Derivatives Covering the Risk

Transcription

1 2008 ANNUAL MEETING AND EDUCATION CONFERENCE American College of Investment Counsel New York, NY Derivatives Covering the Risk 2:45 p.m. - 4:00 p.m. October 23, 2008 MODERATOR: James M. Cain Sutherland Asbill & Brennan LLP PANELISTS: Brett Pacific Sun Capital Advisers LLC Brenda J. Page The Hartford Financial Services Group, Inc. Malcolm G. Pittman John Hancock Financial Services, Inc.

2 MEMORANDUM October 8, 2008 TO: FROM: RE: ACIC Participants James M. Cain Robin J. Powers Richard E. Grant Use of the ISDA Master Agreement for the Documentation of Equity, Credit, FX and Commodity Transactions Over-the-counter ( OTC ) derivatives Transactions 1 in today s financial markets cover a myriad of products, from basic interest rate swaps, credit default swaps and equity options to foreign exchange transactions and even weather-based derivatives. Transactions involving each of these diverse products may be documented using the Master Agreements published by the International Swaps and Derivatives Association, Inc. ( ISDA ) - either the 1992 Master Agreement (Multicurrency Cross Border) (the 1992 Agreement ) or 2002 Master Agreement ( 2002 Agreement ). One of the primary reasons for using ISDA documentation is that these agreements reduce the time and expense involved in negotiating OTC Transactions by providing a standardized form of contract that governs the credit and legal relationship the between the two parties. In addition, documenting Transactions of different types under the ISDA Master Agreement reduces counterparty credit risk with respect to the various types of Transactions entered into between the parties. In the event of an early termination of the ISDA Master Agreement, all Transactions under the Master Agreement between the parties, whether relating to interest rate swaps, FX, equity, credit or commodity 2 options are aggregated and netted to a single amount. This contrasts with the possibility that a party documenting trades under separate agreements could be required to make a payment to its counterparty under various types of transactions (e.g., FX transactions or equity transactions) while it is unable to collect funds due from the counterparty under other transactions (e.g., interest rate swap or commodity Transactions). Even if the only Transactions entered into between the parties are related to a single product, such as credit default swaps, use of the ISDA Master Agreement ensures that in the event of a default by a counterparty, all such Transactions will be subject to a single netting agreement. 1 Unless otherwise indicated, capitalized terms used herein are as defined in the 1992 ISDA Master Agreement (Multicurrency Cross Border). We have focused on the 1992 Agreement in this memorandum because it is still the most widely used version. 2 Although this is the standard, cross product netting can be limited in the Schedule.

3 Set forth below are some general considerations when using the ISDA Master Agreement for different types of Transactions. Impossibility and Force Majeure. The 1992 Agreement does not contemplate the ability of the parties to terminate a particular Transaction on a nonfault basis due to impossibility or force majeure (e.g., war, so-called Acts of God, and market disruptions) other than those which arise due to an Illegality (a change in law after the execution of the Transaction that makes performance unlawful). The FX and commodity markets have typically taken into account the need to consider nonfault termination for events that fall short of an Illegality but are still events beyond the control of the parties to the relevant Transaction. 3 However, Force Majeure is included as a Termination Event in the 2002 Agreement. Derivatives counterparties may insist on some provision regarding impossibility or force majeure in their 1992 Agreements. While such provisions do provide a means for parties to unwind Transactions in extreme conditions without triggering an Event of Default and the early termination of all Transactions documented under the 1992 Agreement, the downside of such provisions is that they are broadly written and do not typically take into account appropriate alternatives to nonfault termination or for calculating payments in such conditions. ISDA Definitions. Although the 1992 and 2002 Agreements provide a uniform starting point for structuring OTC derivatives contracts between counterparties, each agreement should be negotiated to address the types of Transactions expected to be covered under the agreement. In particular, agreements that will control equity, credit, FX and commodity derivatives Transactions should be modified to incorporate the ISDA definitions specific to each product and relevant legal issues. The current definitional booklets for these products are: the 2002 ISDA Equity Derivatives Definitions (the Equity Definitions ), the 2003 ISDA Credit Derivatives Definitions and the May 2003 Supplement to the 2003 ISDA Credit Derivatives Definitions (together, the Credit Derivatives Definitions ), the 1998 FX and Currency Option Definitions (the FX Definitions ) and the 2005 ISDA Commodity Derivatives Definitions (the Commodity Definitions ). 4 Several of the ISDA definitions consist of a booklet containing provisions that are not expected to change frequently and a separate binder or booklet which contains provisions that are expected to be supplemented, such as reference prices and rates. ISDA posts these supplements on its website. In addition to incorporating the relevant ISDA definitions, a number of product-specific modifications should be considered in the negotiation of any Master Agreement covering equity, credit, FX or commodity Transactions. Loss Instead of Market Quotation. One of the major decisions to be made with respect to Transactions under the 1992 Agreement 5 is the method for determining early termination payments as a result of a party s Event of Default or the occurrence of a non-fault 3 The ISDA User s Guide to the 1992 ISDA Master Agreements provides that Impossibility can be added as a Termination Event in the Schedule. In addition, since the advent of the 2002 Agreement, many market participants have included that agreement s Force Majeure provision in lieu of Impossibility provisions. See Annex A 4 Some Schedules may incorporate the 2006 ISDA Definitions to the extent items are not addressed in the relevant definitions, e.g., floating interest rate indices. Any conflict between the two sets of definitions will be resolved by looking to the product-specific definitions. 5 Under the 2002 Agreement only one method for valuing Terminated Transactions, Close Out Amount, is contemplated. However, parties could modify the Schedule to a 2002 Agreement to use other methods of valuation. 3

4 Termination Event (e.g., due to taxes or an illegality). For interest rate and vanilla, liquid, swap Transactions, Market Quotation is the typical method chosen to determine the early termination payment (if no method of calculation is designated in the Schedule or Confirmation, Market Quotation will be the method assumed in the 1992 Agreement for such calculation). In less liquid and more complex transactions, however, Loss often is selected by the parties as the payment measure in the event of early termination, as market quotes may be difficult to obtain for certain types of Transactions, such as for commodities. Loss is a general indemnification provision; a party determines payments on early termination by reasonably calculating in good faith its aggregate total losses and gains under either (i) all Transactions under a 1992 Agreement (in the case of an Event of Default) or (ii) the designated Affected Transactions (in the case of a Termination Event). In the Schedule, a party may wish to specify Market Quotation or Loss as the method for generally determining early termination payments dependant on the type of Transactions to be entered into under the particular 1992 Agreement. Variations of this general methodology could be made in particular Confirmations. Alternatively, the method for determining early termination payments could be specified in the relevant Confirmation, varying the method by Transaction, if it is anticipated that various types of Transactions will be entered into under the relevant 1992 Agreement. Disruption Events. A significant concept in the various ISDA Definitions are provisions concerning Market Disruption Events (Equity and Commodity Transactions) or Disruption Events (FX Transactions) and Disruption Fallbacks. These provide a specific method for allocation of particular event risks by setting forth an agreed-upon method for determining rates or settling a Transaction upon the occurrence of such events. These events and fallbacks can be varied depending on the types of Transactions involved, and are intended to be designated in the Confirmation for a particular Transaction although many parties choose to designate these in the Schedule to their Master Agreement. There are certain presumptive Disruption Fallbacks dependant upon which Disruption Event occurred which will apply unless the parties agree otherwise in a Schedule or Confirmation. Documenting multiple types of Transactions under the ISDA Master Agreement also introduces the potential for premature termination of outstanding unrelated Transactions if unanticipated events occur in one market that result in an Event of Default and early termination under the Master Agreement. For this reason, some parties may decide to document different types of Transactions under separate ISDA Master Agreements. This memorandum summarizes some of the suggested modifications to the 1992 Agreement that may be incorporated into the Schedule of a 1992 Agreement and other considerations for equity, credit, FX and commodity Transactions. 6 In addition, attached are a number of Annexes providing a more detailed description of product-specific considerations, as well as sample provisions for each product. 6 As noted above, we have focused on the 1992 Agreement in this memorandum because it is still the most widely used version of ISDA documentation. Product-specific modifications identified herein may also be used for the 2002 Agreement, although some adaptation may be required. 3

5 Equity Derivatives Equity derivatives provide synthetic exposure to gains or losses on specific securities, indices, and baskets of securities and indices on physical equities. In an equity swap, the return on the underlying share is exchanged for a return based on a reference interest rate or yield. Incorporation of the Equity Definitions. Confirmations relating to equity Transactions generally incorporate the Equity Definitions. The Equity Definitions cover options, swaps and forwards relating to share and share baskets and indices and index baskets. A chart showing the key provisions of the Equity Definitions appears in Annex B. Securities Law Issues. Derivatives relating to equity securities raise issues under federal and state securities laws and the Commodity Exchange Act (the Exchange Act ) that differ significantly from those raised by derivatives involving other underlying interests. These issues, discussed below, should be addressed through modifications to the relevant Schedule. The Commodities Futures Modernization Act of 2000 expressly excludes from the definition of security under the Securities Exchange Act of 1934 (the Securities Act ) and the Exchange Act (collectively, the Acts ) equity swaps between eligible contract participants, the material terms of which are subject to individual negotiation. Equity swaps are instead deemed security-based swaps, and as such, remain subject to fraud, manipulation and insider trading prohibitions of the Acts (including certain rules thereunder). Additional issues may arise under the Acts if equity swaps are entered into with the issuer of the underlying equity, persons that are affiliates or insiders of the issuer or persons that are hedging positions in shares that are Restricted Securities for purposes of the Securities Act. In particular, questions may arise as to whether sale of the underlying stocks in the public market as part of the hedging activity relating to such Transactions would be required to be registered under the Securities Act. Accordingly, such Transactions are typically structured to minimize the risk that the related hedging activity could be characterized as an unregistered distribution of securities. Even where a counterparty is not an issuer, affiliate or holder of restricted securities, equity swaps may raise additional issues under the securities laws particularly for intermediaries such as broker-dealers or for investment advisors. As previously noted, equity swaps remain subject to the fraud, manipulation and insider trading prohibitions of the Act. Consequently, entering into or terminating an equity swap while in possession of material nonpublic information concerning the issuer of the underlying securities would generally violate the Exchange Act. Equity swaps and hedging activity may also be subject to reporting on Schedule 13D under the Exchange Act. The primary method for addressing the securities law issues connected to equity Transactions is through representations made in the Schedule. In addition to the standard representations that are incorporated into Section 3 of the ISDA Master Agreement, and the additional representations in the Equity Definitions, many Confirmations, or Part 6 provisions 3

6 relating to equity derivative transactions contain specific Securities Act representations to address the regulatory considerations discussed above. For an example of a Part 6 provision containing these representations, see Annex C. Confirmations. The individual Confirmations executed under a Master Agreement contain a majority of the decisions that must be made with respect to equity Transactions. Upon publishing the 2002 Equity Definitions, ISDA posted 18 forms of Confirmation templates on its website. At present a Tax Considerations. There are also significant tax considerations with respect to equity, derivatives, notably whether or not a transaction constitutes a sale of a security and the timing of taxable gains or losses. As with respect to any derivatives transactions, an appropriate tax analysis should be done and whether tax provisions need to be modified or included in the ISDA Master Agreement should be considered. Credit Derivatives A credit derivative is a derivative whose value derives from the credit risk on an underlying bond, loan or other financial asset. The section below presents several questions to consider when drafting a Confirmation for a credit derivative Transaction. Incorporation of the Credit Derivatives Definitions. Counterparties entering into credit derivative Transactions under ISDA documentation should ensure that the Credit Derivatives Definitions (including the May 2003 Supplement) are incorporated into their Master Agreement in order to gain the benefit of credit derivative-specific terms contained in those definitions. When entering into credit derivative Transactions, counterparties should be aware of material provisions of the Credit Derivatives Definitions, including the default provisions of such definitions. Additionally, counterparties should carefully construct Confirmations to accurately reflect their intentions, including the opting out of any undesirable default provisions of the Credit Derivatives Definitions Matrix Supplement to the 2003 ISDA Credit Derivatives Definitions. In March 2005, ISDA published the 2005 Matrix Supplement to the 2003 ISDA Credit Derivatives Definitions (the Matrix Supplement ) to set out certain elections applicable to Reference Entities under credit derivative Transactions where Physical Settlement is applicable. The Matrix Supplement allows parties who wish to enter into a physically settled credit derivative Transaction to incorporate the terms contained in the Credit Derivatives Physical Settlement Matrix (the Physical Settlement Matrix ). The Physical Settlement Matrix sets out the terms under different Transaction Types, including market location and counterparty type (e.g. North American, European, Asia, Japan; Corporate, Sovereign and U.S. Municipals) and is updated from time to time. Currently, the Physical Settlement Matrix has been updated six times, most recently on June 9,

7 Counterparties can incorporate the Physical Settlement Matrix by referencing the Physical Settlement Matrix and specifying a Transaction Type that is included in the Physical Settlement Matrix in a Confirmation. Unless otherwise specified, the most recent version of the Matrix Supplement in effect before the Trade Date of the relevant Transaction will be applicable. However, an amended or supplemented Physical Settlement Matrix is not applied retroactively to Transactions documented prior to its publication date, unless counterparties specifically agree otherwise. Confirmations. ISDA published in June 2003 a Master Credit Derivatives Confirmation (the Master Confirmation ) which is intended to be used for North American and European Transactions. The Master Confirmation aims to streamline the confirmations process and incorporates the 2003 ISDA Credit Derivatives Definitions and the May 2003 Supplement. A General Terms Confirmation and Transaction Supplement is also offered. When entering into a credit derivative Transaction, counterparties should draft the Confirmation to ensure that the terms of the Transaction accurately reflect the parties intentions, including the opting out of any undesirable default provisions. Parties should be particularly aware that Default Requirements and Payment Requirements are set at default levels if the Credit Definitions are incorporated into a Master Agreement, unless the parties specify otherwise in a Confirmation. A discussion of key considerations for credit derivative Confirmations is attached as Annex D. FX Transactions As discussed above, use of the 1992 Agreement for different types of Transactions should permit the personnel responsible for documentation to be more confident that a large part of the legal relationship with individual counterparties is consistent. However, utilizing ISDA documentation for FX Transactions introduces a degree of complexity to the ISDA documents and may require additional legal and operational resources to ensure that Transactions are properly documented. For example, the preparation of Confirmations for FX Transactions utilizing the FX Definitions may entail more active deliberation and decisionmaking than the preparation of Confirmations for interest rate swaps or other derivative transactions. Incorporation of the FX Definitions. By incorporating the FX Definitions, certain presumptions that exist under the 1992 Agreement will change. In addition, the forms of Confirmations used to document the FX Transactions must take into account the type of Transactions entered into by the party. Business Day Definition and Presumptions. The FX Definitions anticipate potentially different Business Days for different currencies, as well as for various dates relating to a particular Transaction. The presumptions relating to Business Days under the FX Definitions are set forth in Annex E. Disruption Events and Disruption Fallbacks. Another significant concept introduced in the FX Definitions are provisions concerning Disruption Events and Disruption Fallbacks. These provide a more specific method for allocation of particular event risks by setting forth an agreed-upon method for determining exchange rates or settling a Transaction 3

8 upon the occurrence of such events. These events and fallbacks can be varied depending on the currencies and Transactions involved, and are intended to be designated in the Confirmation for a particular Transaction. There are certain presumptive Disruption Fallbacks dependant upon which Disruption Event occurred. The Disruption Events, Disruption Fallbacks and the relevant presumptions are set forth in Annex F. It is important to understand the appropriate Disruption Events/Disruption Fallbacks to be designated with respect to particular FX Transactions. (This is particularly the case where the parties have not agreed to general language regarding impossibility and force majeure.) Although it may be possible to make general designations in the Schedule to the 1992 Agreement, it is more typical that such designations are made in individual Confirmations. The other significant contribution made by the FX Definitions is the inclusion of currency spot rate definitions that can be used for settling Non-Deliverable Transactions (i.e., Transactions settled in a currency designated by the parties, usually the U.S. dollar or some other nonvolatile currency). Annex A to the FX Definitions includes a list of currency-specific Settlement Rate Options that ISDA updates periodically, as well as general Settlement Rate Options which are not currency-specific. A summary of the general Settlement Rate Options is set forth in Annex G. In connection with using the ISDA documentation for FX Transactions, parties will need to consider which Disruption Events and Settlement Rate Options they will designate for particular Transactions, and whether to include impossibility or force majeure. In addition to taking into account the particular currencies involved, these decisions will vary and will be dependent upon whether the Transaction is Deliverable (i.e., requires payment in the currency subject to the FX Transaction) or is Non-Deliverable. Annex H includes a Part 6 for FX Transactions that may be added to the Schedule. We have included tailored Disruption Events; however, each party should consider whether adding these would be appropriate for its Transactions. Confirmations. Most of the decisions to be made in the ISDA FX documentation structure takes place within the Confirmation of the Transaction. We would recommend that each party to a derivatives transaction establish basic forms of Confirmation for the typical Transactions into which they will be entering. As a starting point, those would include two for currency options--one Deliverable and one Non-Deliverable and two for FX forward transactions--one Deliverable and one Non-Deliverable. As to the latter, the more exotic (i.e., less liquid or stable) the currency, the more likely Non-Deliverable would be a desired option and Disruption Events would be a significant consideration. Commodity Transactions Commodity Transactions, much like the OTC products mentioned above, bring forth unique issues that require modification of standard ISDA documentation. 3

9 Incorporation of Commodity Definitions. To be used for Commodity Transactions, the Schedule must incorporate the Commodity Definitions to take advantage of commodity-related definitions as well as a relevant menu of options for such Transactions. Adequate Assurance. Historically, it has been typical in the commodities markets to post margin or collateral with respect to market exposure. This concept has carried over into the ISDA documentation of commodity Transactions in the form of certain credit-related termination triggers that often are included in the Schedule. These include an Additional Termination Event due to a rating agency credit downgrade or the inclusion of a provision that a party provide adequate assurance of its ability to perform (typically, posting collateral) if the other party has reasonable grounds for insecurity. ISDA Credit Support Annexes, letters of credit and other collateral arrangements are commonly requested by counterparties. Although the Schedule may not contemplate these sorts of provisions, each derivatives counterparty should anticipate that such provisions will be suggested for 1992 Agreements relating to commodity Transactions. By incorporating the Commodity Definitions, certain presumptions that otherwise exist under the 1992 Agreement may change and certain choices may need to be made by the party entering into such agreement. Market Disruption Events and Disruption Fallbacks The most significant concepts included in the Commodity Definitions are provisions concerning Market Disruption Events and Disruption Fallbacks. As opposed to more general impossibility and force majeure provisions, these ISDA provisions provide a more specific method for allocation of particular event risks by setting forth an agreed upon method for determining Commodity prices or settling a Transaction upon the occurrence of particular events. These events and fallbacks can be varied depending on the type of Transactions involved. The intended purpose of Market Disruption Events is to provide a means to arrive at a price when the market fails to clearly do so. In connection with using the ISDA documentation for its Transactions, each party will need to consider which Market Disruption Events and alternate Commodity Price Sources 7 it will also designate for particular Transactions and whether to include impossibility or force majeure. Assuming that a party would typically determine to designate these more specific events and fallbacks, we suggest specifying in a Part 6 to the Schedule that certain Market Disruption Events and Disruption Fallbacks will apply to all Transactions unless otherwise specified in the Confirmation. If Disruption Fallbacks are not specified by the parties in the Schedule or relevant Confirmation, certain Disruption Fallbacks will be presumed to have been designated depending upon which Market Disruption Event occurred. The Market Disruption Events, Disruption Fallbacks and the relevant presumptions are set forth in Annex I. In addition to taking into account party preferences and the particular Commodities involved, these decisions will vary and will be dependant upon whether the Transaction is to be physically delivered or cash-settled. As noted above, the Commodity Definitions do not include all of the provisions necessary for physical settlement and provide that for typical physical delivery contracts the Market Disruption Events will not apply. 7 See Annex J for alternate Commodity Price Sources. 3

10 Commodity Reference Prices. Another major area on which parties to Commodity Transactions will need to focus is the appropriate Commodity Reference Prices for its Transactions. The Commodity Definitions currently include reference prices for agricultural products, energy, freight, metals, paper, composite commodity indices, bullion, weather and physical gas transactions in Europe. Under the Commodity Definitions, parties can specify additional Commodity Reference Prices by setting forth certain designated information, as indicated in Annex J. These could be included in the Schedule or in a Confirmation. Confirmations Since many of the decisions to be made in the ISDA Commodity documentation structure take place within the Confirmation of the Transaction, we would recommend establishing basic forms of Confirmation for the typical Commodity Transactions to be entered into by each party. 8 Some of the terms used by ISDA for the Confirmations are selfevident. However, as is often the case with ISDA documentation, many others require reference to the Commodity Definitions. In Annex K are guides explaining the different types of Confirmations that should help clarify documentation differences between options and swaps and should make clear how parties may document Market Disruption Events and Additional Market Disruption Events. We have used Commodity Reference Prices included in the Commodity Definitions, and modifications will need to be made to take into account the particular commodities used by each party to a Commodity Transaction. 8 It is important to always be aware that the terms of a Confirmation can amend the terms of the ISDA Master Agreement and the Schedule. 3

11 ANNEX A IMPOSSIBILITY AND FORCE MAJEURE ISDA Impossibility Provision: (vi) Impossibility. Due to the occurrence of a natural or man-made disaster, armed conflict, act of terrorism, riot, labor disruption or any other circumstance beyond its control after the date on which a Transaction is entered into, it becomes impossible (other than as a result of its own misconduct) for such a party (which will be the Affected Party): (1) to perform any absolute or contingent obligation, to make a payment or delivery or to receive a payment or delivery in respect of such Transaction or to comply with any other material provision of this Agreement relating to such Transaction; or (2) to perform, or for any Credit Support Provider of such party to perform, any contingent or other obligation which the party (or such Credit Support Provider) has under any Credit Support Document relating to such Transaction. Sample Force Majeure Provision ( ) The Additional Termination Event provision of Section 5(b)(v) will apply with respect to the following Additional Termination Event: (i) Force Majeure Event. After giving effect to any applicable provision, disruption fallback or remedy specified in, or pursuant to, the relevant Confirmation or elsewhere in this Agreement, by reason of force majeure or act of state occurring after the date on which a Transaction is entered into, on any day: (a) the Office through which such party (which will be the Affected Party) makes and receives payments or deliveries with respect to the relevant Transaction, as evidenced in the relevant Confirmation or in another effective form, is prevented from making or receiving any payment or delivery in respect of such Transaction (or would be so prevented if such payment or delivery were required on that day), or it becomes impossible or impracticable for such Office of such party to make or receive any such payment or delivery (or it would be impossible or impracticable for such Office of such party to make or receive such payment or delivery if such payment or delivery were required on that day); (b) any Credit Support Provider of such party (which will be the Affected Party) is prevented from performing any contingent or other obligation which such Credit Support Provider has under any Credit Support Document relating to such Transaction (or would be so prevented if performance were required on that day), or it becomes impossible or impracticable for any Credit Support Provider

12 of such party to perform any such obligation (or it would be impossible or impracticable for such Credit Support Provider to perform such obligation if performance were required on that day); (c) such party (which will be the Affected Party) is prevented from paying or receiving any Early Termination Amount following the occurrence of an Early Termination Date in respect of such Transaction, or it becomes impossible or impracticable for such party to make or receive any such payment; or (d) any Credit Support Provider of such party (which will be the Affected Party) is prevented from making any payment, pursuant to any Credit Support Document, to be made by it in respect of any Early Termination Amount following the occurrence of an Early Termination Date in respect of such Transaction, or it becomes impossible or impracticable for any Credit Support Provider of such party to make any such payment, so long as (x) the force majeure or act of state is beyond the control of such Office of such party, such party or such Credit Support Provider, as appropriate, and such Office of such party, such party or such Credit Support Provider could not, after using all reasonable efforts prior to the end of the relevant Waiting Period (which will not require such party or Credit Support Provider to incur a loss, other than immaterial, incidental expenses), overcome such force majeure or act of state and (y) the relevant Waiting Period has expired; (ii) Definitions (a) The definition of Affected Transactions in Section 14 of this Agreement is amended by adding the word Force Majeure Event immediately after the word Illegality in the first line thereof. (b) The following new definitions are added to Section 14: Scheduled Local Business Day means any day that would have been a Local Business Day but for the occurrence of the Force Majeure Event. Waiting Period means the three (3) Scheduled Local Business Days immediately following the occurrence of the Force Majeure Event. (c) Market Quotation shall apply in respect of an Early Termination Date resulting from a Force Majeure Event, irrespective of any payment measure otherwise applicable under this Agreement. In addition, notwithstanding anything to the contrary in this Agreement, the Calculation Agent will determine the amount payable in respect of such Early Termination Date as if the other party were the sole Affected Party, provided, however, that the Calculation Agent shall request Reference Market-makers to provide mid-market quotations. 3

13 (d) If an event or circumstance which would otherwise constitute or give rise to an Event of Default also constitutes a Force Majeure Event, it will be treated as a Termination Event and will not constitute an Event of Default. If an event or circumstance which would otherwise constitute or give rise to an Illegality also constitutes a Force Majeure Event, it will be treated as a Force Majeure Event. (e) If an event or circumstance that would otherwise constitute or give rise to an Illegality or, if applicable, a Force Majeure Event also constitutes a Disruption Event that is applicable to that Transaction, then such event or circumstance will be treated as a Disruption Event and will be deemed not to constitute an Illegality or Force Majeure Event. 3

14 ANNEX B TRADING ISSUES AFFECTING EQUITY DERIVATIVES DOCUMENTED UNDER THE 2002 ISDA EQUITY DERIVATIVES DEFINITIONS PRODUCTS Equity Options Equity Swaps Forwards Barriers 2002 DEFINITIONS Three Options Styles are available American, European and Bermuda Option Two types of Equity Swap are available: Total Return and Price Return. These can only be Cash Settled. [Shares and Share Basket Swaps can be Physically Settled. Initial and Final Exchange Amounts may also be specified.][?] Provisions for documenting pre-paid, post-paid, variable and fixed obligation Forwards. Knock-in and Knock-out Event and Price concept included. EXERCISE, VALUATION AND MARKET DISRUPTION EVENTS Exercise An option can be exercised on any Scheduled Trading Day during the Exercise Period. A Scheduled Trading Day is a day on which the Exchange and any Related Exchange are scheduled to be open for trading during their regular trading sessions, regardless of whether the Exchange or Related Exchange actually opens for trading on that day. Valuations, Physical Settlement and Market Disruption If a Market Disruption Event occurs on a date that would otherwise be a Valuation Date, the Valuation Date is postponed for a maximum of eight consecutive Exchange Business Days. Valuation Date must be a Disrupted Date : a day on which a Market Disruption Event occurs or a Scheduled Trading Day on which the Exchange or Related Exchange fails to open. These provisions are also applicable to Expiration Dates and Potential Exercise Dates, so Market Disruption also applies to Physically Settled and Bermudan trades. Definition of Market Disruption Event Three categories of Market Disruption Event are recognized: Trading Disruption; Exchange Disruption; Early Closure Exchange Disruption : an event that disrupts or impairs market participants ability to transact on the Exchange or Related Exchange. Early Closure : the closure of the Exchange or Related Exchange prior to its Scheduled Closing Time without at least one hour notice. The Calculation Agent must deem that a Trading Disruption or Market Disruption is material. Such Disruption must occur in the one hour prior to the Valuation/Latest Exercise Time.

15 Definition of Merger Event: Merger Date: Tender Offers: MERGER EVENTS AND TENDER OFFERS A Merger Event is a reclassification, consolidation, amalgamation, merger or other takeover offer. Merger Event also includes Reverse Mergers, in which the shareholders of the original Issuer (who will be the surviving entity of the merger) own less than 50% of the surviving entity s Shares following the Merger Event. The closing date of the Merger Event (or, if the closing date cannot be determined by the local law applicable to the Merger Event, such other date determined by the Calculation Agent). Tender Offers that result in a transfer of 100% of the Shares are defined as Merger Events. Tender offers for more than 10% but less than 100% of the Shares are covered under the Tender Offer election provisions. If Tender Offer is elected to be Applicable, the parties must specify the consequence that will apply on the Tender Offer Date (ie: the date of completion of the Tender Offer). New Shares: Consequences of Merger Events and Tender Offers: Alternative Obligation: Cancellation and Payment: New Shares means ordinary or common share, whether of the entity or person (other than the Issuer) that are, or that as of the Merger Date are promptly scheduled to be (i) publicly quoted, traded or listed on an exchange or quotation system located in the same country as the Exchange (or, where the Shares have been listed on an exchange or quotation system within the European Union, in any member state of the European Union) and (ii) not subject to any currency exchange controls, trading restrictions or other trading limitations. CONSEQUENCES OF MERGER EVENTS & TENDER OFFERS Alternative Obligation (not applicable to Tender Offer) Cancellation and Payment Options Exchange Adjustment Calculation Agent Adjustment Modified Calculation Agent Adjustment Partial Cancellation and Payment Component Adjustment On the Merger Date, the consideration for the Merger will be designated to replace the Shares. The Calculation Agent is prevented from making adjustments to account solely for changes in Stock Loan Rate, liquidity, expected dividends or volatility. The Transaction will be cancelled and a termination payment will be payable by one party to the other. The parties shall agree the amount to be paid within 5 Exchange Business Days of the Announcement Date. If the parties cannot agree the amount, he termination payment may be derived by one of two methods: Agreed Model Calculation Agent Determination Agreed Model Agreed Model: Unadjusted Value + Adjusted Value Unadjusted Value is determined on the following basis: Average of the Implied Vol of the Shares on each of the 15 Exchange Business 3

16 Days ending on and including the Closing Date; Expected dividends for the time period from the Closing Date until the Expiration Date based on (a) the gross ordinary cash dividends on the shares in the one year period ending on the Closing Date or (b) in the event of an Issuer published change to dividend policy prior to the Closing Date, the expected dividends determined in accordance with that policy. NB: Extraordinary Dividends are excluded; The value of the Share (if appropriate, equal to the value of the consideration paid to holder of shares at the time of the Extraordinary Event); A combined interest rate and stock loan rate as specified in the related Confirmation for period from the Closing Date to the Expiration Date; A term of the Transaction from the Closing Date to the Expiration Date. Adjustment Value means the difference between amounts determined pursuant to 1 and 2 below: 1. the value of the Transaction determined by the Calculation Agent based on: Average of the Implied Vol of the Shares on each of the 15 Exchange Business Days ending on but excluding the Announcement Date Expected dividends for the time period from the Announcement Date until the Expiration Date based on (a) the gross ordinary cash dividends on the shares in the one year period ending on the Closing Date or (b) in the event of an Issuer published change to dividend policy prior to the Closing Date, the expected dividends determined in accordance with that policy. NB: Extraordinary Dividends are excluded; A value of the Share equal to the Settlement Price as of the Valuation Time on the Announcement Date A combined interest rate and stock loan rate as specified in the related Confirmation for period from and including the Announcement Date to but excluding the Expiration Date; A term of the Transaction from the Announcement Date to the Expiration Date. Implied Volatility: Calculation Agent Determination: Options Exchange Adjustment: Calculation Agent Adjustment: 2. a value for the Transaction based on the factors listed at 1 above except with the average Implied Vol of the relevant Shares on each of the 15 Exchange Business Days commencing on and including the Announcement Date. The implied volatility of the relevant Shares, as determined by the Calculation Agent by interpolating or extrapolating from the most comparable listed put or call option (which must be the same Option Type as the Option Transaction being cancelled), on the relevant Shares as determined by the Calculation Agent taking into account the nearest strike price, maturity and in-the-money or out-of-the-money amount, as the case may be, and such other factors that the Calculation Agent deems appropriate. To the extent that such a listed option does not exist or the Calculation Agent determines that the market for such listed option is not sufficiently liquid for the purpose of the relevant calculation, the Implied Volatility will be determined by the Calculation Agent. Calculation Agent Determination: Calculation Agent exercises discretion to make a determination in good faith and in a commercially reasonable manner. Calculation Agent will make corresponding adjustments to the exercise, settlement, payment or other terms of options on any relevant Shares that are made by the Options Exchange. Upon the completion of any Merger or Tender, the Calculation Agent will attempt to adjust the terms of the Transaction to reflect the economic impact of the Merger Event or Tender Offer on the Transaction and, if such adjustment can be made in a commercially reasonable manner, the Transaction will continue on the adjusted basis. 3

17 The Calculation Agent has discretion in the nature and amount of the adjustment to be made and can determine the date from which any adjustment would be effective. However, it is explicitly provided that the Calculation Agent may not make any adjustments to account solely for the effect of the Merger Event or Tender Offer on the volatility, Stock Loan Rate, historic dividends or liquidity of the Shares. Purpose is to ensure that Calculation Agent does not return parties to the same position prior to Merger Event or Tender Offer. If the Calculation Agent is unable to make an adjustment that would lead to a commercially reasonable result, then the Transaction will be cancelled and Cancellation and Payment - Calculation Agent Determination (as discussed above) would be deemed to apply. Modified Calculation Agent Adjustment: Partial Cancellation and Payment: Component Adjustment: Change in Law: Failure to Deliver: Insolvency Filing: Hedging Disruption Event: Very similar to Calculation Agent Adjustment, but it is explicitly provided in the MCAA election that the Calculation Agent may make any adjustments necessary to account for the effect of the Merger Event or Tender Offer on the volatility, Stock Loan Rate, historic dividends or liquidity of the Shares. If the Calculation Agent is unable to make an adjustment that would lead to a commercially reasonable result, then the Transaction will be cancelled and Cancellation and Payment - Calculation Agent Determination (as discussed above) would be deemed to apply. Applicable to Share Basket Transaction only. Upon the occurrence of any such Merger Event or Tender Offer, the portion of the Share Basket Transaction relating to the Share that has been affected by the Merger Event or Tender Offer will be cancelled and a termination payment will be payable by one party to the other. The parties must elect whether Agreed Model or Calculation Agent Determination will apply to the terminated portion. May only be elected as a consequence of a Share-for-Combined Merger Event or Tender Offer. Where the consideration is a combination of New Shares and Other Consideration the Component Adjustment election allows the parties to apply the consequence that was elected for the Share-for-Share Merger Event or Tender Offer to the New Share component of the Combined Consideration and the consequence that was elected for the Share-for-Other Merger Event or Tender Offer to the Other Consideration component of the Combined Consideration. ADDITIONAL DISRUPTION EVENTS: A change in applicable law or promulgation of new law that makes holding, acquiring or disposing of Shares relating to the Transaction illegal or results in a materially increased cost in performing obligations under the transaction. This event is triggered upon the failure of a party to deliver Shares when due, where such failure it due to illiquidity in the market for the Shares. Applies to physically settled Options, Swaps and Forwards. If Insolvency Filing is elected as applicable, a Transaction relating to Shares of an Issuer that is in the insolvency process will be terminated at the early stages of the process, upon the filing (and without a grace period), rather than waiting for the far narrower set of circumstances contemplated under the Insolvency Extraordinary Event to occur. The Hedging Party is unable, after using commercially reasonable efforts, to acquire, maintain or unwind transactions or assets necessary for hedging the equity price risk of entering and performing its obligations under the Transaction. 3

18 Increased Cost of Hedging: A Hedging Party would incur a materially increased amount (whether of tax, duty, expense or fee) to maintain or unwind Transactions or assets necessary for hedging the Transaction. In order to avoid termination of the Transaction, the Non-hedging Party can pay a Price Adjustment to cover the increased cost. Loss of Stock Borrow: Increased Cost of Stock Borrow: Consequence of Additional Disruption Events: A Hedging Party is unable, after using commercially reasonable efforts, to borrow or maintain a borrowing of the number of Shares (the Hedging Shares ) that the Hedging Party deems necessary for hedging the equity price risk of entering and performing its obligations under the Transaction at a rate equal to or less than the Maximum Stock Loan Rate. In order to avoid termination of the Transaction, the Non-hedging Party can lend, or refer the Hedging Party to a third party who will lend, the appropriate number of Shares at a rate equal to or less than the Maximum Stock Loan Rate. A Hedging Party would incur a rate to borrow or maintain a borrowing of the Hedging Shares that is greater than the Initial Stock Loan Rate. In order to avoid termination of the Transaction, the Non-hedging Party can either pay a Price Adjustment or lend or refer the Hedging Party to a third party who will lend the appropriate number of Shares at a rate equal to or less than the Initial Stock Loan Rate. Upon the occurrence of any of the Additional Disruption Events (unless, in the case of Increased Cost of Hedging, Loss of Stock Borrow or Increased Cost of Stock Borrow, an alternate stock lender is found or price adjustment is made) such Additional Disruption Event will trigger the termination of the Transaction and a subsequent payment of a Cancellation Amount by one party to the other. Cancellation Amount: Determined based on the losses of the Determining Party, which will be one or both of the parties to the Transaction, as specified in the Confirmation. Nationalisation: Insolvency: Delisting: Consequences of Nationalisation, Insolvency and Delisting: NATIONALISATION, INSOLVENCY AND DELISTING All the Shares or all the assets or substantially all the assets of an Issuer are nationalized, expropriated or are otherwise required to be transferred to any governmental agency, authority or entity By reason of the voluntary or involuntary liquidation, bankruptcy or insolvency of or any analogous proceeding affecting an Issuer, (A) all the Shares of that Issuer are required to be transferred to a trustee, liquidator or other similar official or (B) holders of the Shares of that Issuer become legally prohibited from transferring them The Exchange announces, (or has announced) that pursuant to the rules of such Exchange, the Shares cease (or will cease) to be listed, traded or publicly quoted on an exchange or quotation system located in the same country (or, where the Shares have been listed on an exchange or quotation system within the European Union, in any member state of the European Union). Cancellation and Payment: the Transaction will be cancelled as of the Announcement Date Negotiated Close-Out: the parties may, but are not obliged, to terminate the Transaction on mutually acceptable terms and if the parties do not agree to terminate the Transaction, then it continues on the terms and subject to the conditions then in effect, provided, that, any Options to which Physical Settlement is applicable will at the election of either party become Options to which Cash Settlement is applicable; 3

19 Partial Cancellation and Payment (See Consequences of Merger Events and Tender Offers above). In respect of Cancellation and Payment and Partial Cancellation and Payment, the parties can elect whether Agreed Model or Calculation Agent Determination shall apply as a fallback if the parties are unable to agree on the amount payable within 5 Exchange Business Days of the date of cancellation. Index Modification: Index Disruption: Index Cancellation: INDEX ADJUSTMENT EVENTS: The Index Sponsor announces that it will make a material change or modification to the formula or method of calculating the Index. However, if the modification is prescribed in the formula or method to maintain the Index in the event of changes in the constituent shares and their capitalisation or other routine events, then such a modification will not constitute an Index Modification On any Valuation Date relating to an Index or Index Basket Transaction, the Index Sponsor fails to calculate and announce a level for the relevant Index and such level is not calculated and announced by a successor sponsor. The Index Sponsor cancels the Index and such Index is not replaced by a successor index using, in the determination of the Calculation Agent, substantially the same formula or method for calculating the Index. Consequences of Index Adjustment Events: Calculation Agent Adjustment; Negotiated Close-out; Cancellation and Payment. 3