rights,
consider whether it makes sense for only select Termination
Events to be “Specified Conditions”.
• E.g., Credit Event Upon Merger
63
Paragraph 13 Elections & Variables
• 13(e): Substitution.
• The parties specify in Paragraph 13 whether the
“Substitution Date” has the meaning specified in the CSA
or whether the parties wish to amend such definition.
• “Substitution Date” generally means the Local
Business Day following the date on which the
Secured Party receives the Substitute Credit Support
from the Pledgor.
•
The parties also may amend the general requirement that
consent is required for providing substitute Credit
Support.
64
Paragraph 13 Elections & Variables
• 13(e): Substitution.
• Practice Notes:
• Allowing substitution without consent should
generally be acceptable, so long as Cash and Letters
of Credit are the only forms of Eligible Credit
Support elected under the CSA.
• If other forms of Eligible Credit Support are
permitted, substitution without consent should not be
permitted.
65
Paragraph 13 Elections & Variables
• 13(f): Dispute Resolution.
• The default “Resolution Time” is 1:00 p.m. New York
time on the Local Business Day following the date on
which notice is given that gives rise to a dispute.
• However, the parties may elect to extend the Resolution
Time in order to allow sufficient time to work together in
resolving the dispute before other remedies are necessary.
• The parties also can specify the methods of valuing
Posted Credit Support and the dispute resolution
procedures in the event a party disputes a calculation.
66
Paragraph 13 Elections & Variables
• 13(g): Holding and Using Posted Collateral
• 13(g)(i): Eligibility to Hold Posted Collateral;
Custodians.
• Paragraph 13 generally provides that a party or its
Custodian may hold Posted Collateral provided that:
• Such party is not a Defaulting Party;
• Posted Collateral only may be held in a jurisdiction
specified by the parties (generally, the U.S.);
• Any other terms or conditions the parties may require
in holding collateral, such as minimum credit ratings
or other creditworthiness standards.
67
Paragraph 13 Elections & Variables
• 13(g): Holding and Using Posted Collateral
•
13(g)(ii): Use of Posted Collateral.
• The parties may specify whether or not Paragraph 6(c)
applies to either party such that Posted Collateral may be
sold, assigned, commingled or otherwise disposed of by
the Secured Party.
•
Practice Note: Many parties elect that Paragraph 6(c) shall
apply because (i) such parties want to use Cash posted to them;
and (ii) a Pledgor can avoid a Secured Party commingling
Cash and potentially not returning it by providing a Letter of
Credit as an alternative.
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Paragraph 13 Elections & Variables
• 13(h): Distributions and Interest Amount. The parties specify
in Paragraph 13 the “Interest Rate” to be used under the
Annex, the timing of Transfers of the Interest Amount
(generally the last Local Business Day of each calendar
month), and whether Transfers of the Interest Amount by the
Secured Party shall apply under the Annex pursuant to
Paragraph 6(d)(ii).
• 13(i): Additional Representations. The parties may
incorporate any additional representations into the Annex apart
from those set forth in Paragraph 9 of the Annex.
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Paragraph 13 Elections & Variables
• 13(j): Other Eligible Support and Other Posted Support.
•
Paragraph 13 permits the parties to define how to
calculate the “Value” of Other Eligible Support and Other
Posted Support, as well as what constitutes a “Transfer”
of same.
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Paragraph 13 Elections & Variables
• 13(j): Other Eligible Support and Other Posted Support.
• Practice Notes:
• Because Other Eligible Support or Other Posted Support
generally refers to forms of collateral other than cash, it
may be beneficial to designate how such collateral is
valued and transferred under the Annex.
• For example, with respect to a letter of credit that
constitutes Other Eligible Support, the Value of the Letter
of Credit may not always be 100% of the stated value if
certain conditions exist (e.g., the Letter of Credit expires
within 20 days, etc.).
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Paragraph 13 Elections & Variables
• 13(j): Other Eligible Support and Other Posted Support.
• Practice Notes (cont.):
• Any terms or conditions that affect the Value of such
Letter of Credit would be included in Paragraph 13.
• Moreover, a “Transfer” of amounts with respect to a
Letter of Credit does not necessarily mean a drawing of
funds. Instead, a “Transfer” likely means increasing or
decreasing the stated value of the Letter of Credit
depending on the applicable Delivery Amount or Return
Amount to be Transferred.
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Paragraph 13 Elections & Variables
• 13(m): Other Provisions. The parties may incorporate
additional credit terms and conditions that apply to the CSA.
•
Additional definitions:
• E.g., “Letter of Credit”, “Qualified Institution”,
“Credit Rating”.
•
Changes to Transfer timing:
• E.g., Increasing the time for Pledgor to issue or
amend a Letter of Credit.
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Discussion Topics
• Overview of the CSA
• Key Provisions of the CSA
• Paragraph 13 to the CSA
• Credit Implications of Dodd-Frank
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Credit Implications of Dodd-Frank
• Clearing Requirements:
•
If a Swap is required to be cleared and the counterparty is
not a Major Swap Participant (“MSP”) or Swap Dealer
(“SD”), such counterparty has the right to select the
Derivative Clearing Organization (“DCO”) used for
clearing.
•
If a Swap is not required to be cleared and the relevant
counterparty is not an MSP or SD, such counterparty has
the right to:
• Require that the parties clear the Swap; and
• Select the DCO used for clearing.
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Credit Implications of Dodd-Frank
• Clearing Requirements: PRACTICE NOTES:
• The general mandatory clearing requirement is not specific
to MSPs or SDs—it could apply to any party to a Swap.
• Non-MSPs or Non-SDs should confirm whether the EndUser Exception applies.
• Whether a Swap or category of Swaps is required to be
cleared is a moving target subject to CFTC determination.
• Parties will need to monitor ongoing CFTC rulemakings.
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Credit Implications of Dodd-Frank
• Clearing Requirements: PRACTICE NOTES (cont.):
• Special clearing rules apply when dealing with Non-MSPs
or Non-SDs
• Even if Swap is not required to be cleared, clearing still may
apply.
• MSPs and SDs may be required to use different DCOs than
they otherwise would select, depending on the election of
the counterparty.
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Credit Implications of Dodd-Frank
• Clearing Requirements: End-User Exception:
• Generally: A Swap otherwise subject to mandatory
clearing is subject to an elective exception from clearing if:
• At least one party to the Swap is not a Financial Entity;
• Such party is using the Swap to hedge or mitigate
commercial risk; and
• Notice is provided to the CFTC regarding how it
generally meets its financial obligations associated
with entering into non-cleared Swaps.
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Credit Implications of Dodd-Frank
• Segregation of Collateral Securing Uncleared Swaps:
• Just because a Swap is not subject to mandatory clearing does not
mean that an MSP/SD is “off the hook”:
• Notice requirement disclosing segregation election;
• Potential segregation/custodian obligations; and
• Even if segregation not elected, quarterly reporting.
• Use of custodian and segregated account create additional costs
that currently are not allocated by the CFTC’s Proposed Rules.
• It seems reasonable that such costs would be borne by the
counterparty electing segregation, but the CFTC has not finalized
this issue.
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Credit Implications of Dodd-Frank
• Reporting and Recordkeeping: Key Requirements:*
A. § 727: Real-Time Public Reporting
B. § 729: Reporting and Recordkeeping (SDRs)
C. § 731: Reporting and Recordkeeping (CFTC)
• *Note that additional reporting obligations may apply to MSPs and SDs
under the Clearing Transition Rules of § 723 of the Act.
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Credit Implications of Dodd-Frank
• Capital and Margin Requirements:
• § 731: General Rule: SDs and MSPs must meet minimum capital
requirements and minimum initial and variation margin requirements
as the CFTC shall determined by rule or regulation.
• Capital Requirements:
• The CFTC shall take into account any risks associated with other
types of Swaps the SD/MSP is engaged in and other activities of
the SD/MSP that are not otherwise subject to regulation.
• The capital requirements established by the CFTC shall (i) help
ensure the safety and soundness of the SD or MSP; and (ii) be
appropriate for the risk associated with the uncleared Swaps held
by the SD or MSP.
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Credit Implications of Dodd-Frank
• Capital and Margin Requirements (cont.):
• The CFTC shall permit the use of non-cash collateral, if
appropriate to (i) preserve the financial integrity of markets
trading Swaps; and (ii) preserve the stability of the U.S.
financial system.
• PRACTICE NOTES:
• It does not seem clear what specific types of collateral the
CFTC will permit to satisfy margin requirements. Letters
of Credit? First liens?
• If collateral exchanged under a trading agreement is not a
type permitted by the CFTC, trading counterparties may
need to amend their collateral obligations.
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Credit Implications of Dodd-Frank
• Key Points to Consider:
• The most important determination is whether a party
qualifies as an MSP or SD.
• Most CFTC requirements hinge on that analysis.
• If you qualify as an MSP or SD, you will be subject to
numerous, detailed requirements that significantly impact
your business operations and trading agreements:
•
•
•
•
Mandatory clearing
Capital and margin requirements
Reporting and recordkeeping requirements
Position limits
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Understanding the CSA: Conclusion
• The CSA and accompanying Paragraph 13 should be carefully
reviewed by a company’s Credit Group.
• When negotiating the CSA and Paragraph 13, keep in mind the
ISDA Schedule and the various types of Transactions
anticipated under the ISDA (e.g., physical deals under a
commodity annex, financial derivative transactions, etc.).
• The CSA and Paragraph 13 should be tailored to each
counterparty, as there is no “one size fits all” approach.
• The Dodd-Frank Act may significantly impact rights and
obligations under the CSA.
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Questions?
CRAIG ENOCHS
(713) 752-4315
cenochs@jw.com
KEVIN PAGE
(713) 752-4227
kpage@jw.com
JACKSON WALKER L.L.P.
1401 McKinney Street, Suite 1900
Houston, Texas 77010
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