Overview of the English Law ISDA Credit Support Annex

Michael AmosGlobal Legal Product HeadDerivativesING Bank N.V.

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The ISDA Credit Support Documents

1994 ISDA Credit Support Annex (Security Interest - New York Law)

1995 ISDA Credit Support Deed (Security Interest - English Law)

1995 ISDA Credit Support Annex (Transfer - English Law)

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Common features of the ISDA Credit Support Documents

• each is designed to secure or support net exposure under an ISDA Master Agreement

• each is bilateral (but can be drafted as unilateral)

• each provides for periodic adjustment of collateral on a mark-to-market basis

• each permits considerable customising

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Difficulties with charge-based form

• No use of collateral permitted

• Is it registrable?

• Perfecting security held by a financial intermediary

• Requirement to enforce the security

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Title transfer collateral: key elements

• Outright transfer of cash and securities

• Conditional obligation to repay cash and re-deliver fungible securities

• Re-delivery obligation becomes debt obligation on default

• Set-off or netting of exposure against collateral value

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Title transfer collateral: advantages

• Freedom to deal with collateral

• No “perfection” required

• Simpler document

• May avoid negative pledge

• May avoid insolvency stay or freeze

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Title transfer collateral: potential disadvantages

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• Credit risk on collateral taker

• Tax issues

• Regulatory considerations

• Vulnerable internationally?

- recharacterisation risk

- enforceability of set-off/netting

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Interpretation

• Paragraph 1 of the Annex

• Definitions and consistency

• The Parties:

- Transferor and Transferee

• The Party which is net “in-the-money” (i.e. the Party which is exposed to credit risk on the other Party) is the Transferee and remains the Transferee until the other Party becomes net “in-the-money”

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How is the collateral requirement calculated?

• Paragraph 2 of the Annex

• Compare collateral on hand with net exposure

• If exposure exceeds collateral, more collateral is required

• If collateral exceeds Exposure, the excess collateral is returned

• This leads to the apparent contradiction in terminology where the Transferee returns (i.e. does not transfer) collateral to the Transferor

• The Party which holds the Credit Support Balance remains the “Transferee” regardless of making “returns”

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Collateral Requirement: ISDA Terminology

Credit Suppor

t Amount

Value

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Collateral Requirement: ISDA Terminology

Credit Support Balance

Value

Credit Suppor

t Amount

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Collateral Requirement: ISDA Terminology

Credit Suppor

t Amount

Delivery Amount

Credit Support Balance

Value

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Collateral Returns: ISDA Terminology

Value

Credit Support Amount

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Collateral Returns: ISDA Terminology

Credit Support BalanceValue

Credit Support Amount

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Collateral Returns: ISDA Terminology

Credit Support BalanceValue

ReturnAmount

Credit Support Amount

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How is the Credit Support Amount calculated?

• Remember, the Credit Support Amount is, in essence, adjusted Exposure

• Exposure is the total of the termination values of outstanding Transactions where “in the money” Transactions exceed “out of the money” Transactions (i.e. the credit risk on the Counterparty)

• So, it is calculated by

- Determining the Exposure (in the Base Currency)

- adding all Independent Amounts applicable to the Transferor and then

- subtracting all Independent Amounts applicable to the Transferee and finally

• subtracting the Transferor's Threshold

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How do you calculate the Delivery Amount?

If the Delivery Amount exceeds Transferor's Minimum Transfer Amount, then the Transferor delivers

that amount (subject to Rounding) of additional collateral to the Transferee

If the Delivery Amount exceeds Transferor's Minimum Transfer Amount, then the Transferor delivers

that amount (subject to Rounding) of additional collateral to the Transferee

• Delivery Amount equals the EXCESS of

• the Credit Support Amount (adjusted Exposure) OVER

• the Credit Support Balance (collateral on hand)

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How is the value of the Credit Support Balance determined?

• Credit Support Balance is, in essence, collateral on hand.

• So it is calculated by valuing collateral on hand as provided in the final Paragraph. This includes:

- Applying a “haircut” (valuation percentage) to securities (Valuation Percentage) and

- Converting all values to the Base Currency

- the “haircut” is excluded from the final calculation

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Other matters affecting delivery and return of collateral amounts

Paragraph 3 of the Annex

• Conditions Precedent

- Transfers: manner and timing

- Calculations

- Substitutions/Exchanges of collateral

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How do you calculate the Return Amount?

If the Return Amount exceeds theTransferee'sMinimum Transfer Amount, then the Transferee

returns that amount of additional collateral (subject to Rounding) to the Transferor

If the Return Amount exceeds theTransferee'sMinimum Transfer Amount, then the Transferee

returns that amount of additional collateral (subject to Rounding) to the Transferor

• Return Amount equals the EXCESS of

• the Credit Support Balance (collateral on hand) OVER

• The Credit Support Amount (adjusted exposure)

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How are valuation disputes handled?

Paragraph 4 of the Annex

• Undisputed amount is transferred

• Parties consult

• If dispute relates to Exposure, obtain Market Quotations

• If dispute relates to Value of collateral, resolve in manner stipulated in final Paragraph

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How do you take collateral under the Annex?

• The Transferor delivers the assets to the Transferee together with full ownership interest

• No security interest is intended to be created

• The Transferee is free to deal with the collateral, including (but not limited to) the exercise of voting rights

• The Transferor is entitled to receive Equivalent Distributions

• The Transferee is subject to a conditional obligation to deliver fungible equivalent assets to the Transferor

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How do you enforce the Annex?

Paragraph 6 of the Annex

• The Value of the Credit Support Balance (collateral on hand) becomes an Unpaid Amount for purposes of the Section 6 of the ISDA Master Agreement

• Accordingly, the Annex relies on the effectiveness of the Section 6 close-out netting provisions