VOLUME 1. Events of Default and Termination Events

Transcription

1 Table of Contents VOLUME 1 About the Author... vii Table of Chapters...ix Acknowledgments... xxv Frequently Used Terms...xxvii Chapter 1 Introduction 1:1 In General :2 What Is a Derivative? :2.1 Interest Rate Swaps Diagram 1-1 Interest Rate Swap :2.2 Currency Swaps Diagram 1-2 FX Fixed Currency Swap :2.3 Equity Swaps Diagram 1-3 Equity Swap Diagram 1-4 Equity Swap Diagram 1-5 Equity Swap Diagram 1-6 Commodity Swap Diagram 1-7 Credit Default Swap :2.4 Other Derivatives :3 Terminology :4 What Is the Purpose of Derivative Transactions? :5 Guide to Documentation of Derivative Transactions :6 Overview of Close-Out Netting Chapter 2 Events of Default and Termination Events 2:1 Introduction : and 2002 Master Agreements Events of Default :2.1 Failure to Pay or Deliver (Section 5(a)(i) of Master Agreements) (Durham, Rel. #2, 6/16) xi

2 DERIVATIVES DESKBOOK 2:2.2 Breach of Agreement (Section 5(a)(ii) of Master Agreements) :2.3 Credit Support Default (Section 5(a)(iii) of Master Agreements) :2.4 Misrepresentation (Section 5(a)(iv) of Master Agreements) :2.5 Default Under Specified Transaction (Section 5(a)(v) of Master Agreements) :2.6 Cross-Default (Section 5(a)(vi) of Master Agreements) :2.7 Bankruptcy (Section 5(a)(vii) of Master Agreements) :2.8 Merger Without Assumption (Section 5(a)(viii) of Master Agreements) :3 Termination Events :3.1 Illegality (Section 5(b)(i) of Master Agreements) :3.2 Tax Event (Section 5(b)(ii) of 1992 Master Agreement and Section 5(b)(iii) of 2002 Master Agreement) :3.3 Tax Event upon Merger (Section 5(b)(iii) of 1992 Master Agreement and Section 5(b)(iv) of 2002 Master Agreement) :3.4 Credit Event upon Merger (Section 5(b)(iv) of 1992 Master Agreement and Section 5(b)(v) of 2002 Master Agreement) :3.5 Additional Termination Event (Section 5(b)(v) of 1992 Master Agreement and Section 5(b)(vi) of 2002 Master Agreement) :3.6 Force Majeure (Section 5(b)(ii) of Master Agreements) :4 Termination at Election of Non-Defaulting or Non-Affected Party: Suspension of Obligation :5 Events of Default Chart Chart 2-1 Events of Default Chapter 3 Collateral and Security Arrangements 3:1 Introduction :2 Types of Credit Support Annexes :2.1 U.S. CSA :2.2 English Law CSA :2.3 Japanese CSA :2.4 Main Terms of CSA :2.5 Alternative Security Documentation :3 Collateral Postings xii

3 Table of Contents 3:4 Rating Agency Downgrade Triggers in Rated Transactions :4.1 Downgrade Triggers :4.2 Mitigating Actions :4.3 Failure to Take Necessary Mitigating Actions :4.4 Other Considerations :5 Key Terms of CSA :5.1 Exposure :5.2 Other Key Provisions for Collateral Postings :5.3 Eligible Collateral and Valuation :6 Dispute Resolution Mechanics :6.1 Business Day One: Valuation Date :6.2 Business Day Two: Dispute Notification :6.3 Business Day Two/Three: Resolution Attempt :6.4 Business Day Three: Delivery of Undisputed Amount :6.5 Business Day Three: Failure of Resolution Attempt :6.6 Business Day Three: Dispute Resolution Mechanics :6.7 Business Day Four: Notification to Counterparty :6.8 Business Day Five: Delivery of Eligible Collateral :6.9 Business Day Five: Failure to Deliver Collateral :6.10 Business Day Seven/Eight: Event of Default :6.11 Occurrence of Another Valuation Date During Dispute :6.12 Dispute Resolution Procedure :7 Events of Default :7.1 Failure to Pay or Deliver :7.2 Breach of Agreement :7.3 Failure to Comply :8 Termination Events :9 Other Security Agreements Chapter 4 Early Termination 4:1 Events of Default and Termination Events Are Treated Differently :1.1 Non-Defaulting Party s Option to Terminate :2 Termination Relating to Events of Default :2.1 Automatic Early Termination (Durham, Rel. #2, 6/16) xiii

4 DERIVATIVES DESKBOOK 4:3 Termination Events Under the Master Agreements :3.1 Notification to Non-Affected Party :3.2 Transfer to Avoid Termination :3.3 Consent to Transfer :3.4 Two Affected Parties :3.5 Examples [A] Tax Event [B] Illegality : Master Agreement Illegality and Force Majeure :4 Termination Events Chart 4-1 Termination Events :5 Delivery of Notice of Occurrence of Event of Default or Termination Event Chapter 5 Early Termination Amounts 5:1 Overview :2 Valuation Statement :3 First Method and Second Method Under 1992 Master Agreement :3.1 Hypothetical Example of Early Termination Amount Calculations :4 Second Method, Market Quotation Under 1992 Master Agreement :5 Second Method and Loss :5.1 Loss of Bargain :5.2 Cost of Funding :5.3 Hedging Costs :5.4 Discretion of Non-Defaulting Party :6 Unpaid Amounts :7 Out-of-Pocket Expenses :8 Termination Currency :8.1 Foreign Exchange Agent :8.2 Conversion Time :8.3 Conversion Amount :9 Calculation of Early Termination Amount Under 1992 Master Agreement :9.1 Tables for Early Termination Amount Calculations Table 5-1 Early Termination Amount for Transactions Terminated Due to Event of Default Table 5-2 Early Termination Amount for Transactions Terminated Due to Termination Event with One Affected Party xiv

5 Table of Contents Table 5-3 Early Termination Amount for Transactions Terminated Due to Termination Event with Two Affected Parties :9.2 Applicable Rate :9.3 Interest Accrual Dates :9.4 Payment Date of Early Termination Amount :10 Close-Out Amounts Under 2002 Master Agreement :10.1 Determining Party and Commercial Reasonableness :10.2 Economic Equivalence :10.3 Market Data and Information :10.4 Unpaid Amounts :10.5 Costs of Funding and Hedging Costs :10.6 Out-of-Pocket Expenses :10.7 Termination Currency Equivalent :10.8 Calculation of Early Termination Amount Under 2002 Master Agreement :10.9 Tables for Early Termination Amount Calculations Table 5-4 Early Termination Amount for Transactions Terminated Due to Event of Default Table 5-5 Early Termination Amount for Transactions Terminated Due to Termination Event with One Affected Party Other Than an Illegality or Force Majeure Table 5-6 Early Termination Amount for Transactions Terminated Due to Termination Event with Two Affected Parties Other Than an Illegality or Force Majeure Table 5-7 Early Termination Amount for Transactions Terminated Due to Illegality or Force Majeure with One Affected Party Table 5-8 Early Termination Amount for Transactions Terminated Due to Illegality or Force Majeure with Two Affected Parties :10.10 Applicable Rate [A] Interest on Defaulted Amounts Prior to Termination [B] Interest on Unpaid Amounts [C] Interest on Deferred Payments or Deliveries Due to Illegality or Force Majeure [D] Interest on Deferred Payments or Deliveries Due to Failure of Conditions Precedent [E] Interest on Early Termination Amount (Durham, Rel. #2, 6/16) xv

6 DERIVATIVES DESKBOOK 5:10.11 Payment Date of Early Termination Amount :10.12 Payment of Early Termination Amount If Force Majeure or Illegality :11 Legal Enforceability of Termination Amount Calculations :11.1 Liquidated Damages Under New York Law :11.2 When Can Use of Market Quotation or Loss Be Unreasonable and Unenforceable? Chapter 6 Risk Mitigation and Close-Out Netting 6:1 In General :2 Payment Netting :2.1 Single Transaction Netting :2.2 Multiple Transaction Netting :2.3 Netting Elections :2.4 Netting After Early Termination Date :3 Escrow Arrangements :4 Adequate Assurances Provisions :5 Suspension of Payments or Deliveries :6 Collateral Arrangements :6.1 Collateral Rights Under CSA Upon Occurrence of Event of Default [A] Rights of Secured Party [B] Rights of Pledgor :6.2 Uniform Commercial Code Considerations [A] Mandatory UCC Provisions [B] Purchase of Collateral by Secured Party or Its Affiliates [C] Commercial Reasonableness :7 Setoff Rights :7.1 Bilateral Setoffs [A] Examples of Bilateral Setoff Provisions [B] Legal Enforceability of Bilateral Setoff Provisions :7.2 Triangular Setoffs [A] Examples of Triangular Setoff Provisions [B] Legal Enforceability of Triangular Setoff Provisions :7.3 Cross-Product Netting and Master Netting Agreement :8 Close-Out Netting :9 Lessons from the Lehman Brothers Bankruptcy xvi

7 Table of Contents Chapter 7 U.S. Bankruptcy Implications of Close-Out Netting 7:1 In General :2 General Provisions of the U.S. Bankruptcy Code :2.1 The Automatic Stay Bankruptcy Code Section :2.2 Executory Contracts Bankruptcy Code Section :2.3 Avoidance Powers Bankruptcy Code Sections 544, 547, and :2.4 Property of Estate Bankruptcy Code Section :3 Exercise of Contractual Rights for Derivatives :3.1 Contractual Rights Under Bankruptcy and Validity of Section 2(a)(iii) of Master Agreements [A] Exercise of Contractual Rights in Derivative [B] Transactions Enforceability of Section 2(a)(iii) in Insolvency Proceedings [C] Implications of Metavante Under the Code :3.2 Definitions of Code Sections :3.3 Waiver of Termination Right or Close-Out Netting :4 Setoff Rights for Derivatives in Bankruptcy :4.1 Automatic Stay Exceptions :4.2 Section 553 and the Concept of Mutuality in Setoff Rights :4.3 Applicability of the Mutuality Requirement to Derivative and Other Financial Market Agreements [A] State of New York [B] Other U.S. Jurisdictions :4.4 Damages Arising from Liquidation of Derivative and Other Financial Market Agreements Fixed Post-Petition May Be Pre-Petition Debts :4.5 Escrowed Property :5 Cross-Product Netting :6 Ipso Facto Clauses and Swaps :6.1 Ballyrock ABS CDO and U.S. Synthetic CDOs [A] Ballyrock [B] U.S. Synthetic CDOs (Durham, Rel. #2, 6/16) xvii

8 DERIVATIVES DESKBOOK 7:6.2 Dante ABS CDO and U.K. Synthetic CDOs :7 Lehman Brothers Bankruptcy Proceedings and Impact on Close-Out Netting :7.1 Summary of Motion to Terminate Open Derivative Contracts Proposed Assumption and Assignment Procedures :7.2 Termination and Settlement Procedures [A] Summary of Motion to Force Alternative [B] Dispute Resolution for Derivatives Summary of Lehman Brothers Proposed Alternative Dispute Resolutions Procedures [B][1] Derivatives ADR Counterparties [B][2] Derivatives ADR Disputes [B][3] Notice/Response Stage [B][4] Request for Initial Settlement Conference [B][5] Mediation Stage [B][6] Other Important Provisions Chapter 8 Best Practices Recommendations 8:1 Overview :2 Events of Default :2.1 Default Under Specified Transactions :2.2 Cross-Default :2.3 Bankruptcy Event of Default :3 Termination Events :3.1 Credit Event Upon Merger :3.2 Force Majeure :4 Collateral Arrangements :4.1 Credit Support Annex :4.2 Alternative Security Arrangements :4.3 UCC Filings and Search Reports :5 Declaration of Early Termination Date :6 Foreclosure of Collateral :7 Bankruptcy Considerations :8 Other Legal Risk Mitigation Provisions Chapter 9 Current Developments 9:1 General Review of Systemic Risk and Regulatory Developments :2 Dodd-Frank Act and OTC Derivatives xviii

9 Table of Contents 9:2.1 Regulator :2.2 Key Dodd-Frank Swap Definition :2.3 Categorization of Swap Counterparties :2.4 Swap Repositories :2.5 Exempted Swaps Under Treasury Exemption :2.6 Clearing of OTC Derivatives :2.7 CFTC External Business Conduct Rules/August 2012 Protocol :2.8 LEI Numbers :2.9 Portfolio Reconciliation and Risk Disclosure/March 2013 Protocol :2.10 Corporate End-User Exemption :2.11 Inter-Affiliate Exemption :3 Implications of the Dodd-Frank Act and EMIR :4 Conclusion Appendix A Early Termination Forms... A-1 Appendix A1 Form of Notice of Failure to Pay or Deliver... A1-1 Appendix A2 Form of Notice of Breach of Agreement... A2-1 Appendix A3 Form of Notice of Failure to Deliver Collateral... A3-1 Appendix A4 Form of Notice of an Automatic Early Termination... A4-1 Appendix A5 Form of Notice of Event of Default... A5-1 Appendix A6 Form of Notice of Occurrence of Termination Event... A6-1 Appendix A7 Form of Notice Designating an Early Termination Date Following an Event of Default... A7-1 Appendix A8 Form of Notice Designating an Early Termination Date Following a Termination Event... A8-1 Appendix A9 Form of Short-Form Early Termination Valuation Statement Under the 1992 Master Agreement... A9-1 Appendix A10 Form of Early Termination Valuation Statement Under the 1992 Master Agreement... A10-1 (Durham, Rel. #2, 6/16) xix

10 DERIVATIVES DESKBOOK Appendix A11 Appendix A12 Appendix A13 Appendix A14 Form of Letter to Reference Market-Makers Under the 1992 Master Agreement...A11-1 Form of Close-Out Amount Statement Under the 2002 Master Agreement...A12-1 Form of Demand of Collateral...A13-1 Form of Notice of Suspension of Payment Obligations...A14-1 Appendix B Documents in In re Lehman Brothers Holdings Inc... B-1 Appendix B1 Alternative Dispute Resolution Procedures Order for Affirmative Claims of Debtors Under Derivatives Contracts, In re Lehman Brothers Holdings Inc., No (Bankr. S.D.N.Y. Sept. 17, 2009)... B1-1 Appendix B2 Order Pursuant to Sections 105 and 365 of the Bankruptcy Code to Establish Procedures for the Settlement or Assumption and Assignment of Prepetition Derivative Contracts, In re Lehman Brothers Holdings Inc., No (Bankr. S.D.N.Y. Dec. 16, 2008)... B2-1 Appendix B3 Supplemental Order Pursuant to Sections 105 and 365 of the Bankruptcy Code to Establish Procedures for the Settlement or Assumption and Assignment of Prepetition Derivative Contracts, In re Lehman Brothers Holdings Inc., No (Bankr. S.D.N.Y. Jan. 15, 2009)... B3-1 Appendix B4 Alternative Dispute Resolution Procedures for Affirmative Claims of the Debtors Under Derivatives Transactions with Special Purpose Counterparties, In re Lehman Brothers Holdings Inc., No (Bankr. S.D.N.Y. Mar. 3, 2011)... B4-1 Appendix B5 Order pursuant to Sections 105(a), 362 and 365 of the Bankruptcy Code to Compel Performance of Contract and to Enforce the Automatic Stay, In re Lehman Brothers Holdings Inc., No (Bankr. S.D.N.Y. Sept. 17, 2009)... B5-1 xx

11 Table of Contents Appendix B6 Appendix B7 Appendix B8 Appendix B9 Amended Order Providing for Alternative Dispute Resolution Procedures for Affirmative Claims of the Debtors Under Derivatives Transactions with Special Purpose Vehicle Counterparties, In re Lehman Brothers Holdings Inc., No (Bankr. S.D.N.Y. July 18, 2012)... B6-1 Transcript of Omnibus Hearing Held on 09/15/09, In re Lehman Brothers Holdings Inc., No (Bankr. S.D.N.Y. Sept. 15, 2009)... B7-1 Metavante Corporation s Motion to Alter or Amend the Court s Order Granting Lehman Brothers Special Financing Inc. and Its Affiliated Debtors Motion to Compel Performance and Enforce the Automatic Stay, In re Lehman Brothers Holdings Inc., No (Bankr. S.D.N.Y. Sept. 25, 2009)... B8-1 Declaration of Daniel Ehrmann in Support of Debtors Motion for Approval of a Settlement Agreement with Metavante Corporation (Bankr. S.D.N.Y. Mar. 24, 2010)... B9-1 VOLUME 2 Table of Chapters...vii Appendix C Key Legislation, Regulation and Litigation... C-1 Appendix C1 Wall Street Transparency and Accountability Act of 2010, Pub. L. No , 124 Stat (2010)...C1-1 Appendix C2 CFTC Swap Data Recordkeeping and Reporting Requirements, 17 CFR Part 45 (2011)...C2-1 Appendix C3 CFTC Business Conduct Standards for Swap Dealers and Major Swap Participants with Counterparties, 17 CFR Parts 4 and 23 (2012)...C3-1 (Durham, Rel. #2, 6/16) xxi

12 DERIVATIVES DESKBOOK Appendix C4 Appendix C5 Appendix C6 Appendix C7 Appendix C8 Appendix C9 Appendix C10 Appendix C11 Appendix C12 CFTC Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants, 17 CFR Parts 1, 3, and 23 (2012)...C4-1 CFTC Swap Data Recordkeeping and Reporting Requirements: Pre-Enactment and Transition Swaps, 17 CFR Part 46 (2012)...C5-1 CFTC and SEC, Further Definition of Swap, Security-Based Swap, and Security-Based Swap Agreement ; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 17 CFR Parts 230, 240 and 241 (2012)...C6-1 CFTC Confirmation, Portfolio Reconciliation, Portfolio Compression, and Swap Trading Relationship Documentation Requirements for Swap Dealers and Major Swap Participants, 17 CFR Part 23 (2012)...C7-1 CFTC End-User Exception to the Clearing Requirement for Swaps, 17 CFR Part 39 (2012)... C8-1 Regulation (EU) No 648/2012 of the European Parliament and of the Council of the European Union on OTC Derivatives, Central Counterparties and Trade Repositories (4 July 2012) [hereinafter EMIR]...C9-1 EMIR Implementing Regulation No 1247/2012, Laying Down Implementing Technical Standards for the Format and Frequency of Trade Reports to Trade Repositories (2012)...C10-1 EMIR Implementing Regulation No 1248/2012, Laying Down Implementing Technical Standards for the Format of Applications for Registration of Trade Repositories (2012)...C11-1 EMIR Implementing Regulation No 1249/2012, Laying Down Implementing Technical Standards for the Format of the Records to Be Maintained by Central Counterparties (2012)...C12-1 xxii

13 Table of Contents Appendix C13 EMIR Delegated Regulation No 148/2013 Supplementing EMIR Regarding the Regulatory Technical Standards on the Minimum Elements of the Data to Be Reported to Trade Repositories (2013)...C13-1 Appendix C14 EMIR Delegated Regulation No 149/2013 Supplementing EMIR in Relation to the Regulatory Technical Standards Relating to Indirect Clearing Arrangements, the Clearing Obligation, the Public Register, Access to a Trading Venue, Non-Financial Counterparties and Risk Mitigation Techniques Applicable for OTC Derivative Contracts Not Cleared by a Central Counterparty (2013)...C14-1 Appendix C15 EMIR Delegated Regulation No 150/2013 Supplementing EMIR in Relation to the Regulatory Technical Standards Specifying the Details of the Application for Registration as a Trade Repository (2013)...C15-1 Appendix C16 EMIR Delegated Regulation No 151/2013 Supplementing EMIR Regarding the Regulatory Technical Standards Specifying the Data to Be Published and Made Available by the Trade Repositories and Operational Rules for Aggregation Comparing and Accessing the Data (2013)...C16-1 Appendix C17 EMIR Delegated Regulation No 152/2013 Supplementing EMIR in Relation to the Regulatory Technical Standards on Capital Requirements for Central Counterparties (2013)...C17-1 Appendix C18 EMIR Delegated Regulation No 153/2013 Supplementing EMIR in Relation to the Regulatory Technical Standards Relating to the Requirements to Be Met by Central Counterparties (2013)...C18-1 Appendix C19 In re Lehman Brothers Holdings Inc. v. BNY Corporate Trustee Services Limited, 2010 WL (Bankr. S.D.N.Y. Jan. 25, 2010)...C19-1 Appendix C20 Lehman Brothers Holdings Inc., et al. v. Ballyrock ABS CDO Limited, et al., 452 B.R. 31 (Bankr. S.D.N.Y. 2011)...C20-1 (Durham, Rel. #2, 6/16) xxiii

14 DERIVATIVES DESKBOOK Appendix C21 Transcript of Peregrine Fixed Income Limited v. Robinson Department Store plc, Q.B. (Commercial Division) (18 May 2000)... C21-1 Appendix C22 Lomas (Together the Joint Administrators of Lehman Brothers International (Europe)) v. JFB Firth Rixson Inc. & Ors; Lehman Brothers Special Financing Inc. v. Carlton Communications Ltd; Pioneer Freight Futures Company Limited (in liquidation) v. Cosco Bulk Carrier Company Ltd; Britannia Bulk Plc (in liquidation) v. Bulk Trading S.A. [2012] EWCA Civ 419 (03 April 2012)...C22-1 Appendix C23 Drexel Burnham Lambert Prods. Corp. v. MCorp, 1991 WL (Del. Super. Ct. 1991)...C23-1 Appendix C24 Australia and New Zealand Banking Group Ltd v. Société Genérale, [200] EWCA (Civ) 44...C24-1 Appendix C25 Enron Australia v. TXU Electricity [2003] NSWSC C25-1 Appendix C26 Lehman Brothers Finance S.A. (In Liquidation) v. Sal. Oppenheimer Jr. & Cie. KGAA [2014] EWHC C26-1 Appendix C27 Anthracite Rated Investments (Jersey) Limited v. Lehman Brothers Finance S.A. [2011] EWHC 1822 (Ch)...C27-1 Appendix C28 Fondazione Enasarco v. Lehman Brothers Finance S.A. [2015] EWHC 1307 (Ch)...C28-1 Table of Cases...T-1 Index... I-1 xxiv