10 January ISDA Australian Risk Mitigation Agreement FAQs

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1 10 January 2018 ISDA Australian Risk Mitigation Agreement FAQs ISDA has prepared this list of frequently asked questions to assist in your consideration of the Agreement relating to APRA Risk Mitigation Standards published by ISDA on December 8, 2017 (the Agreement). Capitalized terms not otherwise defined herein have the meanings ascribed to them in the Agreement. THESE FREQUENTLY ASKED QUESTIONS DO NOT PURPORT TO BE AND SHOULD NOT BE CONSIDERED A GUIDE TO OR AN EXPLANATION OF ALL RELEVANT ISSUES OR CONSIDERATIONS IN CONNECTION WITH THE AGREEMENT. PARTIES SHOULD CONSULT WITH THEIR LEGAL ADVISERS AND ANY OTHER ADVISER THEY DEEM APPROPRIATE PRIOR TO USING THE AGREEMENT. ISDA ASSUMES NO RESPONSIBILITY FOR ANY USE TO WHICH ANY OF ITS DOCUMENTATION OR OTHER DOCUMENTATION MAY BE PUT. These FAQs address questions under the following general headings: 1. What does the Agreement do? 2. What does the Agreement cover? 3. Specific questions on the agreement language. The Agreement was developed by a working group of ISDA member institutions. Inevitably, due to the fact we are at the early stages of the implementation of the risk mitigation standards set out in the Australian Prudential Regulation Authority s (APRA) Prudential Standard CPS Margining and risk mitigation for non-centrally cleared derivatives (CPS 226), the working group has had to form certain decisions on questions of interpretation of CPS What does the Agreement do? The Agreement enables parties to bilaterally agree terms to reflect the portfolio reconciliation and dispute resolution requirements imposed by CPS 226. Portfolio Reconciliation CPS 226 requires that an APRA covered entity must establish and implement policies and procedures designed to ensure that the material terms and valuations of all transactions in a non-centrally cleared derivatives (as defined in paragraph 9(r) of CPS 226) portfolio are reconciled with covered counterparties at regular intervals. The policies and procedures must be designed to ensure the process or method of portfolio reconciliation is agreed upon with its counterparties and designed to: (a) (b) ensure an accurate record of material terms and valuations of the non-centrally cleared derivatives transactions in the portfolio; and identify and resolve discrepancies in the material terms and valuations in a timely manner. The Agreement provides for two alternate methods of portfolio reconciliation: Under Exchange of Portfolio Data, both parties (each, a Portfolio Data Sending Entity) send the other a data set comprising the key terms of the relevant transactions between them (the 2018 ISDA is a registered trademark of the

2 Portfolio Data). Each party compares the Portfolio Data received against its own records. If, as a result of this comparison, a party identifies a discrepancy in the data which such party determines, acting reasonably and in good faith, is material to the rights and obligations of the parties or to the valuations in respect of one or more relevant transactions, it notifies its counterparty of the discrepancy and the parties then consult with each other to attempt to resolve the discrepancy in a timely manner. Under One-way Delivery of Portfolio Data, one party (the Portfolio Data Sending Entity) sends the Portfolio Data to the other party (the Portfolio Data Receiving Entity), who compares the Portfolio Data against its own records. If the Portfolio Data Receiving Entity identifies a discrepancy in the data which such party determines, acting reasonably and in good faith, is material to the rights and obligations of the parties or to the valuations in respect of one or more relevant transactions, it notifies its counterparty of the discrepancy and the parties then consult with each other to attempt to resolve the discrepancy in a timely manner. If the Portfolio Data Receiving Entity does not identify a discrepancy to the Portfolio Data Sending Entity within five joint business days, the Portfolio Data is deemed to have been affirmed. Each party to the Agreement elects whether it is a Portfolio Data Sending Entity or a Portfolio Data Receiving Entity. After entering into the Agreement, a party may change its status with its counterparty by agreement. Where both parties to the Agreement are Portfolio Data Sending Entities, the Exchange of Portfolio Data method applies. Where one party to the Agreement is a Portfolio Data Sending Entity and the other is a Portfolio Data Receiving Entity, the One-way Delivery of Portfolio Data method applies. The parties can use agents or third party service providers to carry out all or any part of the portfolio reconciliation process. A party can appoint an Affiliate as its agent unilaterally by notice or a third party as agent or service provider with the agreement of its counterparty. Under CPS 226, an APRA covered entity must conduct portfolio reconciliation with a scope and frequency that reflects: (a) (b) (c) (d) the nature and extent of its non-centrally cleared derivative activity; the materiality and complexity of the risks it faces; global regulatory standards imposed on similar institutions for similar transactions; and market practice and industry protocols in the relevant derivative markets. The Agreement provides for a mechanism whereby (1) if both parties are APRA covered entities (as defined in paragraph 3 of CPS 226), then the Data Reconciliation frequency required by the Portfolio Reconciliation Requirements shall be as agreed between the parties, and (2) if only one party is an APRA covered entity, then the Data Reconciliation frequency required by the Portfolio Reconciliation Requirements shall be determined by such party. The portfolio reconciliation provisions are without prejudice to other processes, rights and obligations the parties may have with respect to each other. This means, for example, that not raising discrepancies with respect to a set of Portfolio Data (even where this leads to deemed affirmation in the One-way Delivery of Portfolio Data method) does not prevent a party from identifying a discrepancy at a later date or disputing a valuation ISDA is a registered trademark of the

3 Dispute Resolution CPS 226 requires that an APRA covered entity must establish and implement policies and procedures designed to ensure rigorous and robust dispute resolution procedures are agreed with its covered counterparties prior to or contemporaneously with executing a non-centrally cleared derivative transaction (as defined in paragraph 9(r) of CPS 226). The dispute resolution procedures must address the mechanism or process for determining when discrepancies in material terms or valuations should be considered disputes as well as how such disputes should be resolved as soon as practicable. The Agreement provides a method for the identification and resolution of disputes without overriding the existing dispute resolution methods that the parties may have agreed. For example, it does not override the selection of governing law and submission to relevant courts in Section 13 of an ISDA Master Agreement and the collateral dispute mechanics that exist in the ISDA Credit Support Annex (English or New York law) and Credit Support Deed or any other process agreed between the parties (an Agreed Process). If a party decides that an issue is serious enough to constitute a dispute (as opposed to, for example, a discrepancy that it expects to resolve easily at an operational level), it can send a dispute notice to its counterparty, identifying to both parties that this is a dispute which is required to be subject to dispute resolution requirements under CPS 226. Once a dispute notice has been sent, the Agreement requires the parties to consult in good faith in an attempt to resolve the dispute in a timely manner, including identifying and using any of the appropriate Agreed Process(es) or otherwise determining and applying a resolution method to the relevant dispute. As with portfolio reconciliation, the dispute resolution provisions are without prejudice to any other rights and obligations the parties may have in respect of each other under other contracts or in law. The Agreement does not prevent a party from handling a dispute in the way it considers best suits the circumstances nor does it free a party from strictly following any applicable dispute resolution process that it has previously agreed with its counterparty. The parties can still attempt to resolve disputes at an operational, relationship or other level. Remedies for Breach Breach of the portfolio reconciliation or dispute resolution requirements as set out in the Agreement, does not constitute an event of default and does not give either party a right to terminate trades. Rights and remedies that may be available to the parties as a matter of law are preserved and each party s obligations to meet the requirements of CPS 226 do, of course, remain. 2. What transactions does the Agreement cover? The provisions in the Agreement only apply to transactions that are subject to the portfolio reconciliation risk mitigation standards set out in paragraphs 80 to 82 of CPS 226 and the dispute resolution risk mitigation standards set out in paragraphs 90 to 94 of CPS 226 (these portfolio reconciliation and dispute resolution standards being the Relevant CPS 226 Standards ) so if parties to the Agreement have a portfolio of trades that include trades that are subject to the Relevant CPS 226 Standards and trades that are not, the Agreement only imposes requirements on the trades subject to the Relevant CPS 226 Standards. The parties may, of course, bilaterally agree to use the same processes for trades that are not subject to the Relevant CPS 226 Standards, if they agree that this is appropriate ISDA is a registered trademark of the

4 3. Specific questions on the agreement language. Do I have to enter into the Agreement with counterparties before 1 March 2018, the date on which, in particular, the portfolio reconciliation and dispute resolution obligations come into effect? We anticipate that parties will want to enter into the Agreement with relevant counterparties before the requirements for parties to comply with the portfolio reconciliation and dispute resolution obligations come into effect on 1 March 2018, so have published this Agreement in advance to allow parties time to review and enter into the Agreement with relevant counterparties. This will help ensure parties have time to identify the relevant counterparties, negotiate this Agreement with relevant counterparties and establish the operational and other internal policies and procedures that underpin the Agreement. We urge parties to enter into the Agreement with relevant counterparties well before the deadline to reduce the risk of processing delays, either of the Agreement or by counterparties. If my counterparty and I enter into the Agreement now, is the agreement effective now and do we have to follow the portfolio reconciliation and dispute resolution methodology before the relevant obligations commence on 1 March 2018? The Agreement is effective on the date of the Agreement (as specified). However, the portfolio reconciliation and dispute resolution provisions in the Agreement only apply to trades subject to the Relevant CPS 226 Standards, so the parties will not be obliged to perform the relevant methodology prior to 1 March Does entering into the Agreement with a relevant counterparty satisfy my regulatory obligations under Relevant CPS 226 Standards? The Agreement is to assist the parties in meeting their regulatory obligations but the parties must, of course, perform the required actions in order to satisfy their obligations. While great care was taken by the working group to draft the Agreement so as to be compliant with the Relevant CPS 226 Standards and many of the key legal questions remaining from the legislation were looked into in some depth, ISDA is not able to certify that the language satisfies any given party s regulatory obligations. Each party should satisfy itself that the language, the further actions the language refers to and such party s policies and procedures, taken together, satisfy such party s regulatory obligations under the Relevant CPS 226 Standards. If my counterparty is an APRA covered entity, what happens if I do not enter into the Agreement by 1 March 2018? An APRA covered entity may not be able to continue to trade with a covered counterparty after 1 March 2018 if the APRA covered entity does not satisfy the requirements of CPS 226. As noted in the question immediately above, the Agreement was prepared to assist the parties in meeting their regulatory obligations. However, parties may choose to comply with the Relevant CPS 226 Standards using alternative arrangements. Most of my trades are out of scope of the Relevant CPS 226 Standards but I do have some within scope trades. Should I enter into the Agreement and, if I do, will I have to follow the portfolio reconciliation and dispute resolution provisions in respect of all trades or just the trades that are within scope of the Relevant CPS 226 Standards? As the portfolio reconciliation and dispute resolution provisions in the Agreement only apply to trades subject to related provisions of the Relevant CPS 226 Standards, you will only have 2018 ISDA is a registered trademark of the

5 to follow the portfolio reconciliation and dispute resolution provisions in respect of the trades that are within scope of the Relevant CPS 226 Standards. However, if you and your counterparty want to apply these provisions to all trades (such as deciding to apply the portfolio reconciliation process to your entire portfolio) you could agree to do so. I am an APRA covered entity facing another APRA covered entity or a covered counterparty (whether Australian or not), should I use the Agreement? As an APRA covered entity, you are subject to CPS 226 and so you may wish to consider using the Agreement, among other things, to help you meet some of your requirements under CPS 226. I am a covered counterparty (whether Australian or non-australian) facing an APRA covered entity, should I use the Agreement? Even if you are not directly subject to CPS 226, your counterparty will be subject to CPS 226 so will either need you to enter into the Agreement or to agree other language which covers the same subject matter. Where the entities have entered into the Agreement and the entities themselves are not subject to the Relevant CPS 226 Standards would they be forced to comply with the obligations in the Agreement? The obligations in the Agreement don t apply unless at least one party is actually subject to the Relevant CPS 226 Standards. The portfolio reconciliation and dispute resolution provisions in the Agreement only apply to trades which are subject to the Relevant CPS 226 Standards (such as where at least one of the parties is a APRA covered entity and the trade is an uncleared noncentrally cleared derivative (as defined in paragraph 9(r) of CPS 226)). If the Relevant CPS 226 Standards do not apply, the parties are not obliged to perform the portfolio reconciliation and dispute resolution procedures set out in the Agreement. Parties may, of course, bilaterally agree to use the processes if they agree that this is appropriate. Portfolio Reconciliation What do I do if I want to change between Portfolio Data Sending Entity and Portfolio Data Receiving Entity status in the future? You can change status by written agreement with your counterparty. If you have previously agreed to the contrary with your counterparty, such agreement could be by an exchange of s or a simple letter signed by both parties, there is no need to amend and restate your Agreement. You should of course fully consider any change to operational or other process that may be required by such change of status. How do I know how frequently I have to reconcile portfolios? CPS 226 does not set out a specific frequencies for reconciliation of portfolios. Paragraph 82 of CPS 226 provides that an APRA covered entity must conduct portfolio reconciliation with a scope and frequency that reflects: (a) (b) (c) (d) the nature and extent of its non-centrally cleared derivative activity; the materiality and complexity of the risks it faces; global regulatory standards imposed on similar institutions for similar transactions; and market practice and industry protocols in the relevant derivative markets ISDA is a registered trademark of the

6 Can I agree a reconciliation schedule with my counterparty? Yes, you can agree a reconciliation schedule with each counterparty, provided that the agreed schedule meets the minimum requirements of CPS 226. If I do not think there are any discrepancies in the Portfolio Data I receive from my counterparty, does the Agreement require that I have to affirm this to them every time? No. You only have to notify your counterparty if you have identified one or more discrepancies which you determine to be material to the rights and obligations of the parties or to the valuations in respect of one or more Relevant Transaction(s). What does material to the rights and obligations of the parties or to the valuations in respect of one or more Relevant Transaction(s) mean? It is anticipated that a reconciliation may identify a number of differences ( discrepancies ) and that not all of these will be seen by the parties as being significant enough to merit a bilateral attempt at resolution. For example, you might determine that a small difference between your and your counterparty s valuation of a transaction actually results from taking data reference points a few hours apart or from the parties using slightly different valuation mechanics or reference sources. The language allows you to apply discretion in reviewing the results of the reconciliation and only contact your counterparty where you believe a discrepancy is material to the rights and obligations of the parties or to the valuations in respect of one or more Relevant Transaction(s). What does attempt to resolve in a timely fashion mean in the portfolio reconciliation provisions? Does it mean I have to reach an agreement with my counterparty and how many days do we have to resolve the point? Resolve does not mean agree in all cases. One aim of the portfolio reconciliation requirement in the Relevant CPS 226 Standards is to identify and resolve discrepancies in the material terms and valuations in a timely manner. Certain differences, such as a typographical error in a name, rate or notional amount, should be relatively easy for the parties to investigate and agree on the correct record. Other differences, such as a difference in valuations might not be something the parties can agree as the valuation arises from a difference in underlying methodology or reference. The Relevant CPS 226 Standards does not set hard deadlines for resolution. in a timely manner indicates that the parties should take a pro-active approach to resolve the discrepancy and should not neglect a material difference. I will be a Portfolio Data Receiving Entity. If I fail to notify my counterparty of a discrepancy within the deadline in Part 1(2)(a)(iv) I am deemed to have affirmed the Portfolio Data. Does this (i) prevent me from notifying the discrepancy to my counterparty the next time we reconcile; (ii) mean I have agreed to a valuation for the purposes of our existing collateral agreement; or (iii) prevent me from raising a dispute? No. See Part I(5) which states that the Agreement is without prejudice to other rights the parties may have under contract or in law ISDA is a registered trademark of the

7 I currently outsource portfolio reconciliation to a service provider, would entering into the Agreement override my existing arrangements or mean I have to change my existing arrangements? No. However, you should consider whether your existing arrangements are sufficient in the context of the Relevant CPS 226 Standards and the extent to which you wish to use your existing arrangements to satisfy the methodology set out in the Agreement. Can I outsource portfolio reconciliation to a third party service provider (as defined in the Agreement) if I enter into the Agreement? Yes, with the agreement of your counterparty. Such agreement may pre-date the date of the Agreement and may (though this should be checked) already exist through the service agreements the parties signed with the third party service provider. If I fail to deliver data or perform a reconciliation on time, what penalties should I be aware of? Failure by a party to take any required action or to otherwise comply with Part I, will not constitute an event of default in respect of such party or any other event which permits either party to terminate any Relevant Transaction or other transaction under this Agreement but the rights and remedies that may be available to the parties as a matter of law are preserved. Failure to comply with the Relevant CPS 226 Standards does not of itself affect the validity of transactions that are subject to the Relevant CPS 226 Standards but it may expose the relevant party to potential regulatory sanction under the Relevant CPS 226 Standards. Do I have to specify contact details for delivery of Portfolio Data and discrepancy notices in the Agreement? No. This is entirely optional and, if you do specify contact details, your counterparties are not obliged to use them. Dispute Resolution Do I have to specify contact details for dispute notices in the Agreement? No. This is entirely optional and, if you do specify contact details, your counterparties are not obliged to use them. Does a Dispute Notice have to be in any particular form? No but it must set out in reasonable detail the issue in dispute (including, without limitation, the Relevant Transaction(s) to which the issue relates) and state that it is a Dispute Notice for the purposes of Part I(4) of the Agreement. For example, you could use the following sentence: This [notice] constitutes a Dispute Notice for the purposes of Part I(4) of the Agreement dated as of [ ] relating to APRA Risk Mitigation Standards published by the International Swaps and Derivatives Association, Inc. on December 8, 2017 and which relate to the subject matter described herein at the beginning of the notice before adding the details of the dispute. What is the difference between a discrepancy and a dispute? The following distinction may help potential parties in considering the Agreement. Neither the Agreement nor the Relevant CPS 226 Standards defines these terms. The Agreement contains significant flexibility (such as in Part I(5)) to allow each party to apply the process that best suits the particular situation it faces. The Relevant CPS 226 Standards is subject to interpretation and, as noted above, the parties should take professional advice ISDA is a registered trademark of the

8 A discrepancy is any difference identified by the portfolio reconciliation process. The Agreement does not require a party to notify its counterparty of any discrepancy identified through the portfolio reconciliation process unless such discrepancy is material to the rights and obligations of the parties or to the valuations in respect of one or more Relevant Transaction(s). A dispute may include a material discrepancy which, despite attempts, has not been resolved at an operational (or, perhaps, a relationship) level such that one or both of the parties is, potentially, considering a more formal procedure. Does entering into the Agreement with a relevant counterparties override my existing portfolio reconciliation and dispute resolution processes which I have agreed with my counterparties? No. Part I(5) states that the Agreement is without prejudice to other rights the parties may have under contract or in law ISDA is a registered trademark of the