Legal Agreements

Question 1

Importance of ISDAs

Answer 1

Right to terminate
net offsetting exposures
liquidate collateral
setoff

• Enforceability of close-out netting in bankruptcy, Netting has balance sheet and capital requirement impacts
• The “single agreement” concept
• Exemption from automatic stay
• Dodd-Frank – Swaps Trading Relationship Documentation Requirements (CFTC § 23.504)
• Negotiation process can act as additional layer of due diligence

Question 2

Primary purpose of Documentation architecture

Answer 2

Close out netting, what does IB owe the CCP, what does the CCP owe IB

Question 3

Set-off

Answer 3

allows a non-defaulting party to “set-off” obligations

For example, if IB owes $100mm to CCP under a swap, CCP has an outstanding loan balance to IB of $90mm for a net $10mm due to CCP.

Question 4

Products Covered under ISDA

Answer 4

ISDA covers over the counter derivatives

Rate swap transaction, swap option, basis swap, forward rate transaction
Commodity swap, commodity option
Equity or equity index swap, equity or equity index option
Bond option, interest rate option, cap transaction, floor transaction, collar transaction, cross currency rate swap transaction
Foreign exchange transaction, currency swap transaction, currency option
Credit protection transaction, credit swap, credit default swap, credit default option, total return swap, credit spread transaction

Question 5

Certain credit protections are built into the preprinted form of ISDA

Answer 5

Standard events of default
 Failure to pay or deliver (5(a)(i)) (1 day cure)
 Breach of covenant (5(a)(ii)) (30 day cure)
 Credit Support Default (5(a)(iii))
 Misrepresentation (5(a)(iv))
 Default under Specified Transaction (5(a)(v))
 Bankruptcy (5(a)(vii))
 Merger without Assumption (5(a)(viii))
 Termination Events
 Illegality
 Force Majeure
 Tax Event Upon Merger
 Additional Termination Events
 Change of Investment Manager
 No Plan Assets / QPAM
Minimum Net Asset Value
Delivery of Statements

Question 6

What is the CSA?

Answer 6

Credit Support Annex - the contractual mechanism by which the parties agree to post mark-to-market collateral to each other and grant each other a security interest in the collateral pledged.

Question 7

How does the CSA work?

Answer 7

How is mark-to-market calculated? The mid-market termination value of trades on the relevant valuation date.
What is the Threshold? The amount of unsecured risk the parties are willing to take to one another before each is required to post collateral. This is typically a fixed amount or ratings-dependent.
What is Independent Amount? This is “upfront margin” – basically, buffer margin to protect the secured party against a decline in collateral value between the time the counterparty is closed-out and the time the collateral is ultimately liquidated. This is typically a fixed amount or a percentage of notional (on a product-specific basis). – this is where we insert the Fallback IA grid
Other concepts
Unilateral vs Bilateral (post NCMR, only bilateral is permitted)
Minimum transfer amount
Eligible collateral
Transfer timing

Question 8

NCF/CCF

Answer 8

enforceability of close-out netting via credit support documents under foreign law in the event of insolvency of a foreign counterparty

Review of legal opinions across jurisdictions. ISDA-commissioned or separately JPM-commissioned.

Question 9

What do clients negotiate?

Answer 9

Lots of different points, but these are some of the most common:
Cross default (Section 5(a)(vi)) – default under Specified Indebtedness
Cross default vs cross acceleration
Default Under Specified Transaction (Section 5(a)(v)
Downgrade triggers against JPM
NAV Triggers
Frequency
Whole NAV vs performance
Change in Investment Manager and / or Investment Guidelines
Delivery of Financial Information
Part 7
CSA