consider whether or not the existing FIA-E netting opinions would continue to apply if such amendments are made.

Transcription

1 Memorandum TO Futures Industry Association Europe DATE 13 November 2014 COPY TO FROM Jeremy Walter and Timothy Cleary Clifford Chance LLP FILE REF DIRECT DIAL Two-Way Margining for Client Clearing 1. Instructions 1.1 You have asked us to analyse the margining provisions in the FIA Europe ("FIA-E") documentation to consider what amendments may be required in order to provide for two-way margining in the context of client clearing under EMIR. 1.2 You have asked us to propose such amendments in a form which can also be used should Firms wish to apply two-way margining to transactions which are not being cleared through an Agreed CCP. 1.3 To the extent that any amendments are required, you have asked us to: (a) (b) (c) classify those amendments as "must haves" or "nice to haves"; consider the impact of those amendments on the netting analysis; and consider whether or not the existing FIA-E netting opinions would continue to apply if such amendments are made. 2. Executive Summary 2.1 The current margining provisions in the FIA-E documentation do not provide for twoway margining. Accordingly, amendments to that documentation are required when Firms are required to implement two-way margining with their Clients in the context of client clearing under EMIR. 2.2 The necessary amendments can be made either by way of provisions which modify and override the existing margining provisions, or by preparing a new set of CLIFFORD CHANCE LLP IS A LIMITED LIABILITY PARTNERSHIP REGISTERED IN ENGLAND AND WALES UNDER NO. OC THE FIRM'S REGISTERED OFFICE AND PRINCIPAL PLACE OF BUSINESS IS AT 10 UPPER BANK STREET LONDON E14 5JJ. THE FIRM USES THE WORD "PARTNER" TO REFER TO A MEMBER OF CLIFFORD CHANCE LLP OR AN EMPLOYEE OR CONSULTANT WITH EQUIVALENT STANDING AND QUALIFICATIONS. THE FIRM IS AUTHORISED AND REGULATED BY THE SOLICITORS REGULATION AUTHORITY.

2 margining provisions to replace the existing provisions in respect of transactions to which two-way margining is to apply. Whichever approach is adopted, the amendments are required, rather than merely being "nice to have", in order to implement two-way margining in the context of client clearing. 2.3 It is unlikely that amending the margin provisions to provide for two-way margining would have any adverse impact on the netting analysis. However, as some of the amendments would not fall within the scope of "Non-material Amendments" for the purposes of the FIA-E netting opinions, revised or supplementary "do no harm" opinions would be required in relation to the new provisions. 2.4 Although two-way margining could be implemented by provisions which modify and override in general terms the existing margining provisions, this could result in a degree of uncertainty as to precisely how those provisions would apply in a dispute scenario or in court proceedings. Accordingly, it would be preferable to adopt alternative provisions to replace the existing provisions. 3. The Issue 3.1 The existing FIA-E documentation currently provides for margin to be provided by Clients to Firms in relation to the transactions which they enter into with that Firm. 3.2 Both the margining arrangements set out in clause 8 of the Professional Client Agreement (July 2011 Version) (the "PCA") and arrangements set out in the Title Transfer Securities and Physical Collateral Annex to the Netting Module (June 2007 Version (the "TT Module") work on the basis that the Client will be obliged to provide margin to the Firm. However, the Firm is not required to post margin to the Client in any circumstances (see, eg, clause 2.6 of the TT Module). The amount of margin required form time to time is determined by the Firm. 3.3 Under clause 5 of the TT Module, if a Liquidation Date occurs as a result of an Event of Default, the value of the outstanding margin balance (referred to as the "Default Margin Amount") is treated as an amount owing by the Firm to the Client, and is included as such in the calculation of the Liquidation Amount. Similarly, under clause 8.4 of the PCA, if an Event of Default occurs or the agreement terminates, the Firm is permitted to set off any cash margin which has been provided by the Client against amounts owed by the Client to the Firm in respect of Transactions. 1 1 If non-cash collateral is provided by the Client under the PCA, this is provided by way of security rather than title transfer, and accordingly the treatment of this collateral following an Event of Default is different. However, this memorandum is concerned with amendments that may be required to facilitate two-way margining on a title transfer basis, which is the most common form of margining currently used in relation to cleared transactions. Accordingly, arrangements for providing margin by way of security are not discussed or analysed further in this memorandum

3 3.4 The FOA Clearing Module (October 2013 Version) (the "Clearing Module") is a module which supplements the existing FIA-E documentation in order to facilitate client clearing of transactions as required by EMIR, including (but not limited to) when clearing using what is commonly referred to as the "individual segregation" model. 3.5 Historically, ETD transactions documented using the FIA-E documentation have tended to be subject to what is termed "settlement to market" rather than margining. This means that each day the transactions are repriced, and the party in whose favour the value of the transaction has moved since the previous valuation date receives a settlement payment in consideration of that movement. Should the value move back in the other direction the following day, a settlement payment will be made in the opposite direction accordingly. Importantly, these settlement payments are not treated as "collateral" by the parties, and therefore do not give rise to a return obligation. Rather, the effect of making the settlement payment is that the mark-to-market on the transaction is reset to zero (and thus if a termination occurred at that time, the Liquidation Amount would be zero). 3.6 In contrast, most OTC transactions are not "settled to market". Rather, as the mark-tomarket value of those transactions fluctuates over time, the out-of-the-money party is required to post collateral to the in-the-money party in respect of that transaction (referred to as "margining" in this memorandum). The in-the-money party is then subject to an obligation to return that collateral when the exposure decreases, and any such collateral provided by either party is taken into account when calculating the termination amount. 3.7 It is possible for either settlement to market or margining to apply to ETD or OTC transactions depending on what is agreed between the parties. However, where transactions are being cleared using the Clearing Module, the approach which is taken between the Firm and the Client needs to match the approach being taken by the CCP in relation to those transactions. This is because on a termination following a Firm Trigger Event or CCP Default, the termination value of the Client Transactions used to calculate the Cleared Set Termination Amount is linked to and equals the termination values determined by the CCP for the purpose of terminating the corresponding Firm/CCP Transactions. Thus, where the CCP is applying margining, the termination values of those transactions will reflect the price movement of the Client Transactions since their trade date, not the "zero" value that would be reflected if they were being settled to market. These values are then netted against the Relevant Collateral Value, which relates to the collateral posted between the Firm and Client, not the collateral posted between the Firm and CCP. Accordingly, if the CCP is applying margining, but the Firm applies settlement to market (or vice versa), there will be a mismatch between the transaction values being used to calculate the Cleared - 3 -

4 Set Termination Amount and the value of the collateral being netted against those transaction values. 3.8 Therefore, if the CCP is applying margining, then, as between the Firm and the Client, in addition to the Client being required to provide initial margin to the Firm, both the Firm and the Client are required to post variation margin to each other in respect of fluctuations in the mark-to-market value of the Cleared Transactions. This creates an issue because, as described above, the existing margining provisions in PCA and the TT Module do not provide for margin to be provided to the Client by the Firm. 3.9 The Clearing Module does contemplate that margin may be provided by either the Client or the Firm, although only indirectly. The definition of "Relevant Collateral Value" in clause 11 of the Clearing Module refers to collateral that is attributable to Client Transactions and which has been transferred by "one party to the other... and has not been returned at the time of... termination or otherwise applied or reduced in accordance with the terms of the Clearing Agreement". The Relevant Collateral Value in included in the calculation of the Cleared Set Termination Amount following a Firm Trigger Event (see clause 5.2.2(c)(C) of the Clearing Module) or a CCP Default (see clause 5.3.3(3) of the Clearing Module). The effect of this is that the value of the collateral is netted against the mark-to-market value of the Client Transactions comprising the relevant cleared set The definition of Relevant Collateral Value then goes on to specify that where the relevant collateral has been transferred by the Client to the Firm, it will be treated as a positive amount, while where the relevant collateral has been transferred by the Firm to the Client it will constitute a negative amount. This is consistent with the fact that where the Cleared Set Termination Amount is positive, it is payable by the Firm to the Client, whereas where it is negative, the absolute value of that Cleared Set Termination Amount is payable by the Client to the Firm The definition of Relevant Collateral Value does not distinguish between initial margin (which the Client will always be required to post to the Firm) and variation margin (which could be posted by either the Client to the Firm or the Firm to the Client, depending on the mark-to-market value of the Client Transactions). Rather, the definition is crafted on the basis that collateral is transferred by either the Client or the Firm. However, the initial margin and variation margin requirements should be interpreted on a net basis for the purposes of this definition. Thus, if initial margin is transferred by the Client to the Firm, and variation margin is subsequently transferred from the Firm to the Client, to the extent that the amount of variation margin is less than the amount of initial margin, that transfer by the Firm should be interpreted as a return of collateral by the Firm to the Client for the purposes of the paragraph (b) of the definition of Relevant Collateral Value. Accordingly, when the total amount of margin required to be provided by the Client exceeds the total amount of margin - 4 -

5 required to be provided by the Firm, the "Title Transfer Collateral" which is valued for the purpose of determining the Relevant Collateral Value should be treated as collateral "transferred by Client to Firm". Conversely, when the total amount of margin required to be provided by the Firm exceeds the total amount of margin required to be provided by the Client, the Title Transfer Collateral should be treated as collateral "transferred by Firm to Client" However, although the definition of Relevant Collateral Value in the Clearing Module does cater for two-way margining, this definition is not, by itself, sufficient to implement fully two-way margining into the documentation for two reasons. (a) (b) First, the Clearing Module only deals with termination following a Firm Trigger Event or a CCP Default. In the case of a Client default, the underlying termination provisions in the Clearing Agreement between the Firm and the Client will apply. Thus, although the Relevant Collateral Value is taken into account in calculating the Cleared Set Termination Amount following a Firm Trigger Event or CCP Default, it will not be taken into account following a Client default. Secondly, the definition of Relevant Collateral Value refers to collateral which is transferred, returned or otherwise applied "in accordance with the terms of the Clearing Agreement". However, the standard form of the Clearing Module does not actually include any provisions providing for margin to be transferred by the Firm to the Client. Rather, clause 4 of the Clearing Module, which deals with margin calls and related matters only addresses the impact of the Clearing Module on how collateral is posted by the Client to the Firm. Thus, to the extent that the net margin requirement is required to be transferred by the Firm to the Client, the Clearing Agreement needs to include provisions specifying how and when such transfers are to be made The remainder of this memorandum will analyse the amendments which could be made to the TT Module and the PCA in order to provide for two-way margining. This is then followed by an analysis of the impact which these amendments would have on the netting mechanics in the PCA and related modules and the existing FIA-E netting opinions for the Clearing Agreement. 4. Approaches to amending the FIA-E Documentation 4.1 There are two approaches which can be taken to amend the existing FIA-E documentation to provide for two-way margining. The first approach is to include some additional provisions which modify and override in general terms the existing provisions in the PCA or the TT Module so as to provide for two-way margining. The second approach is to draft self-contained provisions to replace the existing provisions - 5 -

6 in the PCA or the TT Module in respect of cleared transactions to which two-way margining is to apply. 4.2 The "modify and override" approach is that which has been adopted by Eurex in the Appendix to the Clearing Module Annex which it has published for use when the Clearing Module is being used for the Eurex ICM service. Under this approach, provisions are included in the Module Annex which provide that the TT Module or other margining provisions (as applicable) are amended so as to allow for two-way margining. The provisions then go on to specify that for the purpose of calculating the amount of margin, the amount which the Firm is required to post to the Client is equal to the amount which the CCP is required to post to the Firm in relation to the Firm/CCP Transactions. Although the Eurex terms also specify how the amount of margin which the Client is required to post is calculated, this is not strictly necessary as the existing PCA and TT Module gives the Firm a very broad discretion to determine the amount of margin which the Client is required to provide, which is wide enough to cover the minimum amount required by the CCP. 4.3 There are, however, two shortcomings with this approach. (a) First, by including provisions to modify and override the underlying provisions of the PCA or TT Module, but without providing for "line-by-line" amendment of those underlying provisions, there is a degree of uncertainty as to precisely how the provisions would apply in practice. To take the Eurex provisions as an example, as noted above, they provide that the TT Module is deemed to be modified to allow for transfer of margin by Firm to Client, and to determine how the amount of margin required is to be determined. They also provide that the valuation dates will be each Eurex business day. However, no provisions are included to prescribe how margin will be transferred by the Firm to the Client, or returned by the Client to the Firm. Nor is there any amendment of the definition of "Default Margin Amount" or how it is to be determined. 2 This does not mean the provisions are not effective. However, it does mean that the parties are essentially relying on a court implying such provisions into TT Module, presumably on a mutatis mutandis basis by reference to the provisions which apply to the transfer of margin by the Client to Firm, and by a common sense adjustment of the Default Margin Amount to reflect any margin transferred by Firm to Client. Under English law, the rules for when terms may be implied into a contract and, where such implication is permitted, what those provisions would be, are complex and 2 Although such an amendment is not required for the purpose of calculating the Cleared Set Termination Amount following a Firm Trigger Event or CCP Default, it would be relevant in the case of a Client Default

7 (b) difficult to apply with any certainty. This uncertainty would makes it more difficult to provide clean legal opinions on the effect of the "modify and override" provisions. Secondly, and related to the first shortcoming, because the general approach to the Clearing Module is that the provisions of the underlying Clearing Agreement should apply to govern any termination following a Client Default (see clause 5.1 of the Clearing Module), the Clearing Module does not provide for what should happen to margin in those circumstances. While provisions could nevertheless be included to address this, it may be difficult to draft a general provision which would be equally compatible with all forms of termination provisions which may be used by Firms in their Clearing Agreements. On the other hand, however, a provision could be drafted based on the "Core Provisions" used in the FOA netting opinions on the basis that provided Firms were using a termination mechanic which satisfied those Core Provisions, the amendment would achieve the necessary result. Nevertheless, this does not completely address the uncertainty which may arise with the "modify and override" approach discussed in the previous paragraph. 4.4 Of course, the shortcomings discussed above could be overcome by more detailed drafting of the "modify and override" provisions. However, there comes a point at which such provisions become so detailed that they essentially amount to the redrafting or replacement of the existing PCA or TT Module provisions with alternative provisions which should apply when an agreement is a Clearing Agreement. 4.5 The second approach would be to draft a new module or annex to be used with the Clearing Module to replace the TT Module or the margining provisions in the PCA in relation to cleared transactions to which two-way margining is to apply with provisions which apply on a two-way basis, similar to the way the ISDA Credit Support Annex allows for collateral to be posted by either party. This approach would avoid the uncertainty discussed in relation to the "modify and override" approach above. From an English law perspective at least, it should also be possible to give the same legal opinions in relation to a Clearing Agreement incorporating such replacement provisions as are currently provided in relation to the margining provisions in the PCA and the TT Module. 5. Amendments to the FIA-E Documentation 5.1 An example set of "replacement" margining provisions is set out in Schedule 1 to this memorandum. In drafting these provisions we have adopted the "Core Provisions" approach which is used in the FOA netting opinions and specified only the minimum provisions which would be required to provide for two-way margining. We have - 7 -

8 drafted these amendments to following the structure and format of the existing TT Module as closely as possible. These provisions would apply in place of the TT Module or other existing collateral provisions in relation to any cleared transactions to which two-way margining is to apply, and this would be designated the parties on an Agreed CCP Service basis. The Firm could also designate any other set of transactions as a set of transactions to which two-way margining would apply (ie, such set need not be a set of transactions which are cleared through an Agreed CCP Service). 5.2 An example set of "modify and override" provisions is set out in Schedule 2 to this memorandum. In drafting these provisions we have adopted a minimalist approach on the basis that a more comprehensive set of provisions would essentially be very similar to the "alternative margin" provisions set out in Schedule 1. It may, therefore, be the case that where a Firm already has in place a Clearing Agreement with a Client which incorporates the PCA or TT Module margining provisions it may wish to adopt the "modify and override" approach based but by using the more comprehensive provisions set out in Schedule In drafting both sets of provisions we have proceed on the basis that Firms will generally distinguish between initial margin and variation margin. As initial margin will only be provided by the Client to the Firm, the provisions dealing with initial margin follow the existing provisions very closely. However, the effect of the amendments is to introduce requirements for variation margin to be posted by the Client or the Firm as applicable alongside the provision of initial margin. We have not, at this time, included any explicit net settlement provisions providing for payments or deliveries of initial and variation margin to be set off against each other. However, such net settlement provisions could be included if that would work from an operational perspective without adversely. 6. Impact on Netting Analysis 6.1 Amending the margining provisions in the PCA or the TT Module so as to provide for margin to be provided on a two-way basis will not affect the netting analysis under English law in relation to the FIA-E documentation. That is, provided that the documentation is actually amended to provide for two-way margining and the relevant termination and close-out netting provisions are modified accordingly, the value of any margin provided by Firm to Client can be either included in the calculation of the net sum payable (as a gain to Client and cost to Firm) or set-off against any other amounts owing by Firm to Client. 6.2 Although a separate analysis would have to be done in relation to other jurisdictions, in most cases we would expect the result to be the same as under English law

9 7. Impact on Legal Opinions 7.1 The FIA-E netting opinions are currently given on the basis of Clearing Agreements which incorporate the "Core Provisions" set out in those opinions. Those Core Provisions are based on the existing text of the PCA and the TT Module and, as such, reflect the one-way margining of that documentation. 7.2 The definition of "Core Provisions" does include those provisions as modified by any "Non-material Amendments". A list of amendments that are "Non-material Amendments" is also set out in the opinion. Relevantly, this includes any change to the FOA Netting Provision adding or taking from the amounts to be taken into account for the calculation of the Liquidation Amount". Therefore, to the extent that the amendments to the margining provisions modify what is taken into account in calculating the Liquidation Amount by including the value of any margin transferred by Firm to Client, that modification would not affect the opinion given on the FOA Netting Provision. 7.3 The modifications would also not affect the opinion given on the Clearing Module Netting Provision, as those provisions would not be amended. 7.4 However, the opinion on the Title Transfer Provisions and the Margin Cash Set-off Clause would be affected because the modifications to those provisions do not fall within the scope of the Non-material Amendments. Thus, while the required amendments should not actually have the effect of rending those opinions incorrect, revised or supplementary "do no harm" opinions would be required in order for Firms to rely on those opinions in relation to the two-way margining provisions. 8. Reliance 8.1 We hereby consent to members of FIA-E (other than associate members) and their affiliates whose terms of subscription give them access to this memorandum, (as evidenced by the records maintained by FIA-E and each a "subscribing member") relying on the memorandum. This memorandum may not, without our prior written consent, be relied upon by or be disclosed to any other person save that it may be disclosed without such consent to: (a) (b) (c) the officers, employees, auditors and professional advisers of any addressee or any subscribing member; any person to whom disclosure is required to be made by applicable law or court order or pursuant to the rules or regulations of any supervisory or regulatory body or in connection with any judicial proceedings; and any competent authority supervising a subscribing member or its affiliates, on the basis that (i) such disclosure is made solely to enable any such person to be informed that a memorandum has been prepared and to be made aware of its terms - 9 -

10 but not for the purposes of reliance, and (ii) we do not assume any duty or liability to any person to whom such disclosure is made and in preparing this memorandum we have not had regard to the interests of any such person. 8.2 This memorandum was prepared by us on the basis of instructions from FIA-E and we have not taken instructions from, and this memorandum does not take account of the specific circumstances of, any subscribing member. In preparing this memorandum, we had regard solely to the matters addressed in the memorandum and not to any other matters. This memorandum does not constitute or contain any formal legal opinion on the enforceability of any agreement incorporating any of the provisions set out in Schedules 1 or 2 to this memorandum, or the regulatory capital or other regulatory effect of such provisions or any agreement or arrangement incorporating them. 8.3 By permitting subscribing members to rely on this memorandum as stated above, we do not have or assume any client relationship in connection therewith or assume any wider duty to any subscribing member. This memorandum has not been prepared in connection with, and is not intended for use in, any specific transaction. 8.4 Furthermore this memorandum is given on the basis that any limitation on the liability of any other adviser to FIA-E or any subscribing member, whether or not we are aware of that limitation, will not adversely affect our position in any circumstances. Clifford Chance LLP

11 SCHEDULE 1 MARGINING PROVISIONS The following provisions are intended to be included as an additional Annex or Schedule to the Clearing Agreement or Clearing Module to provide for the provision of variation margin in relation to each Cleared Transaction Set in respect of each Agreed CCP Service which does not apply settlement to market. In these circumstances, the "Transaction Set" referred to below should be defined in a Two- Way Margining Notice by reference to transactions being cleared through such Agreed CCP Service. These provisions can also be used to apply two-way margining to other Transaction Sets which may not be cleared through an Agreed CCP Service. These provisions are based on the existing provisions of the TT Module to the extent applicable. These provisions do not replace the existing collateral provisions in the Clearing Agreement (whether the comprise the TT Module or otherwise) entirely, and those existing provisions will continue to govern the provision of margin in respect of any Transactions which do not form part of a Transaction Set to which two-way margining applies. 3 ***** 1. APPLICATION 1.1 Application to Transaction Set: The provisions of this [Annex]/[Schedule] shall apply separately in respect of each Transaction Set in respect of which we have delivered to you a Two-Way Margining Notice. Accordingly, at any time during which these provisions apply to a Transaction Set: (a) separate Transaction Exposures and a separate Initial Margining Requirement shall be determined in respect of each such Transaction Set, and separate Transferred Variation Margin Balances, Variation Margin Delivery Amounts, Variation Margin Return Amounts, Transferred Initial Margin Balance, Initial Margin Delivery Amounts and Initial Margin Return Amounts shall arise in respect of each such 3 Note: This introductory text does not form part of the two-way margining provisions and should not be included in the legal agreement

12 Transaction Set in accordance with the provisions of this [Annex]/ [Schedule]; and (b) for the avoidance of doubt, each separate Default Initial Margin Amount and Default Variation Margin Amount shall be taken into account in determining any Liquidation Amount in accordance with Paragraph Disapplication of existing collateral provisions: Any other provisions of this Agreement relating to the provision of margin or collateral shall not apply in respect of any Transactions from time to time forming part of a Transaction Set to which these provisions apply, and such Transactions shall be disregarded for the purpose of determining the amount of collateral or margin to be provided pursuant to those other provisions. 2. TRANSFER AND RETURN OBLIGATIONS 2.1 Initial Margin Transfer: Upon a demand made by us on or promptly following a Valuation Date, if the amount of the Initial Margining Requirement exceeds the Value of the Transferred Initial Margin Balance, then you will Transfer to us such Acceptable Margin having a Value as of the date of Transfer at least equal to the applicable Initial Margin Delivery Amount (rounded up to the nearest integral multiple of the Minimum Transfer Quota). 2.2 Initial Margin Return: Upon a demand made by you on or promptly following a Valuation Date, if the Value of the Transferred Initial Margin Balance exceeds the amount of the Initial Margining Requirement, then we will Transfer to you such Equivalent Margin having a Value as of the date of Transfer as close as practicable to the applicable Initial Margin Return Amount (rounded down to the nearest integral multiple of the Minimum Transfer Quota). 2.3 Variation Margin Transfer: Upon a demand made by a Transferee on or promptly following a Valuation Date, if the amount of the Transferee's Exposure exceeds the Value of the Transferred Variation Margin Balance, then the Transferor will Transfer to the Transferee Acceptable Margin having a Value as of the date of Transfer at least equal to the applicable Variation Margin Delivery Amount (rounded up to the nearest integral multiple of the Minimum Transfer Quota). 2.4 Variation Margin Return: Upon a demand being made by a Transferor on or promptly following a Valuation Date, if the Value of the Transferred Variation Margin Balance exceeds the amount of the Transferee's Exposure, then the Transferee will Transfer to the Transferor Equivalent Margin having a Value

13 as of the date of Transfer as close as practicable to the applicable Variation Margin Return Amount (rounded down to the nearest integral multiple of the Minimum Transfer Quota). 2.4 Redelivery Obligations: On the earlier of the date of termination of this Agreement, or when there are no actual or contingent obligations outstanding between us: (a) (b) we will also Transfer to you Equivalent Margin having a Value as of the date of Transfer equal to the Initial Margin Return Amount calculated as if the Initial Margining Requirement were then zero; and any Transferee shall Transfer to the Transferor Equivalent Margin having a Value as of the date of Transfer equal to the Variation Margin Return Amount calculated as if the Transferee's Exposure were then zero. 3. DIVIDENDS AND INTEREST AMOUNT 3.1 Dividends: Any cash, securities or other property of the same type, nominal value, description and amount as the relevant Dividends (less any deductions on account of any tax) ("Equivalent Dividends") shall be treated as an addition to the Transferred Initial Margin Balance or the Transferred Variation Margin Balance (as applicable). "Dividend" means all payments and distributions of cash or other property which a holder of securities of the same type, nominal value, description and amount as securities comprised in the Transferred Initial Margin Balance or Transferred Variation Margin Balance (as applicable) would be entitled to receive on any Business Day. 3.2 Interest: An amount equal to any interest payable on the principal amount of any cash comprised in the Transferred Initial Margin Balance or Transferred Variation Margin Balance ("Interest") shall be treated as an addition to the Transferred Initial Margin Balance or Transferred Variation Margin Balance (as applicable). 3.3 Payment of Dividends and Interest: We will Transfer to you, on the first Business Day after receipt of any Dividend in respect of the Transferred Initial Margin Balance or the Business Day on which any applicable Interest in respect of the Transferred Initial Margin Balance becomes payable, any Equivalent Dividends or Interest, provided that we reasonably consider that to do so would not require an Initial Margin Delivery Amount to be transferred to us if that Business Day were a Valuation Date. The Transferee will Transfer to the Transferor, on the first Business Day after receipt of any Dividend in respect of the Transferred Variation Margin Balance or the Business Day on which any applicable Interest in respect of the Transferred Variation Margin

14 Balance becomes payable, any Equivalent Dividends or Interest, provided that we reasonably consider that to do so would not require a Variation Margin Delivery Amount to be transferred to us if that Business Day were a Valuation Date. 4. SUBSTITUTIONS 4.1 Substitution by Client: In respect of the Transferred Initial Margin Balance or, where you are the Transferor in respect of the Transferred Variation Margin Balance, you may, with our prior written consent, Transfer new Acceptable Margin to us in substitution for the Transferred Initial Margin Balance or the Transferred Variation Margin Balance (as applicable) having the same [nominal value]/[value] and of the same amount, as determined by us, as such new Acceptable Margin, whereupon we will transfer to you Equivalent Margin in respect of the Transferred Initial Margin Balance or Transferred Variation Margin Balance (as applicable) being substituted. 4.2 Substitution by Firm: Where we are the Transferor in respect of the Transferred Variation Margin Balance, we may Transfer new Acceptable Margin to you in substitution for the Transferred Variation Margin Balance having the same nominal value and of the same amount, as determined by us, as such new Acceptable Margin, whereupon you will transfer to us Equivalent Margin in respect of the Transferred Variation Margin Balance being substituted. [4.3 Deemed Substitution by Client: Without limiting clause 4.1, and notwithstanding anything to the contrary in this Agreement, if we so elect in our sole and absolute discretion, we may notify you that collateral substitution has occurred in respect of the Transferred Initial Margin Balance or the Transferred Variation Margin Balance in respect of which you are the Transferor. In such circumstance, you agree that, with effect from delivery of such notification, the relevant original Transferred Margin forming part of the Transferred Initial Margin Balance or Transferred Variation Margin Balance (as applicable) will be deemed for all purposes to comprise such amount and type of the substituted Acceptable Margin as determined by us as having an equivalent Value to such original Transferred Margin then comprised in the Transferred Initial Margin Balance or Transferred Variation Margin Balance (as applicable).] 4 4 To be inserted where Firm wishes to have the right to effect automatic substitution of the Client s Transferred Initial Margin Balance or Transferred Variation Margin Balance to reflect any corresponding substitutions occurring at the CCP level

15 5. DEFAULT 5.1 Default: If a Liquidation Date is specified or deemed to occur as a result of an Event of Default: (a) (b) the Default Initial Margin Amount as at that date will be deemed to be [a gain (if we are the Non-Defaulting Party) or a cost (if you are the Non-Defaulting Party)] [a gain by us] for the purposes of calculating the Liquidation Amount. For this purpose, "Default Initial Margin Amount" means an amount, calculated in our Base Currency of the aggregate value as at the relevant Liquidation Date (as determined by us) of the Transferred Initial Margin Balance; and in respect of any Transferee, the Default Variation Margin Amount as at that date will be deemed to be [a gain (if the Transferee is the Non- Defaulting Party) or a cost (if the Transferee is the Defaulting Party)] [a gain by the Transferee] for the purposes of calculating the Liquidation Amount. For this purpose, the "Default Variation Margin Amount" means an amount, calculated in our Base Currency of the aggregate value as of the relevant Liquidation Date (as determined by us) of the Transferred Variation Margin Balance. 6. GROSS UP 6.1 Gross-up: All payments under the provisions will be made free of and without withholding or deduction for any taxes, duties, assessments or governmental charges of whatsoever nature imposed, withheld or assessed by any relevant tax authority, unless required by law, in which case the payer shall pay such additional amounts as will result in the receipt by the payee of an amount which it would have received had no deduction or withholding been made. 7. REPRESENTATIONS AND TRANSFER OF TITLE 7.1 Encumbrances: Each party represents to the other party (which representation will be deemed repeated as of each date on which a Transfer of Acceptable Margin, Equivalent Margin, Equivalent Dividends or Interest is made) that it is the sole owner or otherwise has the right to Transfer all the aforementioned property, free and clear of any security interest, lien, encumbrance or other restriction. 7.2 Clean title: Each party agrees that all right, title and interest in and to any Acceptable Margin, Equivalent Margin, Equivalent Dividends or Interest which it Transfers to the other party shall vest in the recipient free and clear of any security interest, lien, claims, charges, encumbrance or other restriction. Notwithstanding the use of terms such as "Margin" which are used to reflect

16 terminology used in the market for such transactions, nothing in these provisions is intended to create or does create in favour of either party mortgage, charge, lien, pledge, encumbrance or other security interest in any Acceptable Margin, Equivalent Margin, Equivalent Dividends or Interest Transferred hereunder. 8. CALCULATIONS AND CONVERSION 8.1 Calculations and conversion: All calculations shall be done by us in a commercially reasonable manner. We shall convert any amount not denominated in GBP to GBP at the spot rate quoted in the London interbank market for the sale of GBP against a purchase of that currency. 8.2 Notification: We will notify you of our calculations not later than [1.00 p.m. London time] on the Business Day following the applicable Valuation Date. 9. DISPUTE RESOLUTION 9.1 Disputed valuation: If you reasonably dispute the calculation of an Initial Margin Delivery Amount, an Initial Margin Return Amount, a Variation Margin Delivery Amount or a Delivery Margin Return Amount or any Value calculated under this module, then: (a) (b) (c) (d) you will notify us not later than the close of business on the Business Day following the date on which the disputed calculation was received by you; in the case of an Initial Margin Delivery Amount, an Initial Margin Return Amount, a Variation Margin Delivery Amount or a Variation Margin Return Amount, the appropriate party will Transfer the undisputed amount to the other party promptly, notwithstanding the dispute; the parties will consult with each other in an attempt to resolve the dispute expeditiously; and if they fail to resolve the dispute by the end of the Business Day following the Business Day mentioned in (a) then: (i) in the case of a dispute concerning the amount of the Initial Margining Requirement or the Transaction Exposure, we shall within one Business Day thereafter obtain a quotation from two leading dealers in the relevant market as to the reasonable amount of the Initial Margining Requirement or Transaction Exposure in respect of the affected Transactions or other

17 (ii) matters in dispute, and the arithmetic mean of the quotations so provided shall apply instead of our calculation; in the case of a dispute involving the Value of any Transfer of Acceptable Margin or Equivalent Margin we will recalculate the Value as of the date of Transfer[, provided that, where and to the extent that such calculation or valuation has been determined by an Agreed CCP in accordance with the terms of this Agreement relating to Client Transactions, the foregoing shall not apply] Re-notification: The appropriate Party will upon demand following notification by us of any recalculations under this clause make the appropriate Transfer. 9.3 Recalculation fee: We may charge you a fee for recalculations carried out under this clause. 9.4 No Event of Default: The failure by a Party to make a Transfer of any amount which is the subject of a dispute to which this Clause applies will not constitute an Event of Default so long as the procedures set out in this Clause are being carried out. 10. DEFINITIONS "Acceptable Margin" means: (i) (ii) in respect of any Initial Margin Delivery Amount or Initial Margin Return Amount, those items specified as such in the Individually Agreed Terms Schedule; and in respect of any Variation Margin Delivery Amount or Variation Margin Return Amount, those items specified as such in the Individually Agreed Terms Schedule, the valuation of which shall, in each case, be subject to such haircut as is specified therein. "Equivalent Margin" means cash and/or securities of the same type, nominal value, currency and amount as Acceptable Margin Transferred hereunder. "Initial Margin Delivery Amount" means with respect to any Valuation Date, the amount by which the Initial Margining Requirement exceeds the Value, as of that 5 To be inserted where the parties wish to apply CCP valuations in connection with any cleared Client Transactions. This language should not be included if the Clearing Module does not form part of the Agreement

18 date, of the Transferred Initial Margin Balance (adjusted to include any prior Initial Margin Delivery Amount and to exclude any prior Initial Margin Return Amount, the Transfer of which, in either case, has not yet been completed). "Initial Margin Return Amount" means with respect to any Valuation Date, the amount by which the Value as of that date of the Transferred Initial Margin Balance (adjusted to include any prior Initial Margin Delivery Amount and to exclude any prior Initial Margin Return Amount, the Transfer of which, in either case, has not yet been completed) exceeds the Initial Margining Requirement. "Initial Margining Requirement" means, on any day, our requirement in relation to the amount or value of Acceptable Margin to be Transferred by you as initial margin in relation to your outstanding obligations to us on that day, which requirement shall be determined by us in accordance with the mechanism in respect of Transactions forming part of the relevant Transaction Set, specified in the Individually Agreed Terms Schedule, and if not specified, in accordance with our standard practice form time to time. "Minimum Transfer Quota" means an amount specified as such in the Individually Agreed Terms Schedule; "Transaction Exposure" means, in respect of a party and a Valuation Date, the greater of: (i) (ii) zero; and the amount which would constitute the Liquidation Amount if a Liquidation Date occurred on such Valuation Date in respect of which the other party was the Defaulting Party, the Default Margin Amount was zero and the only Netting Transactions were those Transactions forming part of the relevant Transaction Set. "Transaction Set" means a set of Transactions identified as such in a Two-Way Margining Notice, as modified by any Transaction Set Adjustment Notice from time to time. For the avoidance of doubt: (i) (ii) a Transaction Set may be identified by reference to specific Transactions and/or as a set of Transactions having particular features or characteristics; and an individual Transaction may not form part of more than one Transaction Set at any one time. "Transaction Set Adjustment Notice" means a notice from us to you modifying a Transaction Set. For the avoidance of doubt, a Transaction Set Adjustment Notice may:

19 (i) (ii) identify specific Transactions to be included or excluded from a Transaction Set; or state that Transactions having particular features or characteristics shall be included or excluded from a Transaction Set. "Transfer" means, with respect to any Acceptable Margin, Equivalent Margin, Equivalent Dividends or Interest Amount: (i) (ii) (iii) in the case of cash, payment into the recipient's bank account or to another account designated by the recipient; in the case of securities that can be delivered by book-entry, the giving of irrevocable transfer instructions to the relevant depository, clearing system or other institution responsible for the books, and/or compliance with any other procedures necessary to enable the recipient to obtain legal and beneficial ownership in the securities; and in the case of certificated securities that cannot be delivered by book-entry, delivery in suitable physical form to the recipient accompanied by all certificates and other documents of title, duly executed and stamped stock transfer forms and any other documents necessary to enable the recipient to obtain legal and beneficial ownership in the securities. "Transferee" means, on any day, each party in respect of which the Transaction Exposure is greater than zero on that day. "Transferor" means, in respect of a Transferee, the other party. "Transferred Initial Margin Balance" means the aggregate of all Acceptable Margin that has been Transferred to us pursuant to clauses 2.1 or 4.1 of this Annex or which has been added to the Transferred Initial Margin Balance pursuant to clauses 3.1 or 3.2 of this Annex, as reduced from time to time by any Transfer of Equivalent Margin to you pursuant to clauses 2.2 or 4.1 of this Annex or pursuant to clause 3.3 of this Annex to the extent that such Transfer related to Equivalent Dividends or Interest arising in respect of the Transferred Initial Margin Balance. "Transferred Margin" means, at any time, any Acceptable Margin at that time forming part of the Transferred Initial Margin Balance or any Transferred Variation Margin Balance. "Transferred Variation Margin Balance" means, with respect to a Transferee, the aggregate of all Acceptable Margin that has been Transferred to the Transferee pursuant to clauses 2.3 or 4.1 of this Annex or which has been added to the Transferred Variation Margin Balance pursuant to clauses 3.1 or 3.2 of this Annex, as reduced from time to time by any Transfer of Equivalent Margin to the Transferor

20 pursuant to clauses 2.4 or 4.1 of this Annex or pursuant to clause 3.3 of this Annex to the extent that such Transfer related to Equivalent Dividends or Interest arising in respect of the Transferred Variation Margin Balance. "Two-Way Margining Notice" means a notice from us to you stating that the provisions of this [Annex]/[Schedule] shall apply to a Transaction Set, as identified therein. "Valuation Date" means any Business Day selected by us unless otherwise specified in the Individually Agreed Terms Schedule. "Value" means, for any Valuation Date or other date for which Value is calculated, with respect to: (i) (ii) (iii) (iv) cash, the amount expressed in the Base Currency; and securities for which, prices are publicly quoted an amount, expressed in our Base Currency and reasonably determined by us by reference to the closing price of such securities on such trading venue as may be reasonably selected by us; other Acceptable Margin or Equivalent Margin, an amount expressed in our Base Currency and reasonably determined by us by reference where reasonably practicable to independent price sources, as reflecting the value of such Acceptable Margin or Equivalent Margin; and items that are not Acceptable Margin or Equivalent Margin, zero. "Variation Margin Delivery Amount" means with respect to a Transferee and a Valuation Date, the amount by which the Transferee's Transaction Exposure exceeds the Value, as of that date, of the Transferred Variation Margin Balance (adjusted to include any prior Variation Margin Delivery Amount and to exclude any prior Variation Margin Return Amount, the Transfer of which, in either case, has not yet been completed. "Variation Margin Return Amount" means with respect to a Transferee and a Valuation Date, the amount by which the Value as of that date of the Transferred Variation Margin Balance (adjusted to include any prior Variation Margin Delivery Amount and to exclude any prior Variation Margin Return Amount, the Transfer of which, in either case, has not yet been completed) exceeds Transferee's Transaction Exposure

21 SCHEDULE 2 MODIFY AND OVERRIDE MARGINING PROVISIONS The following provisions are intended to modify and override the existing margining provisions in the Clearing Agreement and would be included as an Annex or Schedule to the Clearing Agreement or Clearing Module to provide for the provision of variation margin in relation to each Cleared Transaction Set in respect of each Agreed CCP Service which does not apply settlement to market. In these circumstances, the "Transaction Set" referred to below should be defined in a Two- Way Margining Notice by reference to transactions being cleared through such Agreed CCP Service. These provisions can also be used to apply two-way margining to other Transaction Sets which may not be cleared through an Agreed CCP Service. 6 ***** 1. [Notwithstanding Clause of the Module,] 7 to the extent of any inconsistency between the provisions in this Annex and the other provisions of the Agreement, the provisions of this Annex will prevail. 2. If the provisions of the Agreement which provide for the provision of margin do not provide for margin to be provided on a two way basis, those provisions will be amended to permit the two way transfer of margin in respect of Transactions from time to time forming part of each Transaction Set in respect of which we have delivered to you a Two-Way Margining Notice (each an "Applicable Transaction Set"). 3. For the purpose of giving effect to Paragraph 2 of this Annex: (a) (b) separate margin requirements shall be determined in respect of initial margin and variation margin for each Applicable Transaction Set; only the Client shall be required to transfer initial margin to the Firm, and the amount of initial margin in respect of each Applicable Transaction Set shall be the amount determined by the Firm; 6 Note: This introductory text does not form part of the two-way margining provisions and should not be included in the legal agreement. 7 To be included when using these provisions with a Clearing Module