8th Annual Gas & Power Institute
September 10-11, 2009
ISDA and its Commodity Annexes:
The New EEI or NAESB?
Craig R. Enochs
Craig R. Enochs
cenochs@jw.com
Jackson Walker L.L.P.
1401 McKinney, Suite 1900
Houston, Texas 77010
(713) 752-4200 phone
1
Issues

Are the ISDA Gas and Power Annexes
becoming more widely-used than the NAESB
and EEI?

Why use the ISDA Gas and Power Annexes
instead of the NAESB and EEI?

What are the “gap risks” between the ISDA
Gas and Power Annexes, the NAESB and
the EEI?
2
Use of the ISDA Commodity Annexes: A
Growing Trend

ISDA originally intended for use with financial
products


Drafted by bankers and lawyers in New York and London
to standardize derivative transactions
In the last few years, the ISDA has gained
popularity in the energy industry because of
the publication of various commodity
annexes

Power Annex (2003), Gas Annex (2004), Emissions
Allowance Annex (2006), Coal Annex (2007), Crude Oil
Annex (2008)
3
ISDA Gas Annex and the NAESB
Joint Effort:



After NAESB published in 2002, ISDA and NAESB
worked together in creating the Gas Annex
Gas Annex published by ISDA in 2004
Similar Provisions:



Gas Annex closely follows the NAESB’s provisions
relating to the purchase and sale of physical gas
Clauses (b) through (g), (h) and (i) of the Gas Annex
are similar to Sections 3 through 8, 11 and 13 of the
2002 NAESB, respectively
4
ISDA Power Annex and the EEI
Joint Effort:



After EEI Master Agreement published in 2000,
ISDA and EEI worked together in creating the
Power Annex
Power Annex published by ISDA in 2003
Similar Provisions:



Power Annex closely follows the EEI’s provisions
relating to the purchase and sale of physical power
Clauses (b)-(c), (d)-(e), (f) and (g) of the Power
Annex are similar to Articles 3-4, 6-7, 9 and
Sections 10.3-10.4 of the EEI Master Agreement,
respectively
5
Why Use the ISDA Instead of
the NAESB or EEI?

Trade various energy commodities under a
single agreement by using the ISDA
Annexes



Net credit exposures across transactions and
products
Single agreement setoff rights in bankruptcy
Payment netting across transactions and
products
6
Why Use the ISDA Instead of
the NAESB or EEI? (cont.)

Streamlines negotiation and documentation
process

Once ISDA Master Agreement and Schedule
are in place, fairly simple to added Gas and/or
Power Annex.
7
Sources of Gap Risk in ISDA,
NAESB and EEI

Though similar to the NAESB and EEI, the
Gas and Power Annexes (respectively) are
not exclusive agreements



Annexes form only part of entire ISDA
agreement
Contain only those provisions necessary to
implement purchase/sale and delivery of gas
and power
E.g., delivery/receipt, scheduling, title, force
majeure
8
Sources of Gap Risk in ISDA,
NAESB and EEI (cont.)

ISDA Master Agreement, Schedule and
Credit Support Annex (as applicable) govern
all transactions under Gas and Power
Annexes


Provisions not specifically related to physical
commodities, but still applicable to gas and
power transactions
E.g., events of default, termination and
settlement, credit provisions, notices,
confirmation procedures
9
Sources of Gap Risk in ISDA,
NAESB and EEI (cont.)

Common reasons for gap risk across trading
agreements:
ISDA, NAESB and/or EEI with same
counterparty at the same time


ISDA, NAESB and/or EEI with different
counterparties at the same time



E.g., ISDA for new transactions with Counterparty A, and
NAESB/EEI for existing transactions with Counterparty A
E.g., ISDA for all transactions with Counterparty A, and
NAESB/EEI for all transactions with Counterparty B.
To mitigate gap risk, must be aware of
differences across agreements.
10
Gap Risks in the
NAESB, EEI and ISDA
A.
B.
C.
D.
E.
F.
G.
Confirmation Procedures
Netting
Notices
Credit Obligations
Events of Default & Termination Event
Termination, Liquidation and Settlement
Setoff
11
A. Confirmation Procedures
1. NAESB § 1.2: Procedure elected on Cover Sheet

Oral Transaction Procedure



Transaction is binding when parties orally agree upon
terms
Failure to send Transaction Confirmation does not affect
performance obligations
Written Transaction Procedure

Parties must exchange non-conflicting Transaction
Confirmation before parties legally obligated to perform
12
A. Confirmation Procedures
2. EEI § 2.3

Parties evidence a transaction by exchanging a
written Confirmation



Seller provides Confirmation to Buyer (or if Seller fails to
provide, then Buyer may send)
Similar to a written transaction procedure
Failure to send or return an executed Confirmation
does not invalidate the oral transaction agreed-upon
by the parties

Similar to oral transaction procedure under NAESB
13
A. Confirmation Procedures
3. Gas and Power Annexes: ISDA Master § 9(e)(ii)

Parties legally bound from the moment they agree on
commercial terms

Confirm transaction terms by sending written
Confirmations

No other specific terms or procedures in Master
Agreement, Gas Annex or Power Annex
14
A. Confirmation Procedures
4. NAESB, EEI and ISDA: Risk Analysis

Confirmation procedures should conform to risk in
underlying transactions
 Short-term v. Long-term
 Risk of disagreement regarding future performance
obligations
 Operational Risk in Confirming Transactions
 Seller confirms in NAESB and EEI, but ISDA does not specify
 Inconsistent Dispute Resolution Procedures
 NAESB v. EEI v. ISDA
15
B. Netting
1. NAESB § 7.7

All payments due and owing (or past due and owing)
netted into single amount

The party owing the greater amount shall make a
single payment to the other party

Not limited to amounts owed under a single
transaction
16
B. Netting
2. EEI § 6.4

All payments owed by each party in a monthly billing
period are netted into single amount

The party owing the greater amount makes a single
payment to the other party

Netting applies across all transactions
17
B. Netting
3. Gas and Power Annexes: ISDA Master § 2(c)

Netting generally limited to amounts due (i) on the
same date; (ii) in the same currency; and (iii) in
respect of the same Transaction

Often modified by the parties in the ISDA Schedule
18
B. Netting
4. Risk Analysis

Inconsistent netting provisions across multiple
agreements may create cash flow and operational
risks



Incorrect calculations on invoices
Incorrect payments to counterparty
Cross-Transactional Netting

NAESB v. EEI v. ISDA
19
C. Notices
1. NAESB § 9.2

Methods: Fax, mutually-accepted electronic means, overnight
courier, first class mail or hand delivery

General Rule: deemed delivered when received on a Business
Day

If no proof of actual receipt, the following presumptions apply:

Fax: deemed delivered when sending party receives fax machine’s
confirmation of successful transmission. If after 5:00 p.m., deemed
received the following Business Day

Overnight Courier or Mail: deemed delivered on following Business
Day after sent, or earlier if confirmed by receiving party

First Class Mail: deemed delivered five (5) Business Days after
mailing
20
C. Notices
2. EEI § 10.7
 Fax or Hand Delivery:
 If received during business hours on a Business Day, notice
deemed effective at the close of business on such day
 If received after business hours, deemed effective at close of
business on following Business Day
 Overnight Courier or U.S. Mail:
 Deemed effective on the following Business Day after sent
21
C. Notices
3. Gas and Power Annexes: ISDA Master § 12(a)

Writing/Hand Delivery: effective on date delivered

Fax: effective on date received by responsible recipient in
legible form

Proof of receipt is on sending party and cannot be proven through
fax confirmation

Certified or Registered Mail: effective on date delivered (or
delivery is attempted)

Electronic Messaging System: effective on date received

Email (2002 ISDA): effective on date delivered
22
C. Notices
3. Gas and Power Annexes: ISDA Master § 12(a)
(cont.)

If notice (i) not delivered on Local Business Day, or (ii) is
delivered after close of business, notice deemed delivered on
following Local Business Day

Notices relating to Events of Default or Termination Events may
not be sent by electronic messaging system (1992/2002), fax
(1992) or email (2002 ISDA).
23
C. Notices
4. Risk Analysis
 Operational Risk:
 Various methods of notice permitted in trading contracts
 Ex: ISDA contemplates electronic means, including email
(2002 ISDA), but EEI does not contemplate electronic means
unless otherwise elected by the parties
 Inconsistent notice provisions across trading agreements
 More likely that manner or method of notice may be insufficient
24
C. Notices
4. Risk Analysis (cont.)
 Credit and Payment Risk:
 Ineffective notice may create credit risk as to a defaulting
counterparty:
 Ex: ISDA does not allow electronic means (1992/2002), fax
(1992) or email (2002) notices with respect to Events of Default
or Termination Events
 If notice is ineffective, Non-Defaulting Party cannot declare an
Early Termination Date
 Parties should consider consistent notice provisions across
trading contracts
25
D. Credit Obligations
1. NAESB § 10.1

Either party can demand Adequate Assurance of
Performance if it has “reasonable grounds for
insecurity” regarding other party’s performance

“Reasonable grounds for insecurity” not defined in
NAESB, except that it includes a “material change in
creditworthiness”

Only credit provision in NAESB apart from any CSA
incorporated into the Contract
26
D. Credit Obligations
2. EEI §§ 8.1 and 8.2: Elected on Cover Sheet

Credit Assurances (8.1(b) and 8.2(b))


Collateral Threshold (8.1(c) and 8.2(c))


Can demand Performance Assurance upon “reasonable
grounds” for believing that Party’s creditworthiness or
performance is unsatisfactory
Threshold margining, similar to Collateral Annex
Downgrade Event (8.1(d) and 8.2(d))


Parties can demand Performance Assurance upon the
occurrence of a “Downgrade Event”
Downgrade Event defined by the Parties on the Cover
Sheet
27
D. Credit Obligations
3. ISDA Gas and Power Annexes:

No credit provisions in the Master Agreement or
Commodity Annexes

Parties generally rely on threshold margining under
the ISDA CSA
4. Risk Analysis:


Inconsistent credit requirements across agreements
(e.g., Adequate Assurances under NAESB v.
margining under ISDA)
Benefit of ISDA: netting of exposures across
products to minimize collateral obligations
28
E. Events of Default &
Termination Events
1. NAESB v. ISDA Gas Annex

Common Events of Default: NAESB § 10.2; ISDA § 5(a)




Failure to pay when due
Breach of credit obligations
Insolvency and bankruptcy-related events
Events of Default in ISDA not found in NAESB:





Breach of Agreement (other than failure to pay)
Misrepresentations
Default under Specified Transaction
 Similar to Transactional Cross Default election in 2006 NAESB
Cross Default
 Similar to Indebtedness Cross Default election in 2006 NAESB
Merger Without Assumption
29
E. Events of Default &
Termination Events
1. NAESB v. ISDA Gas Annex (cont.)

Termination Events in ISDA not found in NAESB:





Illegality
Force Majeure Event (2002)
Tax Event and Tax Event Upon Merger
Credit Event Upon Merger
Additional Termination Event
30
E. Events of Default &
Termination Events
2. EEI v. ISDA Power Annex

Common Events of Default: EEI § 5.1 and ISDA § 5(a):

Failure to pay when due

False or misleading representations

Breach of Agreement (other than failure to pay)

Insolvency and bankruptcy-related events

Breach of credit obligations

Merger without assumption

Cross Default
31
E. Events of Default &
Termination Events
2. EEI v. ISDA Power Annex (cont.)

Events of Default and Termination Events in ISDA not found in
EEI:

Default under Specified Transaction

Illegality

Force Majeure Event (2002 ISDA)

Tax Event and Tax Event Upon Merger

Credit Event Upon Merger

Additional Termination Event
32
E. Events of Default &
Termination Events
3. Automatic Early Termination under ISDA

How it works:
 Upon occurrence of certain bankruptcy events, an Early Termination
Date is deemed to occur
 Parties do not follow Early Termination Date notice procedures
 Not in standard NAESB or EEI
 May be useful in jurisdictions without U.S. Bankruptcy Code
“safe harbor” provisions
33
E. Events of Default &
Termination Events
3. Automatic Early Termination under ISDA (cont.)
 Between U.S. counterparties, often not elected:
 Avoids risk of termination without Non-Defaulting Party’s knowledge
 Allows for cure and/or negotiation of better terms
 Avoids risk of unwanted Settlement Payments by Non-Defaulting
Party
34
E. Events of Default &
Termination Events
4. Risk Analysis

Events of Default mitigate credit and payment risks with respect
to the Defaulting Party

More ways to terminate under ISDA than under NAESB or EEI,
but all may not be necessary for every transaction

Risks of underlying transaction help determine which Events of
Default make sense (short term v. long-term; index v. fixed
price)

Automatic Early Termination: May be beneficial under certain
circumstances

May create operational and credit risk if elected in some but not
all contracts with a counterparty
35
F. Termination, Liquidation & Settlement
1. NAESB v. ISDA Gas Annex

NAESB § 10.3.1



Non-Defaulting Party determines:

Amount owed by each party for Gas delivered and received on or
before the Termination Date

All other applicable charges related to such deliveries and receipts for
which payment has not yet been made
If “Additional Termination Damages” apply:

Liquidation and acceleration of Terminated Transactions at Market
Value

If Market Value greater than Contract Value, difference due to Buyer

If Market Value less than Contract Value, difference due to Seller
Default two-way payment
36
F. Termination, Liquidation & Settlement
1. NAESB v. ISDA Gas Annex (cont.)

ISDA § 6(e): Market Quotation and Loss


Market Quotation:

Value of Terminated Transactions based on quotations from ReferenceMarket Makers plus any Unpaid Amounts owed to Non-Defaulting
Party; minus

Unpaid Amounts owed to the Defaulting Party
Loss:


Non-Defaulting Party’s total losses and costs resulting from early
termination and liquidation, including loss of bargain, costs of funding,
and costs of terminating, liquidating or reestablishing any hedge
ISDA § 6(e): First and Second Method

One-way v. two-way payment
37
F. Termination, Liquidation & Settlement
2. EEI v. ISDA Power Annex
 EEI:
 § 5.2: Non-Defaulting Party calculates Settlement Amount for each
Terminated Transaction in a “commercially reasonable manner”
 § 5.3: Settlement Amounts netted into Termination Payment,
payable either to or from the Non-Defaulting Party
 Default two-way payment unless changed by parties
 ISDA:
 § 6(e): Market Quotation or Loss, as elected by parties
 ISDA § 6(e): First or Second Method, as elected by the parties
(one-way or two-way payment)
38
F. Termination, Liquidation & Settlement
3. NAESB, EEI and ISDA: Risk Analysis

Inherent operational risks in various calculation methods:

NAESB method and Market Quotation are substantively similar,
while EEI requires calculation in a “commercially reasonable
manner”

Use of market quotes may not accurately reflect actual or
anticipated value of transactions

Subjective nature of Loss calculation
 Inconsistent Payment Risks to Defaulting Party:

NAESB and EEI are two-way payment

Potential exposure if one-way payment elected in ISDA
39
G. Setoff
1. NAESB v. ISDA Gas Annex

NAESB § 10.3.2: Election on Cover Sheet

Other Agreement Setoffs Apply:



Other Agreement Setoffs Do Not Apply


2002 NAESB: Bilateral
2006 NAESB: Bilateral or Triangular, as elected by the parties
Setoff limited to amounts owed under the NAESB.
ISDA Gas Annex:

2002 ISDA § 6(f): Setoff provision
 Setoff amounts owed between the parties arising under ISDA or any
other agreement
 No cross-Affiliate setoff
 Identical to bilateral setoff in 2002 NAESB
40
G. Setoff
2. EEI v. ISDA Power Annex
 EEI § 5.6: Setoff options elected on Cover Sheet
 Option A: Non-Defaulting Party sets off obligations owed by
Defaulting Party to Non-Defaulting Party under any agreements
between the Parties
 Options B: Non-Defaulting Party sets off obligations owed by
Defaulting Party (or its Affiliates) to the Non-Defaulting Party (or its
Affiliates) under any agreements between the Parties and/or their
Affiliates
 ISDA Power Annex:
 2002 ISDA: Setoff provision in § 6(f)
 Setoff amounts owed between the parties arising under ISDA or any
other agreement
 No cross-Affiliate setoff
41
G. Setoff
3. Risk Analysis: Risks Mitigated by Setoff
 Commercial Risks:
 Immediately extinguishes payment obligations
 Reduces involvement in bankruptcy proceedings
 Credit Risks:
 Amounts owed by Defaulting Party are immediately setoff
 Cash Flow Risk:
 No waiting for payments from Defaulting Party
 Enterprise-wide risks among Affiliates:
 Manages risk of having to pay Termination Payments across trading
contracts and Affiliates
42
Conclusion

ISDA is becoming more widely-used in energy commodity industry

Differences exist between ISDA Gas Annex, Power Annex,
NAESB and EEI

May be difficult to make all agreements consistent

Important to prioritize issues and determine scope of transactions
when deciding whether to use ISDA Commodity Annexes and/or
the NAESB and EEI

Research paper

Gap risk summaries located at Appendices 1 and 2
Craig R. Enochs
cenochs@jw.com
Jackson Walker L.L.P.
1401 McKinney, Suite 1900
Houston, Texas 77010
(713) 752-4200 phone
43