Current Legal Issues Affecting Central Banks, Volume IV.
Back Matter

Back Matter

Author(s):
Robert Effros
Published Date:
April 1997
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    Appendix I International Agreements

    Appendix I 1 General Agreement on Trade in Services

    Members,*

    Recognizing the growing importance of trade in services for the growth and development of the world economy;

    Wishing to establish a multilateral framework of principles and rules for trade in services with a view to the expansion of such trade under conditions of transparency and progressive liberalization and as a means of promoting the economic growth of all trading partners and the development of developing countries;

    Desiring the early achievement of progressively higher levels of liberalization of trade in services through successive rounds of multilateral negotiations aimed at promoting the interests of all participants on a mutually advantageous basis and at securing an overall balance of rights and obligations, while giving due respect to national policy objectives;

    Recognizing the right of Members to regulate, and to introduce new regulations, on the supply of services within their territories in order to meet national policy objectives and, given asymmetries existing with respect to the degree of development of services regulations in different countries, the particular need of developing countries to exercise this right;

    Desiring to facilitate the increasing participation of developing countries in trade in services and the expansion of their service exports including, inter alia, through the strengthening of their domestic services capacity and its efficiency and competitiveness;

    Taking particular account of the serious difficulty of the least-developed countries in view of their special economic situation and their development, trade and financial needs;

    Hereby agree as follows:

    PART I SCOPE AND DEFINITION

    Article I Scope and Definition

    1. This Agreement applies to measures by Members affecting trade in services.

    2. For the purposes of this Agreement, trade in services is defined as the supply of a service;

    • (a) from the territory of one Member into the territory of any other Member;

    • (b) in the territory of one Member to the service consumer of any other Member;

    • (c) by a service supplier of one Member, through commercial presence in the territory of any other Member;

    • (d) by a service supplier of one Member, through presence of natural persons of a Member in the territory of any other Member.

    3. For the purposes of this Agreement:

    • (a) “measures by Members” means measures taken by:

      • (i) central, regional or local governments and authorities; and

      • (ii) non-governmental bodies in the exercise of powers delegated by central, regional or local governments or authorities.

    In fulfilling its obligations and commitments under the Agreement, each Member shall take such reasonable measures as may be available to it to ensure their observance by regional and local governments and authorities and non-governmental bodies within its territory;

    • (b) “services” includes any service in any sector except services supplied in the exercise of governmental authority;

    • (c) “a service supplied in the exercise of governmental authority” means any service which is supplied neither on a commercial basis nor in competition with one or more service suppliers.

    PART II GENERAL OBLIGATIONS AND DISCIPLINES

    Article II Most-Favoured-Nation Treatment

    1. With respect to any measure covered by this Agreement, each Member shall accord immediately and unconditionally to services and service suppliers of any other Member treatment no less favourable than that it accords to like services and service suppliers of any other country.

    2. A Member may maintain a measure inconsistent with paragraph 1 provided that such a measure is listed in, and meets the conditions of, the Annex on Article II Exemptions.

    3. The provisions of this Agreement shall not be so construed as to prevent any Member from conferring or according advantages to adjacent countries in order to facilitate exchanges limited to contiguous frontier zones of services that are both locally produced and consumed.

    Article III Transparency

    1. Each Member shall publish promptly and, except in emergency situations, at the latest by the time of their entry into force, all relevant measures of general application which pertain to or affect the operation of this Agreement. International agreements pertaining to or affecting trade in services to which a Member is a signatory shall also be published.

    2. Where publication as referred to in paragraph 1 is not practicable, such information shall be made otherwise publicly available.

    3. Each Member shall promptly and at least annually inform the Council for Trade in Services of the introduction of any new, or any changes to existing, laws, regulations or administrative guidelines which significantly affect trade in services covered by its specific commitments under this Agreement.

    4. Each Member shall respond promptly to all requests by any other Member for specific information on any of its measures of general application or international agreements within the meaning of paragraph 1. Each Member shall also establish one or more enquiry points to provide specific information to other Members, upon request, on all such matters as well as those subject to the notification requirement in paragraph 3. Such enquiry points shall be established within two years from the date of entry into force of the Agreement Establishing the WTO (referred to in this Agreement as die “WTO Agreement”). Appropriate flexibility with respect to the time-limit within which such enquiry points are to be established may be agreed upon for individual developing country Members. Enquiry points need not be depositories of laws and regulations.

    5. Any Member may notify to the Council for Trade in Services any measure, taken by any other Member, which it considers affects the operation of this Agreement.

    Article III bis Disclosure of Confidential Information

    Nothing in this Agreement shall require any Member to provide confidential information, the disclosure of which would impede law enforcement, or otherwise be contrary to the public interest, or which would prejudice legitimate commercial interests of particular enterprises, public or private.

    Article IV Increasing Participation of Developing Countries

    1. The increasing participation of developing country Members in world trade shall be facilitated through negotiated specific commitments, by different Members pursuant to Parts III and IV of this Agreement, relating to:

    • (a) the strengthening of their domestic services capacity and its efficiency and competitiveness, inter alia through access to technology on a commercial basis;

    • (b) the improvement of their access to distribution channels and information networks; and

    • (c) the liberalization of market access in sectors and modes of supply of export interest to them.

    2. Developed country Members, and to the extent possible other Members, shall establish contact points within two years from the date of entry into force of the WTO Agreement to facilitate the access of developing country Members’ service suppliers to information, related to their respective markets, concerning:

    • (a) commercial and technical aspects of the supply of services;

    • (b) registration, recognition and obtaining of professional qualifications; and

    • (c) the availability of services technology.

    3. Special priority shall be given to the least-developed country Members in the implementation of paragraphs 1 and 2. Particular account shall be taken of the serious difficulty of the least-developed countries in accepting negotiated specific commitments in view of their special economic situation and their development, trade and financial needs.

    Article V Economic Integration

    1. This Agreement shall not prevent any of its Members from being a party to or entering into an agreement liberalizing trade in services between or among the parties to such an agreement, provided that such an agreement:

    • (a) has substantial sectoral coverage,1 and

    • (b) provides for the absence of elimination of substantially all discrimination, in the sense of Article XVII, between or among the parties, in the sectors covered under subparagraph (a), through;

      • (i) elimination of existing discriminatory measures, and/or

      • (ii) prohibition of new or more discriminatory measures,

        at the entry into force of that agreement or on the basis of a reasonable time-frame, except for measures permitted under Articles XI, XII, XIV, and XIV bis.

    2. In evaluating whether the conditions under paragraph l(b) are met, consideration may be given to the relationship of the agreement to a wider process of economic integration or trade liberalization among the countries concerned.

    3. (a) Where developing countries are parties to an agreement of the type referred to in paragraph 1, flexibility shall be provided for regarding the conditions set out in paragraph 1, particularly with reference to sub-paragraph (b) thereof, in accordance with the level of development of the countries concerned, both overall and in individual sectors and subsectors.

    (b) Notwithstanding paragraph 6, in the case of an agreement of the type referred to in paragraph 1 involving only developing countries, more favourable treatment may be granted to juridical persons owned or controlled by natural persons of the parties to such an agreement.

    4. Any agreement referred to in paragraph 1 shall be designed to facilitate trade between the parties to the agreement and shall not in respect of any Member outside the agreement raise the overall level of barriers to trade in services within the respective sectors or subsectors compared to the level applicable prior to such an agreement.

    5. If, in the conclusion, enlargement or any significant modification of any agreement under paragraph 1, a Member intends to withdraw or modify a specific commitment inconsistently with the terms and conditions set out in its Schedule, it shall provide at least 90 days advance notice of such modification or withdrawal and the procedure set forth in paragraphs 2, 3 and 4 of Article XXI shall apply.

    6. A service supplier of any other Member that is a juridical person constituted under the laws of a party to an agreement referred to in paragraph 1 shall be entitled to treatment granted under such agreement, provided that it engages in substantive business operations in the territory of the parties to such agreement.

    7. (a) Members which are parties to any agreement referred to in paragraph 1 shall promptly notify any such agreement and any enlargement or any significant modification of that agreement to the Council for Trade in Services. They shall also make available to the Council such relevant information as may be requested by it. The Council may establish a working party to examine such an agreement or enlargement or modification of that agreement and to report to the Council on its consistency with this Article.

    (b) Members which are parties to any agreement referred to in paragraph 1 which is implemented on the basis of a time-frame shall report periodically to the Council for Trade in Services on its implementation. The Council may establish a working party to examine such reports if it deems such a working party necessary.

    (c) Based on the reports of the working parties referred to in subparagraphs (a) and (b), the Council may make recommendations to the parties as it deems appropriate.

    8. A Member which is a party to any agreement referred to in paragraph 1 may not seek compensation for trade benefits that may accrue to any other Member from such agreement.

    Article V bis Labour Markets Integration Agreements

    This Agreement shall not prevent any of its Members from being a party to an agreement establishing full integration2 of the labour markets between or among the parties to such an agreement, provided that such an agreement:

    • (a) exempts citizens of parties to the agreement from requirements concerning residency and work permits;

    • (b) is notified to the Council for Trade in Services.

    Article VI Domestic Regulation

    1. In sectors where specific commitments are undertaken, each Member shall ensure that all measures of general application affecting trade in services are administered in a reasonable, objective and impartial manner.

    2. (a) Each member shall maintain or institute as soon as practicable juridical, arbitral or administrative tribunals or procedures which provide, at the request of an affected service supplier, for the prompt review of, and where justified, appropriate remedies for, administrative decisions affecting trade in services. Where such procedures are not independent of the agency entrusted with the administrative decision concerned, the Member shall ensure that the procedures in fact provide for an objective and impartial review.

    (b) The provisions of subparagraph (a) shall not be construed to require a Member to institute such tribunals or procedures where this would be inconsistent with its constitutional structure or the nature of its legal system.

    3. Where authorization is required for the supply of a service on which a specific commitment has been made, the competent authorities of a Member shall, within a reasonable period of time after the submission of an application considered complete under domestic laws and regulations, inform the applicant of the decision concerning the application. At the request of the applicant, the competent authorities of the Member shall provide, without undue delay, information concerning the status of the application.

    4. With a view to ensuring that measures relating to qualification requirements and procedures, technical standards and licensing requirements do not constitute unnecessary barriers to trade in services, the Council for Trade in Services shall, through appropriate bodies it may establish, develop any necessary disciplines. Such disciplines shall aim to ensure that such requirements are, inter alia:

    • (a) based on objective and transparent criteria, such as competence and the ability to supply the service;

    • (b) not more burdensome than necessary to ensure the quality of the service;

    • (c) in the case of licensing procedures, not in themselves a restriction on the supply of the service.

    5. (a) In sectors in which a Member has undertaken specific commitments, pending the entry into force of disciplines developed in these sectors pursuant to paragraph 4, the Member shall not apply licensing and qualification requirements and technical standards that nullify or impair such specific commitments in a manner which:

    • (i) does not comply with the criteria outlined in subparagraphs 4(a), (b) or (c); and

    • (ii) could not reasonably have been expected of that Member at the time the specific commitments in those sectors were made.

    (b) In determining whether a Member is in conformity with the obligation under paragraph 5(a), account shall be taken of international standards of relevant international organizations3 applied by that Member.

    6. In sectors where specific commitments regarding professional services are undertaken, each Member shall provide for adequate procedures to verify the competence of professionals of any other Member.

    Article VII Recognition

    1. For the purpose of fulfilment, in whole or in part, of its standards or criteria for the authorization, licensing or certification of services suppliers, and subject to the requirements of paragraph 3, a Member may recognize the education or experience obtained, requirements met, or licenses or certifications granted in a particular country. Such recognition, which may be achieved through harmonization or otherwise, may be based upon an agreement or arrangement with the country concerned or may be accorded autonomously.

    2. A Member that is a party to an agreement or arrangement of the type referred to in paragraph 1, whether existing or future, shall afford adequate opportunity for other interested Members to negotiate their accession to such an agreement or arrangement or to negotiate comparable ones with it. Where a Member accords recognition autonomously, it shall afford adequate opportunity for any other Member to demonstrate that education, experience, licenses, or certifications obtained or requirements met in that other Member’s territory should be recognized.

    3. A Member shall not accord recognition in a manner which would constitute a means of discrimination between countries in the application of its standards or criteria for the authorization, licensing or certification of services suppliers, or a disguised restriction on trade in services.

    4. Each Member shall:

    • (a) within 12 months from the date on which the WTO Agreement takes effect for it, inform the Council for Trade in Services of its existing recognition measures and state whether such measures are based on agreements or arrangements of the type referred to in paragraph 1;

    • (b) promptly inform the Council for Trade in Services as far in advance as possible of the opening of negotiations on an agreement or arrangement of the type referred to in paragraph 1 in order to provide adequate opportunity to any other Member to indicate their interest in participating in the negotiations before they enter a substantive phase;

    • (c) promptly inform the Council for Trade in Services when it adopts new recognition measures or significantly modifies existing ones and state whether the measures are based on an agreement or arrangement of the type referred to in paragraph 1.

    5. Wherever appropriate, recognition should be based on multilaterally agreed criteria. In appropriate cases, Members shall work in cooperation with relevant intergovernmental and non-governmental organizations towards the establishment and adoption of common international standards and criteria for recognition and common international standards for the practice of relevant services trades and professions.

    Article VIII Monopolies and Exclusive Service Suppliers

    1. Each Member shall ensure that any monopoly supplier of a service in its territory does not, in the supply of the monopoly service in the relevant market, act in a manner inconsistent with that Member’s obligations under Article II and specific commitments.

    2. Where a Member’s monopoly supplier competes, either directly or through an affiliated company, in the supply of a service outside the scope of its monopoly rights and which is subject to that Member’s specific commitments, the Member shall ensure that such a supplier does not abuse its monopoly position to act in its territory in a manner inconsistent with such commitments.

    3. The Council for Trade in Services may, at the request of a Member which has a reason to believe that a monopoly supplier of a service of any other Member is acting in a manner inconsistent with paragraph 1 or 2, request the Member establishing, maintaining or authorizing such supplier to provide specific information concerning the relevant operations.

    4. If, after the date of entry into force of the WTO Agreement, a Member grants monopoly rights regarding the supply of a service covered by its specific commitments, that Member shall notify the Council for Trade in Services no later than three months before the intended implementation of the grant of monopoly rights and the provisions of paragraphs 2, 3 and 4 of Article XXI shall apply.

    5. The provisions of this Article shall also apply to cases of exclusive service suppliers, where a Member, formally or in effect, (a) authorizes or establishes a small number of service suppliers and (b) substantially prevents competition among those suppliers in its territory.

    Article IX Business Practices

    1. Members recognize that certain business practices of service suppliers, other than those falling under Article VIII, may restrain competition and thereby restrict trade in services.

    2. Each Member shall, at the request of any other Member, enter into consultations with a view to eliminating practices referred to in paragraph 1. The Member addressed shall accord full and sympathetic consideration to such a request and shall cooperate through the supply of publicly available non-confidential information of relevance to the matter in question. The Member addressed shall also provide other information available to the requesting Member, subject to its domestic law and to the conclusion of satisfactory agreement concerning the safeguarding of its confidentiality by the requesting Member.

    Article X Emergency Safeguard Measures

    1. There shall be multilateral negotiations on the question of emergency safeguard measures based on the principle of non-discrimination. The results of such negotiations shall enter into effect on a date not later than three years from the date of entry into force of the WTO Agreement.

    2. In the period before the entry into effect of the results of the negotiations referred to in paragraph 1, any Member may, notwithstanding the provisions of paragraph 1 of Article XXI, notify the Council on Trade in Services of its intention to modify or withdraw a specific commitment after a period of one year from the date on which the commitment enters into force; provided that the Member shows cause to the Council that the modification or withdrawal cannot await the lapse of the three-year period provided for in paragraph 1 of Article XXI.

    3. The provisions of paragraph 2 shall cease to apply three years after the date of entry into force of the WTO Agreement.

    Article XI Payments and Transfers

    1. Except under the circumstances envisaged in Article XII, a Member shall not apply restrictions on international transfers and payments for current transactions relating to its specific commitments.

    2. Nothing in this Agreement shall affect the rights and obligations of the members of the International Monetary Fund under the Articles of Agreement of the Fund, including the use of exchange actions which are in conformity with the Articles of Agreement, provided that a Member shall not impose restrictions on any capital transactions inconsistently with its specific commitments regarding such transactions, except under Article XII or at the request of the Fund.

    Article XII Restrictions to Safeguard the Balance of Payments

    1. In the event of serious balance-of-payments and external financial difficulties or threat thereof, a Member may adopt or maintain restrictions on trade in services on which it has undertaken specific commitments, including on payments or transfers for transactions related to such commitments. It is recognized that particular pressures on the balance of payments of a Member in the process of economic development or economic transition may necessitate the use of restrictions to ensure, inter alia, the maintenance of a level of financial reserves adequate for the implementation of its programme of economic development or economic transition.

    2. The restrictions referred to in paragraph 1:

    • (a) shall not discriminate among Members;

    • (b) shall be consistent with the Articles of Agreement of the International Monetary Fund;

    • (c) shall avoid unnecessary damage to the commercial, economic and financial interests of any other Member;

    • (d) shall not exceed those necessary to deal with the circumstances described in paragraph 1;

    • (e) shall be temporary and be phased out progressively as the situation specified in paragraph 1 improves.

    3. In determining the incidence of such restrictions, Members may give priority to the supply of services which are more essential to their economic or development programmes. However, such restrictions shall not be adopted or maintained for the purpose of protecting a particular service sector.

    4. Any restrictions adopted or maintained under paragraph 1, or any changes therein, shall be promptly notified to the General Council.

    5. (a) Members applying the provisions of this Article shall consult promptly with the Committee on Balance-of-Payments Restrictions on restrictions adopted under this Article.

    (b) The Ministerial Conference shall establish procedures4 for periodic consultations with the objective of enabling such recommendations to be made to the Member concerned as it may deem appropriate.

    (c) Such consultations shall assess the balance-of-payment situation of the Member concerned and the restrictions adopted or maintained under this Article, taking into account, inter alia^ such factors as:

    • (i) the nature and extent of the balance-of-payments and the external financial difficulties;

    • (ii) the external economic and trading environment of the consulting Member;

    • (iii) alternative corrective measures which may be available.

    (d) The consultations shall address the compliance of any restrictions with paragraph 2, in particular the progressive phaseout of restrictions in accordance with paragraph 2(e).

    (e) In such consultations, all findings of statistical and other facts presented by the International Monetary Fund relating to foreign exchange, monetary reserves and balance of payments, shall be accepted and conclusions shall be based on the assessment by the Fund of the balance-of-payments and the external financial situation of the consulting Member.

    6. If a Member which is not a member of the International Monetary Fund wishes to apply the provisions of this Article, the Ministerial Conference shall establish a review procedure and any other procedures necessary.

    Article XIII Government Procurement

    1. Articles II, XVI and XVII shall not apply to laws, regulations or requirements governing the procurement by governmental agencies of services purchased for governmental purposes and not with a view to commercial resale or with a view to use in the supply of services for commercial sale.

    2. There shall be multilateral negotiations on government procurement in services under this Agreement within two years from the date of entry into force of the WTO Agreement.

    Article XIV General Exceptions

    Subject to the requirement that such measures are not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where like conditions prevail, or a disguised restriction on trade in services, nothing in this Agreement shall be construed to prevent the adoption or enforcement by any Member of measures:

    • (a) necessary to protect public morals or to maintain public order;5

    • (b) necessary to protect human, animal or plant life or health;

    • (c) necessary to secure compliance with laws or regulations which are not inconsistent with the provisions of this Agreement including those relating to:

      • (i) the prevention of deceptive and fraudulent practices or to deal with the effects of a default on services contracts;

      • (ii) the protection of the privacy of individuals in relation to the processing and dissemination of personal data and the protection of confidentiality of individual records and accounts;

      • (iii) safety;

    • (d) inconsistent with Article XVII, provided that the difference in treatment is aimed at ensuring the equitable or effective6 imposition or collection of direct taxes in respect of services or service suppliers of other Members;

    • (e) inconsistent with Article II, provided that the difference in treatment is the result of an agreement on the avoidance of double taxation or provisions on the avoidance of double taxation in any other international agreement or arrangement by which the Member is bound.

    Article XIV bis Security Exceptions

    1. Nothing in this Agreement shall be construed:

    • (a) to require any Member to furnish any information, the disclosure of which it considers contrary to its essential security interests; or

    • (b) to prevent any Member from taking any action which it considers necessary for the protection of its essential security interests:

      • (i) relating to the supply of services as carried out directly or indirectly for the purpose of provisioning a military establishment;

      • (ii) relating to fissionable and fusionable materials or the materials from which they are derived;

      • (iii) taken in time of war or other emergency in international relations; or

    • (c) to prevent any Member from taking any action in pursuance of its obligations under the United Nations Charter for the maintenance of international peace and security;

    2. The Council for Trade in Services shall be informed to the fullest extent possible of measures taken under paragraphs l(b) and (c) and of their termination.

    Article XV Subsidies

    1. Members recognize that, in certain circumstances, subsidies may have distortive effects on trade in services. Members shall enter into negotiations with a view to developing the necessary multilateral disciplines to avoid such trade-distortive effects.7 The negotiations shall also address the appropriateness of countervailing procedures. Such negotiations shall recognize the role of subsidies in relation to the development programmes of developing countries and take into account the needs of Members, particularly developing country Members, for flexibility in this area. For the purpose of such negotiations, Members shall exchange information concerning all subsidies related to trade in services that they provide to their domestic service suppliers.

    2. Any Member which considers that it is adversely affected by a subsidy of another Member may request consultations with that Member on such matters. Such requests shall be accorded sympathetic consideration.

    PART III SPECIFIC COMMITMENTS

    Article XVI Market Access

    1. With respect to market access through the modes of supply identified in Article 1, each Member shall accord services and service suppliers of any other Member treatment no less favourable than that provided for under the terms, limitations and conditions agreed and specified in its schedule.8

    2. In sectors where market-access commitments are undertaken, the measures which a Member shall not maintain or adopt either on the basis of a regional subdivision or on the basis of its entire territory, unless otherwise specified in its Schedule, are defined as:

    • (a) limitations on the number of service suppliers whether in the form of numerical quotas, monopolies, exclusive service suppliers or the requirements of an economic needs test;

    • (b) limitations on the total value of service transactions or assets in the form of numerical quotas or the requirement of an economic needs test;

    • (c) limitations on the total number of service operations or on the total quantity of service output expressed in terms of designated numerical units in the form of quotas or the requirement of an economic needs test;9

    • (d) limitations on the total number of natural persons that may be employed in a particular service sector or that a service supplier may employ and who are necessary for, and directly related to, the supply of a specific service in the form of numerical quotas or the requirement of an economic needs test;

    • (e) measures which restrict or require specific types of legal entity or joint venture through which a service supplier may supply a service; and

    • (f) limitations on the participation of foreign capital in terms of maximum percentage limit on foreign shareholding or the total value of individual or aggregate foreign investment.

    Article XVII National Treatment

    1. In the sectors inscribed in its Schedule, and subject to any conditions and qualifications set out therein, each Member shall accord to services and service suppliers of any other Member, in respect of all measures affecting the supply of services, treatment no less favourable than that it accords to its own like services and service suppliers.10

    2. A Member may meet the requirement of paragraph 1 by according to services and service suppliers of any other Member, either formally identical treatment or formally different treatment to that it accords to its own like services and service suppliers.

    3. Formally identical or formally different treatment shall be considered to be less favourable if it modifies the conditions of competition in favour of services or service suppliers of the Member compared to like services or service suppliers of any other Member.

    Article XVIII Additional Commitments

    Members may negotiate commitments with respect to measures affecting trade in services not subject to scheduling under Articles XVI or XVII, including those regarding qualifications, standards or licensing matters. Such commitments shall be inscribed in a Member’s Schedule.

    PART IV PROGRESSIVE LIBERALIZATION

    Article XIX Negotiation of Specific Commitments

    1. In pursuance of the objectives of this Agreement, Members shall enter into successive rounds of negotiations, beginning not later than five years from the date of entry into force of the WTO Agreement and periodically thereafter, with a view to achieving a progressively higher level of liberalization. Such negotiations shall be directed to the reduction or elimination of the adverse effects on trade in services of measures as a means of providing effective market access. This process shall take place with a view to promoting the interests of all participants on a mutually advantageous basis and to securing an overall balance of rights and obligations.

    2. The process of liberalization shall take place with due respect for national policy objectives and the level of development of individual Members, both overall and in individual sectors. There shall be appropriate flexibility for individual developing country Members for opening fewer sectors, liberalizing fewer types of transactions, progressively extending market access in line with their development situation and, when making access to their markets available to foreign service suppliers, attaching to such access conditions aimed at achieving the objectives referred to in Article IV.

    3. For each round, negotiating guidelines and procedures shall be established. For the purposes of establishing such guidelines, the Council for Trade in Services shall carry out an assessment of trade in services in overall terms and on a sectoral basis with reference to the objectives of the Agreement, including those set out in paragraph 1 of Article IV. Negotiating guidelines shall establish modalities for the treatment of liberalization undertaken autonomously by Members since previous negotiations, as well as for the special treatment for least-developed country Members under the provisions of paragraph 3 of Article IV.

    4. The process of progressive liberalization shall be advanced in each such round through bilateral, plurilateral or multilateral negotiations directed towards increasing the general level of specific commitments undertaken by Members under this Agreement.

    Article XX Schedules of Specific Commitments

    1. Each Member shall set out in a schedule the specific commitments it undertakes under Part III of this Agreement. With respect to sectors where such commitments are undertaken, each Schedule shall specify:

    • (a) terms, limitations and conditions on market access;

    • (b) conditions and qualifications on national treatment;

    • (c) undertakings related to additional commitments;

    • (d) where appropriate the time-frame for implementation of such commitments; and

    • (e) the date of entry into force of such commitments.

    2. Measures inconsistent with both Articles XVI and XVII shall be inscribed in the column relating to Article XVI. In this case the inscription will be considered to provide a condition or qualification to Article XVII as well.

    3. Schedules of specific commitments shall be annexed to this Agreement and shall form an integral part thereof.

    Article XXI Modification of Schedules

    1. (a)A Member (referred to in this Article as the “modifying Member”) may modify or withdraw any commitment in its Schedule, at any time after three years have elapsed from the date on which that commitment entered into force, in accordance with the provisions of this Article.

    (b) A modifying Member shall notify its intent to modify or withdraw a commitment pursuant to this Article to the Council for Trade in Services no later than three months before the intended date of implementation of the modification or withdrawal.

    2. (a) At the request of any Member the benefits of which under this Agreement may be affected (referred to in this Article as an “affected Member”) by a proposed modification or withdrawal notified under sub-paragraph l(b), the modifying Member shall enter into negotiations with a view to reaching agreement on any necessary compensatory adjustment. In such negotiations and agreement, the Members concerned shall endeavour to maintain a general level of mutually advantageous commitments not less favourable to trade than that provided for in Schedules of specific commitments prior to such negotiations.

    (b) Compensatory adjustments shall be made on a most-favoured-nation basis.

    3. (a) If agreement is not reached between the modifying Member and any affected Member before the end of the period provided for negotiations, such affected Member may refer the matter to arbitration. Any affected Member that wishes to enforce a right that it may have to compensation must participate in the arbitration.

    (b) If no affected Member has requested arbitration, the modifying Member shall be free to implement the proposed modification or withdrawal.

    4. (a) The modifying Member may not modify or withdraw its commitment until it has made compensatory adjustments in conformity with the findings of the arbitration.

    (b) If the modifying Member implements its proposed modification or withdrawal and does not comply with the findings of the arbitration, any affected Member that participated in the arbitration may modify or withdraw substantially equivalent benefits in conformity with those findings. Notwithstanding Article II, such a modification or withdrawal may be implemented solely with respect to the modifying Member.

    5. The Council for Trade in Services shall establish procedures for rectification or modification of Schedules. Any Member which has modified or withdrawn scheduled commitments under this Article shall modify its Schedule according to such procedures.

    PART V INSTITUTIONAL PROVISIONS

    Article XXII Consultation

    1. Each Member shall accord sympathetic consideration to, and shall afford adequate opportunity for, consultation regarding such representations as may be made by any other Member with respect to any matter affecting the operation of this Agreement. The Dispute Settlement Understanding (DSU) shall apply to such consultations.

    2. The Council for Trade in Services or the Dispute Settlement Body (DSB) may, at the request of a Member, consult with any Member or Members in respect of any matter for which it has not been possible to find a satisfactory solution through consultation under paragraph 1.

    3. A Member may not invoke Article XVII, either under this Article or Article XXIII, with respect to a measure of another Member that falls within the scope of an international agreement between them relating to the avoidance of double taxation. In case of disagreement between Members as to whether a measure falls within the scope of such an agreement between them, it shall be open to either Member to bring this matter before the Council for Trade in Services.11 The Council shall refer the matter to arbitration. The decision of the arbitrator shall be final and binding on the Members.

    Article XXIII Dispute Settlement and Enforcement

    1. If any Member should consider that any other Member fails to carry out its obligations or specific commitments under this Agreement, it may with a view to reaching a mutually satisfactory resolution of the matter, have recourse to the DSU.

    2. If the DSB considers that the circumstances are serious enough to justify such action, it may authorize a Member or Members to suspend the application to any other Member or Members of such obligations and specific commitments in accordance with Article 22 of the DSU.

    3. If any Member considers that any benefit it could reasonably have expected to accrue to it under a specific commitment of another Member under Part III of this Agreement is being nullified or impaired as a result of the application of any measure which does not conflict with the provisions of this Agreement, it may have recourse to the DSU. If the measure is determined by the DSB to have nullified or impaired such a benefit, the Member affected shall be entitled to a mutually satisfactory adjustment on the basis of paragraph 2 of Article XXI, which may include the modification or withdrawal of the measure. In the event an agreement cannot be reached between the Members concerned, Article 22 of the DSU shall apply.

    Article XXIV Council for Trade in Services

    1. The Council for Trade in Services shall carry out such functions as may be assigned to it to facilitate the operation of this Agreement and further its objectives. The Council may establish such subsidiary bodies as it considers appropriate for the effective discharge of its functions.

    2. The Council and, unless the Council decides otherwise, its subsidiary bodies shall be open to participation by representatives of all Members.

    3. The Chairman of the Council shall be elected by the Members.

    Article XXV Technical Cooperation

    1. Service suppliers of Members which are in need of such assistance shall have access to the services of contact points referred to in paragraph 2 of Article IV.

    2. Technical assistance to developing countries shall be provided at the multilateral level by the Secretariat and shall be decided upon by the Council for Trade in Services.

    Article XXVI Relationship with Other International Organizations

    The General Council shall make appropriate arrangements for consultation and cooperation with the United Nations and its specialized agencies as well as with other intergovernmental organizations concerned with services.

    PART VI FINAL PROVISIONS

    Article XXVII Denial of Benefits

    A Member may deny the benefits of this Agreement:

    • (a) to the supply of a service, if it establishes that the service is supplied from or in the territory of a non-Member, or of a Member to which the denying Member does not apply the WTO Agreement;

    • (b) in the case of the supply of a maritime transport service, if it establishes that the service is supplied:

      • (i) by a vessel registered under the laws of a non-Member or of a Member to which the denying Member does not apply the WTO Agreement, and

      • (ii) by a person which operates and/or uses the vessel in whole or in part but which is of a non-Member or of a Member to which the denying Member does not apply the WTO Agreement;

    • (c) to a service supplier that is a juridical person, if it establishes that it is not a service supplier of another Member, or that it is a service supplier of a Member to which the denying Member does not apply the WTO Agreement.

    Article XXVIII Definitions

    For the purpose of this Agreement:

    • (a) “measure” means any measure by a Member, whether in the form of a law, regulation, rule, procedure, decision, administrative action, or any other form;

    • (b) “supply of service” includes the production, distribution, marketing, sale and delivery of a service;

    • (c) “measures by Members affecting trade in services” include measures in respect of

      • (i) the purchase, payment or use of a service;

      • (ii) the access to and use of, in connection with the supply of a service, services which are required by those Members to be offered to the public generally;

      • (iii) the presence, including commercial presence, of persons of a Member for the supply of a service in the territory of another Member;

    • (d) “commercial presence” means any type of business or professional establishment, including through

      • (i) the constitution, acquisition or maintenance of a juridical person, or

      • (ii) the creation or maintenance of a branch or a representative office, within the territory of a Member for the purpose of supplying a service;

    • (e) “sector” of a service means,

      • (i) with reference to a specific commitment, one or more, or all, subsectors of that service, as specified in the Member’s Schedule,

      • (ii) otherwise, the whole of that service sector, including all of its subsectors;

    • (f) “service of another Member” means a service which is supplied,

      • (i) from or in the territory of that other Member, or in the case of maritime transport, by a vessel registered under the laws of that other Member, or by a person of that other Member which supplies the service through the operation of a vessel and/or its use in whole or in part; or

      • (ii) in the case of the supply of a service through commercial presence or through the presence of natural persons, by a service supplier of that other Member;

    • (g) “service supplier” means any person that supplies a service;12

    • (h) “monopoly supplier of a service” means any person, public or private, which in the relevant market of the territory of a Member is authorized or established formally or in effect by that Member as the sole supplier of that service;

    • (i) “service consumer” means any person that receives or uses a service;

    • (j) “person” means either a natural person or a juridical person;

    • (k) “natural person of another Member” means a natural person who resides in the territory of that other Member or any other Member, and who under the law of that other Member:

      • (i) is a national of that other Member; or

      • (ii) has the right of permanent residence in that other Member, in the case of a Member which:

        • does not have nationals; or

        • accords substantially the same treatment to its permanent residents as it does to its nationals in respect of measures affecting trade services, as notified in its acceptance of or accession to the WTO Agreement, provided that no Member is obligated to accord to such permanent residents treatment more favourable than would be accorded by that other Member to such permanent residents. Such notification shall include the assurance to assume, with respect to those permanent residents, in accordance with its laws and regulations, the same responsibilities that other Member bears with respect to its nationals;

    • (l) “juridical person” means any legal entity duly constituted or otherwise organized under applicable law, whether for profit or otherwise, and whether privately-owned or governmentally owned, including any corporation, trust, partnership, joint venture, sole proprietorship or association;

    • (m) “juridical person of another Member” means a juridical person which is either:

      • (i) constituted or otherwise organized under the law of that other Member, and is engaged in substantive business operations in the territory of that Member or any other Member; or

      • (ii) in the case of the supply of a service through commercial presence, owned or controlled by:

        • natural persons of that Member; or

        • juridical persons of that other Member identified under sub-paragraph (i);

    • (n) A juridical person is:

      • (i) “owned” by persons of a Member if more than 50 per cent of the equity interest in it is beneficially owned by persons of that Member;

      • (ii) “controlled” by persons of a Member if such persons have the power to name a majority of its directors or otherwise legally direct its actions;

      • (iii) “affiliated” with another person when it controls, or is controlled by, that other person; or when it and the other person are both controlled by the same person; and

    • (o) “direct taxes” comprise all taxes on total income, on total capital or on elements of income or of capital, including taxes on gains from the alienation of property, taxes on estates, inheritances and gifts, and taxes on the total amounts of wages or salaries paid by enterprises, as well as taxes on capital appreciation.

    Article XXIX Annexes

    The Annexes to this Agreement are an integral part of this Agreement.

    ANNEXES

    Annex on Article II Exemptions

    Scope

    1. This Annex specifies the conditions under which a Member, at the entry into force of this Agreement, is exempted from its obligations under paragraph 1 of Article II.

    2. Any new exemptions applied for after the date of entry into force of the WTO Agreement shall be dealt with under paragraph 3 of Article IX of that Agreement.

    Review

    3. The Council for Trade in Services shall review all exemptions granted for a period of more than five years. The first such review shall take place no more than five years after the entry into force of the WTO Agreement.

    4. The Council for Trade in Services in a review shall:

    • (a) examine whether the conditions which created the need for the exemption still prevail; and

    • (b) determine the date of any further review.

    Termination

    5. The exemption of a Member from its obligations under paragraph 1 of Article II of the Agreement with respect to a particular measure terminates on the date provided for in the exemption.

    6. In principle, such exemptions should not exceed a period of 10 years. In any event, they shall be subject to negotiation in subsequent trade-liberalizing rounds.

    7. A Member shall notify the Council for Trade in Services at the termination of the exemption period that the inconsistent measure has been brought into conformity with paragraph 1 of Article II of the Agreement.

    Lists of Article II Exemptions

    [The agreed lists of exemptions under paragraph 2 of Article II appear as part of this Annex in the treaty copy of the WTO Agreement.]

    Annex on Movement of Natural Persons Supplying Services under the Agreement

    1. This Annex applies to measures affecting natural persons who are service suppliers of a Member, and natural persons of a Member who are employed by a service supplier of a Member, in respect of the supply of a service.

    2. The Agreement shall not apply to measures affecting natural persons seeking access to the employment market of a Member, nor shall it apply to measures regarding citizenship, residence or employment on a permanent basis.

    3. In accordance with Parts III and IV of the Agreement, Members may negotiate specific commitments applying to the movement of all categories of natural persons supplying services under the Agreement. Natural persons covered by a specific commitment shall be allowed to supply the service in accordance with the terms of that commitment.

    4. The Agreement shall not prevent a Member from applying measures to regulate the entry of natural persons into, or their temporary stay in, its territory, including those necessary to protect the integrity of, and to ensure the orderly movement of natural persons across, its borders, provided that such measures are not applied in such a manner as to nullify or impair the benefits accruing to any Member under the terms of a specific commitment.13

    Annex on Financial Services

    1. Scope and Definition

    (a) This Annex applies to measures affecting the supply of financial services. Reference to the supply of a financial service in this Annex shall mean the supply of a service as defined in paragraph 2 of Article I of the Agreement.

    (b) For the purposes of subparagraph 3(b) of Article I of the Agreement, “services supplied in the exercise of governmental authority” means the following:

    • (i) activities conducted by a central bank or monetary authority or by any other public entity in pursuit of monetary or exchange rate policies;

    • (ii) activities forming part of a statutory system of social security or public retirement plans; and

    • (iii) other activities conducted by a public entity for the account or with the guarantee or using the financial resources of the Government.

    (c) For the purposes of subparagraph 3(b) of Article I of the Agreement, if a Member allows any of the activities referred to in sub-paragraph (b)(ii) or (b)(iii) of this paragraph to be conducted by its financial service suppliers in competition with a public entity or a financial service supplier, “services” shall include such activities.

    (d) Subparagraph 3(c) of Article I of the Agreement shall not apply to services covered by this Annex.

    2. Domestic Regulation

    (a) Notwithstanding any other provisions of the Agreement, a Member shall not be prevented from taking measures for prudential reasons, including for the protection of investors, depositors, policy holders or persons to whom a fiduciary duty is owed by a financial service supplier, or to ensure the integrity and stability of the financial system. Where such measures do not conform with the provisions of the Agreement, they shall not be used as a means of avoiding the Member’s commitments or obligations under the Agreement.

    (b) Nothing in the Agreement shall be construed to require a Member to disclose information relating to the affairs and accounts of individual customers or any confidential or proprietary information in the possession of public entities.

    3. Recognition

    (a) A Member may recognize prudential measures of any other country in determining how the Member’s measures relating to financial services shall be applied. Such recognition, which may be achieved through harmonization or otherwise, may be based upon an agreement or arrangement with the country concerned or may be accorded autonomously.

    (b) A Member that is a party to such an agreement or arrangement referred to in subparagraph (a), whether future or existing, shall afford adequate opportunity for other interested Members to negotiate their accession to such agreements or arrangements, or to negotiate comparable ones with it, under circumstances in which there would be equivalent regulation, oversight, implementation of such regulation, and, if appropriate, procedures concerning the sharing of information between the parties to the agreement or arrangement. Where a Member accords recognition autonomously, it shall afford adequate opportunity for any other Member to demonstrate that such circumstances exist.

    (c) Where a Member is contemplating according recognition to prudential measures of any other country, paragraph 4(b) of Article VII shall not apply.

    4. Dispute Settlement

    Panels for disputes on prudential issues and other financial matters shall have the necessary expertise relevant to the specific financial service under dispute.

    5. Definitions

    For the purposes of this Annex:

    (a) A financial service is any service of a financial nature offered by a financial service supplier of a Member. Financial services include all insurance and insurance-related services, and all banking and other financial services (excluding insurance). Financial services include the following activities:

    Insurance and insurance-related services

    • (i) Direct insurance (including co-insurance):

      • (A) life

      • (B) non-life

    • (ii) Reinsurance and retrocession;

    • (iii) Insurance intermediation, such as brokerage and agency;

    • (iv) Services auxiliary to insurance, such as consultancy, actuarial, risk assessment and claim settlement services.

    Banking and other financial services (excluding insurance)

    • (v) Acceptance of deposits and other repayable funds from the public:

    • (vi) Lending of all types, including consumer credit, mortgage credit, factoring and financing of commercial transaction;

    • (vii) Financial leasing;

    • (viii) All payment and money transmission services, including credit, charge and debit cards, travellers cheques and bankers drafts;

    • (ix) Guarantees and commitments;

    • (x) Trading for own account or for account of customers, whether on an exchange, in an over-the-counter market or otherwise, the following:

      • (A) money market instruments (including cheques, bills, certificates of deposits);

      • (B) foreign exchange;

      • (C) derivative products including, but not limited to, futures and options;

      • (D) exchange rate and interest rate instruments, including products such as swaps, forward rate agreements;

      • (E) transferable securities;

      • (F) other negotiable instruments and financial assets, including bullion.

    • (xi) Participation in issues of all kinds of securities, including underwriting and placement as agent (whether publicly or privately) and provision of services related to such issues;

    • (xii) Money broking;

    • (xiii) Asset management, such as cash or portfolio management, all forms of collective investment management, pension fund management, custodial, depository and trust services;

    • (xiv) Settlement and clearing services for financial assets, including securities, derivative products, and other negotiable instruments;

    • (xv) Provision and transfer of financial information, and financial data processing and related software by suppliers of other financial services;

    • (xvi) Advisory, intermediation and other auxiliary financial services on all the activities listed in subparagraphs (v) through (xv), including credit reference and analysis, investment and portfolio research and advice, advice on acquisitions and on corporate restructuring and strategy.

    (b) A financial service supplier means any natural or juridical person of a Member wishing to supply or supplying financial services but the term “financial service supplier” does not include a public entity.

    (c) “Public entity” means:

    • (i) a government, a central bank or a monetary authority, of a Member, or an entity owned or controlled by a Member, that is principally engaged in carrying out governmental functions or activities for governmental purposes, not including an entity principally engaged in supplying financial services on commercial terms; or

    • (ii) a private entity, performing functions normally performed by a central bank or monetary authority, when exercising those functions.

    Second Annex on Financial Services

    1. Notwithstanding Article II of the Agreement and paragraphs 1 and 2 of the Annex on Article II Exemptions, a Member may, during a period of 60 days beginning four months after the date of entry into force of the WTO Agreement, list in that Annex measures relating to financial services which are inconsistent with paragraph 1 of Article II of the Agreement.

    2. Notwithstanding Article XXI of the Agreement, a Member may, during a period of 60 days beginning four months after the date of entry into force of the WTO Agreement, improve, modify or withdraw all or part of the specific commitments on financial services inscribed in its Schedule.

    3. The Council for Trade in Services shall establish any procedures necessary for the application of paragraphs 1 and 2.

    [The annexes regarding Air Transport Services, Maritime Transport Services, and Telecomunications are omitted.]

    Appendix I 1a Understanding on Commitments in Financial Services

    Participants in the Uruguay Round have been enabled to take on specific commitments with respect to financial services under the General Agreement on Trade in Services (hereinafter referred to as the “Agreement”) on the basis of an alternative approach to that covered by the provisions of Part III of the Agreement.1 It was agreed that this approach could be applied subject to the following understanding:

    • (i) it does not conflict with the provisions of the Agreement;

    • (ii) it does not prejudice the right of any Member to schedule its specific commitments in accordance with the approach under Part III of the Agreement;

    • (iii) resulting specific commitments shall apply on a most-favoured-nation basis;

    • (iv) no presumption has been created as to the degree of liberalization to which a Member is committing itself under the Agreement.

    Interested Members, on the basis of negotiations, and subject to conditions and qualifications where specified, have inscribed in their schedule specific commitments conforming to the approach set out below.

    A. Standstill

    Any conditions, limitations and qualifications to the commitments noted below shall be limited to existing non-conforming measures.

    B. Market Access

    Monopoly Rights

    1. In addition to Article VIII of the Agreement, the following shall apply:

    Each Member shall list in its schedule pertaining to financial services existing monopoly rights and shall endeavour to eliminate them or reduce their scope. Notwithstanding subparagraph 1(b) of the Annex on Financial Services, this paragraph applies to the activities referred to in subparagraph 1(b)(iii) of the Annex.

    Financial Services Purchased by Public Entities

    2. Notwithstanding Article XIII of the Agreement, each Member shall ensure that financial service suppliers of any other Member established in its territory are accorded most-favoured-nation treatment and national treatment as regards the purchase or acquisition of financial services by public entities of the Member in its territory.

    Cross-Border Trade

    3. Each Member shall permit non-resident suppliers of financial services to supply, as a principal, through an intermediary or as an intermediary, and under terms and conditions that accord national treatment, the following services:

    • (a) insurance of risks relating to:

      • (i) maritime shipping and commercial aviation and space launching and freight (including satellites), with such insurance to cover any or all of the following: the goods being transported, the vehicle transporting the goods and any liability arising therefrom; and

      • (ii) goods in international transit;

    • (b) reinsurance and retrocession and the services auxiliary to insurance as referred to in subparagraph 5(a)(iv) of the Annex;

    • (c) provision and transfer of financial information and financial data processing as referred to in subparagraph 5(a)(xv) of the Annex and advisory and other auxiliary services, excluding intermediation, relating to banking and other financial services as referred to in subparagraph 5(a)(xvi) of the Annex.

    4. Each Member shall permit its residents to purchase in the territory of another Member the financial services indicated in:

    • (a) subparagraph 3(a);

    • (b) subparagraph 3(b); and

    • (c) subparagraphs 5(a)(v) to (xvi) of the Annex.

    Commercial Presence

    5. Each Member shall grant financial service suppliers of any other Member the right to establish or expand within its territory, including through the acquisition of existing enterprises, a commercial presence.

    6. A Member may impose terms, conditions and procedures for authorization of the establishment and expansion of a commercial presence in so far as they do not circumvent the Member’s obligation under paragraph 5 and they are consistent with the other obligations of this Agreement.

    New Financial Services

    7. A Member shall permit financial service suppliers of any other Member established in its territory to offer in its territory any new financial service.

    Transfers of Information and Processing of Information

    8. No Member shall take measures that prevent transfers of information or the processing of financial information, including transfers of data by electronic means, or that, subject to importation rules consistent with international agreements, prevent transfers of equipment, where such transfers of information, processing of financial information or transfers of equipment are necessary for the conduct of the ordinary business of a financial service supplier. Nothing in this paragraph restricts the right of a Member to protect personal data, personal privacy and the confidentiality of individual records and accounts so long as such right is not used to circumvent the provisions of the Agreement.

    Temporary Entry of Personnel

    • 9. (a) Each Member shall permit temporary entry into its territory of the following personnel of a financial service supplier of any other Member that is establishing or has established a commercial presence in the territory of the Member:

      • (i) senior managerial personnel possessing proprietary information essential to the establishment, control and operation of the services of the financial service supplier; and

      • (ii) specialists in the operation of the financial service supplier.

    • (b) Each Member shall permit, subject to the availability of qualified personnel in its territory, temporary entry into its territory of the following personnel associated with a commercial presence of a financial service supplier of any other Member:

      • (i) specialists in computer services, telecommunications services, and accounts of the financial service supplier; and

      • (ii) actuarial and legal specialists.

    Non-discriminatory Measures

    10. Each Member shall endeavour to remove or to limit any significant adverse effects on financial service suppliers of any other Member of:

    • (a) non-discriminatory measures that prevent financial service suppliers from offering in the Member’s territory, in the form determined by the Member, all the financial services permitted by the Member;

    • (b) non-discriminatory measures that limit the expansion of the activities of financial service suppliers into the entire territory of the Member;

    • (c) measures of a Member, when such a Member applies the same measures to the supply of both banking and securities services, and a financial service supplier of any other Member concentrates its activities in the provision of securities services; and

    • (d) other measures that, although respecting the provisions of the Agreement, affect adversely the ability of financial service suppliers of any other Member to operate, compete or enter the Member’s market;

    provided that any action taken under this paragraph would not unfairly discriminate against financial service suppliers of the Member taking such action.

    11. With respect to the non-discriminatory measures referred to in subparagraphs 10(a) and (b), a Member shall endeavour not to limit or restrict the present degree of market opportunities nor the benefits already enjoyed by financial service suppliers of all other Members as a class in the territory of the Member, provided that this commitment does not result in unfair discrimination against financial service suppliers of the Member applying such measures.

    C. National Treatment

    1. Under terms and conditions that accord national treatment, each Member shall grant to financial service suppliers of any other Member established in its territory access to payment and clearing systems operated by public entities, and to official funding and refinancing facilities available in the normal course of ordinary business. This paragraph is not intended to confer access to the Member’s lender of last resort facilities.

    2. When membership or participation in, or access to, any self-regulatory body, securities or futures exchanges or market, clearing agency, or any other organization or association, is required by a Member in order for financial service suppliers of any other Member to supply financial services on an equal basis with financial service suppliers of the Member, or when the Member provides directly or indirectly such entities, privileges or advantages in supplying financial services, the Member shall ensure that such entities accord national treatment to financial service suppliers of any other Member resident in the territory of the Member.

    D. Definitions

    For the purposes of this approach:

    1. A non-resident supplier of financial services is a financial service supplier of a Member which supplies a financial service into the territory of another Member from an establishment located in the territory of another Member, regardless of whether such a financial service supplier has or has not a commercial presence in the territory of the Member in which the financial service is supplied.

    2. “Commercial presence” means an enterprise within a Member’s territory for the supply of financial services and includes wholly- or partly-owned subsidiaries, joint ventures, partnerships, sole proprietorships, franchising operations, branches, agencies, representative offices or other organizations.

    3. A new financial service is a service of a financial nature, including services related to existing and new products or the manner in which a product is delivered, that is not supplied by any financial service supplier in the territory of a particular Member but which is supplied in the territory of another Member.

    Appendix I 2 North American Free Trade Agreement

    [Selected Provisions]1

    Chapter Eleven

    Investment

    Section A - Investment

    * * * * *

    Article 1109: Transfers

    1. Each Party shall permit all transfers relating to an investment of an investor of another Party in the territory of the Party to be made freely and without delay. Such transfers include:

    • (a) profits, dividends, interest, capital gains, royalty payments, management fees, technical assistance and other fees, returns in kind and other amounts derived from the investment;

    • (b) proceeds from the sale of all or any part of the investment or from the partial or complete liquidation of the investment;

    • (c) payments made under a contract entered into by the investor, or its investment, including payments made pursuant to a loan agreement;

    • (d) payments made pursuant to Article 1110; and

    • (e) payments arising under Section B.

    2. Each Party shall permit transfers to be made in a freely usable currency at the market rate of exchange prevailing on the date of transfer with respect to spot transactions in the currency to be transferred.

    3. No Party may require its investors to transfer, or penalize its investors that fail to transfer, the income, earnings, profits or other amounts derived from, or attributable to, investments in the territory of another Party.

    4. Notwithstanding paragraphs 1 and 2, a Party may prevent a transfer through the equitable, non-discriminatory and good faith application of its laws relating to:

    • (a) bankruptcy, insolvency or the protection of the rights of creditors;

    • (b) issuing, trading or dealing in securities;

    • (c) criminal or penal offenses;

    • (d) reports of transfers of currency or other monetary instruments; or

    • (e) ensuring the satisfaction of judgments in adjudicatory proceedings.

    5. Paragraph 3 shall not be construed to prevent a Party from imposing any measure through the equitable, non-discriminatory and good faith application of its laws relating to the matters set out in subparagraphs (a) through (e) of paragraph 4.

    6. Notwithstanding paragraph 1, a Party may restrict transfers of returns in kind in circumstances where it could otherwise restrict such transfers under this Agreement, including as set out in paragraph 4.

    Article 1110: Expropriation and Compensation

    1. No Party may directly or indirectly nationalize or expropriate an investment of an investor of another Party in its territory or take a measure tantamount to nationalization or expropriation of such an investment (“expropriation”), except:

    • (a) for a public purpose;

    • (b) on a non-discriminatory basis;

    • (c) in accordance with due process of law and Article 1105(1); and

    • (d) on payment of compensation in accordance with paragraphs 2 through 6.

    2. Compensation shall be equivalent to the fair market value of the expropriated investment immediately before the expropriation took place (“date of expropriation”), and shall not reflect any change in value occurring because the intended expropriation had become known earlier. Valuation criteria shall include going concern value, asset value including declared tax value of tangible property, and other criteria, as appropriate, to determine fair market value.

    3. Compensation shall be paid without delay and be fully realizable.

    4. If payment is made in a G7 currency, compensation shall include interest at a commercially reasonable rate for that currency from the date of expropriation until the date of actual payment.

    5. If a Party elects to pay in a currency other than a G7 currency, the amount paid on the date of payment, if converted into a G7 currency at the market rate of exchange prevailing on that date, shall be no less than if the amount of compensation owed on the date of expropriation had been converted into that G7 currency at the market rate of exchange prevailing on that date, and interest had accrued at a commercially reasonable rate for that G7 currency from the date of expropriation until the date of payment.

    6. On payment, compensation shall be freely transferable as provided in Article 1109.

    7. This Article does not apply to the issuance of compulsory licenses granted in relation to intellectual property rights, or to the revocation, limitation or creation of intellectual property rights, to the extent that such issuance, revocation, limitation or creation is consistent with Chapter Seventeen (Intellectual Property).

    8. For purposes of this Article and for greater certainty, a non-discriminatory measure of general application shall not be considered a measure tantamount to an expropriation of a debt security or loan covered by this Chapter solely on the ground that the measure imposes costs on the debtor that cause it to default on the debt.

    Article 1111: Special Formalities and Information Requirements

    1. Nothing in Article 1102 shall be construed to prevent a Party from adopting or maintaining a measure that prescribes special formalities in connection with the establishment of investments by investors of another Party, such as a requirement that investors be residents of the Party or that investments be legally constituted under the laws or regulations of the Party, provided that such formalities do not materially impair the protections afforded by a Party to investors of another Party and investments of investors of another Party pursuant to this Chapter.

    2. Notwithstanding Article 1102 or 1103, a Party may require an investor of another Party, or its investment in its territory, to provide routine information concerning that investment solely for informational or statistical purposes. The Party shall protect such business information that is confidential from any disclosure that would prejudice the competitive position of the investor or the investment. Nothing in this paragraph shall be construed to prevent a Party from otherwise obtaining or disclosing information in connection with the equitable and good faith application of its law.

    * * * * *

    Article 1113: Denial of Benefits

    1. A Party may deny the benefits of this Chapter to an investor of another Party that is an enterprise of such Party and to investments of such investor if investors of a non-Party own or control the enterprise and the denying Party:

    • (a) does not maintain diplomatic relations with the non-Party; or

    • (b) adopts or maintains measures with respect to the non-Party that prohibit transactions with the enterprise or that would be violated or circumvented if the benefits of this Chapter were accorded to the enterprise or to its investments.

    2. Subject to prior notification and consultation in accordance with Article 1803 (Notification and Provision of Information) and 2006 (Consultations), a Party may deny the benefits of this Chapter to an Investor of another Party that is an enterprise of such Party and to investments of such investors if investors of a non-Party own or control the enterprise and the enterprise has no substantial business activities in the territory of the Party under whose law it is constituted or organized.

    Article 1114: Environmental Measures

    1. Nothing in this Chapter shall be construed to prevent a Party from adopting, maintaining or enforcing any measure otherwise consistent with this Chapter that it considers appropriate to ensure that investment activity in its territory is undertaken in a manner sensitive to environmental concerns.

    2. The Parties recognize that it is inappropriate to encourage investment by relaxing domestic health, safety or environmental measures. Accordingly, a Party should not waive or otherwise derogate from, or offer to waive or otherwise derogate from, such measures as an encouragement for the establishment, acquisition, expansion or retention in its territory of an investment of an investor. If a Party considers that another Party has offered such an encouragement, it may request consultation with the other Party and the two Parties shall consult with a view to avoiding any such encouragement.

    Section B - Settlement of Disputes between a Party and an Investor of Another Party

    Article 1115: Purpose

    Without prejudice to the rights and obligations of the Parties under Chapter Twenty (Institutional Arrangements and Dispute Settlement Procedure), this Section establishes a mechanism for the settlement of investment disputes that assures both equal treatment among the investors of the Parties in accordance with the principle of international reciprocity and due process before an impartial tribunal.

    Article 1116: Claim by an Investor of a Party on Its Own Behalf

    1. An investor of a Party may submit to arbitration under this Section a claim that another Party has breached an obligation under:

    • (a) Section A or Article 1503(2) (State Enterprises), or

    • (b) Article 1502(3)(a) (Monopolies and State Enterprises) where the monopoly has acted in a manner inconsistent with the Party’s obligations under Section A,

    and that the investor has incurred loss or damage by reason of, or arising out of, that breach.

    2. An investor may not make a claim if more than three years have elapsed from the date on which the investor first acquired, or should have first acquired, knowledge of the alleged breach and knowledge that the investor has incurred loss or damage.

    Article 1117: Claim by an Investor of a Party on Behalf of an Enterprise

    1. An investor of a Party, on behalf of an enterprise of another Party that is a juridical person that the investor owns or controls directly or indirectly, may submit to arbitration under this Section a claim that the other Party has breached an obligation under:

    • (a) Section A or Article 1503(2) (State Enterprises), or

    • (b) Article 1502(3)(a) (Monopolies and State Enterprises) where the monopoly has acted in a manner inconsistent with the Party’s obligations under Section A,

    and that the enterprise has incurred loss or damage by reason of, or arising out of, that breach.

    2. An investor may not make a claim on behalf of an enterprise described in paragraph 1 if more than three years have elapsed from the date on which the enterprise first acquired, or should have first acquired, knowledge of the alleged breach and knowledge that the enterprise has incurred loss or damage.

    3. Where an investor makes a claim under this Article and the investor or a noncontrolling investor in the enterprise makes a claim under Article 1116 arising out of the same events that gave rise to the claim under this Article, and two or more of the claims are submitted to arbitration under Article 1120, the claims should be heard together by a Tribunal established under Article 1126, unless the Tribunal finds that the interests of a disputing party would be prejudiced thereby.

    4. An investment may not make a claim under this Section.

    Article 1118: Settlement of a Claim through Consultation and Negotiation

    The disputing parties should first attempt to settle a claim through consultation or negotiation.

    Article 1119: Notice of Intent to Submit a Claim to Arbitration

    The disputing investor shall deliver to the disputing Party written notice of its intention to submit a claim to arbitration at least 90 days before the claim is submitted, which notice shall specify:

    • (a) the name and address of the disputing investor and, where a claim is made under Article 1117, the name and address of the enterprise;

    • (b) the provisions of this Agreement alleged to have been breached and any other relevant provisions;

    • (c) the issues and the factual basis for the claim; and

    • (d) the relief sought and the approximate amount of damages claimed.

    Article 1120: Submission of a Claim to Arbitration

    1. Except as provided in Annex 1120.1, and provided that six months have elapsed since the events giving rise to a claim, a disputing investor may submit the claim to arbitration under:

    • (a) the ICSID Convention, provided that both the disputing Party and the Party of the investor are parties to the Convention;

    • (b) the Additional Facility Rules of ICSID, provided that either the disputing Party or the Party of the investor, but not both, is a party to the ICSID Convention; or

    • (c) the UNCITRAL Arbitration Rules.

    2. The applicable arbitration rules shall govern the arbitration except to the extent modified by this Section.

    Article 1121: Conditions Precedent to Submission of a Claim to Arbitration

    1. A disputing investor may submit a claim under Article 1116 to arbitration only if:

    • (a) the investor consents to arbitration in accordance with the procedures set out in this Agreement; and

    • (b) the investor and, where the claim is for loss or damage to an interest in an enterprise of another Party that is a juridical person that the investor owns or controls directly or indirectly, the enterprise, waive their right to initiate or continue before any administrative tribunal or court under the law of any Party, or other dispute settlement procedures, any proceedings with respect to the measure of the disputing Party that is alleged to be a breach referred to in Article 1116, except for proceedings for injunctive, declaratory or other extraordinary relief, not involving the payment of damages, before an administrative tribunal or court under the law of the disputing Party.

    2. A disputing investor may submit a claim under Article 1117 to arbitration only if both the investor and the enterprise:

    • (a) consent to arbitration in accordance with the procedures set out in this Agreement; and

    • (b) waive their right to initiate or continue before any administrative tribunal or court under the law of any Party, or other dispute settlement procedures, any proceedings with respect to the measure of the disputing Party that is alleged to be a breach referred to in Article 1117, except for proceedings for injunctive, declaratory or other extraordinary relief, not involving the payment of damages, before an administrative tribunal or court under the law of the disputing Party.

    3. A consent and waiver required by this Article shall be in writing, shall be delivered to the disputing Party and shall be included in the submission of a claim to arbitration.

    4. Only where a disputing Party has deprived a disputing investor of control of an enterprise:

    • (a) a waiver from the enterprise under paragraph l(b) or 2(b) shall not be required; and

    • (b) Annex 1120.1(A)(b) shall not apply.

    Article 1122: Consent to Arbitration

    1. Each Party consents to the submission of a claim to arbitration in accordance with the procedures set out in this Agreement.

    2. The consent given by paragraph 1 and the submission by a disputing investor of a claim to arbitration shall satisfy the requirement of:

    • (a) Chapter II of the ICSID Convention (Jurisdiction of the Centre) and the Additional Facility Rules for written consent of the Parties;

    • (b) Article II of the New York Convention for an agreement in writing; and

    • (c) Article I of the Inter-American Convention for an agreement.

    Article 1123: Number of Arbitrators and Method of Appointment

    Except in respect of a Tribunal established under Article 1126, and unless the disputing Parties otherwise agree, the Tribunal shall comprise three arbitrators, one arbitrator appointed by each of the disputing parties and the third, who shall be the presiding arbitrator, appointed by agreement of the disputing Parties.

    Article 1124: Constitution of a Tribunal When a Party Fails to Appoint an Arbitrator or the Disputing Parties Are Unable to Agree on a Presiding Arbitrator

    1. The Secretary-General shall serve as appointing authority for an arbitration under this Section.

    2. If a Tribunal, other than a Tribunal established under Article 1126, has not been constituted within 90 days from the date that a claim is submitted to arbitration, the Secretary-General, on the request of either disputing Party, shall appoint, in his discretion, the arbitrator or arbitrators not yet appointed, except that the presiding arbitrator shall be appointed in accordance with paragraph 3.

    3. The Secretary-General shall appoint the presiding arbitrator from the roster of presiding arbitrators referred to in paragraph 4, provided that the presiding arbitrator shall not be a national of the disputing Party or a national of the Party of the disputing investor. In the event that no such presiding arbitrator is available to serve, the Secretary-General shall appoint, from the ICSID Panel of Arbitrators, a presiding arbitrator who is not a national of any of the Parties.

    4. On the date of entry into force of this Agreement, the Parties shall establish, and thereafter maintain, a roster of 45 presiding arbitrators meeting the qualifications of the Convention and rules referred to in Article 1120 and experienced in international law and investment matters. The roster members shall be appointed by consensus and without regard to nationality.

    Article 1125: Agreement to Appointment of Arbitrators

    For purposes of Article 39 of the ICSID Convention and Article 7 of Schedule C to the ICSID Additional Facility Rules, and without prejudice to an objection to an arbitrator based on Article 1124(3) or on a ground other than nationality:

    • (a) the disputing Party agrees to the appointment of each individual member of a Tribunal established under the ICSID Convention or the ICSID Additional Facility Rules;

    • (b) a disputing investor referred to in Article 1116 may submit a claim to arbitration, or continue a claim, under the ICSID Convention or the ICSID Additional Facility Rules, only on condition that the disputing investor agrees in writing to the appointment of each individual member of the Tribunal; and

    • (c) a disputing investor referred to in Article 1117(1) may submit a claim to arbitration, or continue a claim, under the ICSID Convention or the ICSID Additional Facility Rules, only on condition that the disputing investor and the enterprise agree in writing to the appointment of each individual member of the Tribunal.

    Article 1126: Consolidation

    1. A Tribunal established under this Article shall be established under the UNCITRAL Arbitration Rules and shall conduct its proceedings in accordance with those Rules, except as modified by this Section.

    2. Where a Tribunal established under this Article is satisfied that claims have been submitted to arbitration under Article 1120 that have a question of law or fact in common, the Tribunal may, in the interests of fair and efficient resolution of the claims, and after hearing the disputing Parties, by order:

    • (a) assume jurisdiction over, and hear and determine together, all or part of the claims; or

    • (b) assume jurisdiction over, and hear and determine one or more of the claims, the determination of which it believes would assist in the resolution of the others.

    3. A disputing Party that seeks an order under paragraph 2 shall request the Secretary-General to establish a Tribunal and shall specify in the request:

    • (a) the name of the disputing Party or disputing investors against which the order is sought;

    • (b) the nature of the order sought; and

    • (c) the grounds on which the order is sought.

    4. The disputing Party shall deliver to the disputing Party or disputing investors against which the order is sought a copy of the request.

    5. Within 60 days of receipt of the request, the Secretary-General shall establish a Tribunal comprising three arbitrators. The Secretary-General shall appoint the presiding arbitrator from the roster referred to in Article 1124(4). In the event that no such presiding arbitrator is available to serve, the Secretary-General shall appoint, from the ICSID Panel of Arbitrators, a presiding arbitrator who is not a national of any of the Parties. The Secretary-General shall appoint the two other members from the roster referred to in Article 1124(4), and to the extent not available from that roster, from the ICSID Panel of Arbitrators, and to the extent not available from that Panel, in the discretion of the Secretary-General. One member shall be a national of the disputing Party and one member shall be a national of a Party of the disputing investors.

    6. Where a Tribunal has been established under this Article, a disputing investor that has submitted a claim to arbitration under Article 1116 or 1117 and that has not been named in a request made under paragraph 3 may make a written request to the Tribunal that it be included in an order made under paragraph 2, and shall specify in the request:

    • (a) the name and address of the disputing investor;

    • (b) the nature of the order sought; and

    • (c) the grounds on which the order is sought.

    7. A disputing investor referred to in paragraph 6 shall deliver a copy of its request to the disputing Parties named in a request made under paragraph 3.

    8. A Tribunal established under Article 1120 shall not have jurisdiction to decide a claim, or a part of a claim, over which a Tribunal established under this Article has assumed jurisdiction.

    9. On application of a disputing Party, a Tribunal established under this Article, pending its decision under paragraph 2, may order that the proceedings of a Tribunal established under Article 1120 be stayed, unless the latter Tribunal has already adjourned its proceedings.

    10. A disputing Party shall deliver to the Secretariat, within 15 days of receipt by the disputing Party, a copy of:

    • (a) a request for arbitration made under paragraph (1) of Article 36 of the ICSID Convention;

    • (b) a notice of arbitration made under Article 2 of Schedule C of the ICSID Additional Facility Rules; or

    • (c) a notice of arbitration given under the UNCITRAL Arbitration Rules.

    11. A disputing Party shall deliver to the Secretariat a copy of a request made under paragraph 3:

    • (a) within 15 days of receipt of the request, in the case of a request made by a disputing investor;

    • (b) within 15 days of making the request, in the case of a request made by the disputing Party.

    12. A disputing Party shall deliver to the Secretariat a copy of a request made under paragraph 6 within 15 days of receipt of the request.

    13. The Secretariat shall maintain a public register of the documents referred to in paragraphs 10, 11, and 12.

    Article 1127: Notice

    A disputing Party shall deliver to the other Parties:

    • (a) written notice of a claim that has been submitted to arbitration no later than 30 days after the date that the claim is submitted; and

    • (b) copies of all pleadings filed in the arbitration.

    Article 1128: Participation by a Party

    On written notice to the disputing parties, a Party may make submissions to a Tribunal on a question of interpretation of this Agreement.

    Article 1129: Documents

    1. A Party shall be entitled to receive from the disputing Party, at the cost of the requesting Party a copy of:

    • (a) the evidence that has been tendered to the Tribunal; and

    • (b) the written argument of the disputing parties.

    2. A Party receiving information pursuant to paragraph 1 shall treat the information as if it were a disputing Party.

    Article 1130: Place of Arbitration

    Unless the disputing Parties agree otherwise, a Tribunal shall hold an arbitration in the territory of a Party that is a Party to the New York Convention, selected in accordance with:

    • (a) the ICSID Additional Facility Rules if the arbitration is under those Rules or the ICSID Convention; or

    • (b) the UNCITRAL Arbitration Rules if the arbitration is under those Rules.

    Article 1131: Governing Law

    1. A Tribunal established under this Section shall decide the issues in dispute in accordance with this Agreement and applicable rules of international law.

    2. An interpretation by the Commission of a provision of this Agreement shall be binding on a Tribunal established under this Section.

    Article 1132: Interpretation of Annexes

    1. Where a disputing Party asserts as a defense that the measure alleged to be a breach is within the scope of a reservation or exception set out in Annex I, Annex II, Annex III or Annex IV, on request of the disputing Party, the Tribunal shall request the interpretation of the Commission on the issue. The Commission, within 60 days of delivery of the request, shall submit in writing its interpretation to the Tribunal.

    2. Further to Article 1131(2), a Commission interpretation submitted under paragraph 1 shall be binding on the Tribunal. If the Commission fails to submit an interpretation within 60 days, the Tribunal shall decide the issue.

    Article 1133: Expert Reports

    Without prejudice to the appointment of other kinds of experts where authorized by the applicable arbitration rules, a Tribunal, at the request of a disputing Party or, unless the disputing parties disapprove, on its own initiative, may appoint one or more experts to report to it in writing on any factual issue concerning environmental, health, safety or other scientific matters raised by a disputing Party in a proceeding, subject to such terms and conditions as the disputing Parties may agree.

    Article 1134: Interim Measures of Protection

    A Tribunal may order an interim measure of protection to preserve the rights of a disputing party, or to ensure that the Tribunal’s jurisdiction is made fully effective, including an order to preserve evidence in the possession or control of a disputing party or to protect the Tribunal’s jurisdiction. A Tribunal may not order attachment or enjoin the application of the measure alleged to constitute a breach referred to in Article 1116 or 1117. For purposes of this paragraph, an order includes a recommendation.

    Article 1135: Final Award

    1. Where a Tribunal makes a final award against a Party, the Tribunal may award, separately or in combination, only:

    • (a) monetary damages and any applicable interest;

    • (b) restitution of property, in which case the award shall provide that the disputing Party may pay monetary damages and any applicable interest in lieu of restitution.

    A tribunal may also award costs in accordance with the applicable arbitration rules.

    2. Subject to paragraph 1, where a claim is made under Article 1117(1):

    • (a) an award of restitution of property shall provide that restitution be made to the enterprise;

    • (b) an award of monetary damages and any applicable interest shall provide that the sum be paid to the enterprise; and

    • (c) the award shall provide that it is made without prejudice to any right that any person may have in the relief under applicable domestic law.

    3. A Tribunal may not order a Party to pay punitive damages.

    Article 1136: Finality and Enforcement of an Award

    1. An award made by a Tribunal shall have no binding force except between the disputing Parties and in respect of the particular case.

    2. Subject to paragraph 3 and the applicable review procedure for an interim award, a disputing Party shall abide by and comply with an award without delay.

    3. A disputing party may not seek enforcement of a final award until:

    • (a) in the case of a final award made under the ICSID Convention

      • (i) 120 days have elapsed from the date the award was rendered and no disputing Party has requested revision or annulment of the award, or

      • (ii) revision or annulment proceedings have been completed; and

    • (b) in the case of a final award under the ICSID Additional Facility Rules or the UNCITRAL Arbitration Rules

      • (i) three months have elapsed from the date the award was rendered and no disputing Party has commenced a proceeding to revise, set aside or annul the award, or

      • (ii) a court has dismissed or allowed an application to revise, set aside or annul the award and there is no further appeal.

    4. Each Party shall provide for the enforcement of an award in its territory.

    5. If a disputing Party fails to abide by or comply with a final award, the Commission, on delivery of a request by a Party whose investor was a Party to the arbitration, shall establish a panel under Article 2008 (Request for an Arbitral Panel). The requesting Party may seek in such proceedings:

    • (a) a determination that the failure to abide by or comply with the final award is inconsistent with the obligations of this Agreement; and

    • (b) a recommendation that the Party abide by or comply with the final award.

    6. A disputing investor may seek enforcement of an arbitration award under the ICSID Convention, the New York Convention or the Inter-American Convention regardless of whether proceedings have been taken under paragraph 5.

    7. A claim that is submitted to arbitration under this Section shall be considered to arise out of a commercial relationship or transaction for purposes of Article I of the New York Convention and Article I of the Inter-American Convention.

    Article 1137: General

    Time When a Claim Is Submitted to Arbitration

    1. A claim is submitted to arbitration under this Section when:

    • (a) the request for arbitration under paragraph 1 of Article 36 of the ICSID Convention has been received by the Secretary-General;

    • (b) the notice of arbitration under Article 2 of Schedule C of the ICSID Additional Facility Rules has been received by the Secretary-General; or

    • (c) the notice of arbitration given under the UNCITRAL Arbitration Rules is received by the disputing Party.

    Service of Documents

    2. Delivery of notice and other documents on a Party shall be made to the place named for that Party in Annex 1137.2.

    Receipts under Insurance or Guarantee Contracts

    3. In an arbitration under this Section, a Party shall not assert, as a defense, counterclaim, right of setoff or otherwise, that the disputing investor has received or will receive, pursuant to an insurance or guarantee contract, indemnification or other compensation for all or part of its alleged damages.

    Publication of an Award

    4. Annex 1137.4 applies to the Parties specified in that Annex with respect to publication of an award.

    Article 1138: Exclusions

    1. Without prejudice to the applicability or non-applicability of the dispute settlement provisions of this Section or of Chapter Twenty (Institutional Arrangements and Dispute Settlement Procedure) to other actions taken by a Party pursuant to Article 2102 (National Security), a decision by a Party to prohibit or restrict the acquisition of an investment in its territory by an investor of another Party, or its investment, pursuant to that Article shall not be subject to such provisions.

    2. The dispute settlement provisions of this Section and of Chapter Twenty shall not apply to the matters referred to in Annex 1138.2.

    * * * * *

    Chapter Twelve Cross-Border Trade in Services

    * * * * *

    Article 1211: Denial of Benefits

    1. A Party may deny the benefits of this Chapter to a service provider of another Party where the Party establishes that:

    • (a) the denying Party is being provided by an enterprise owned or controlled by nationals of a non-Party, and

      • (i) the denying Party does not maintain diplomatic relations with the non-Party, or

      • (ii) the denying Party adopts or maintains measures with respect to the non-Party that prohibit transactions with the enterprise or that would be violated or circumvented if the benefits of this Chapter were accorded to the enterprise; or

    • (b) the cross-border provision of a transportation service covered by this Chapter is provided using equipment not registered by any Party.

    2. Subject to prior notification and consultation in accordance with Articles 1803 (Notification and Provision of Information) and 2006 (Consultations), a Party may deny the benefits of this Chapter to a service provider of another Party where the Party establishes that the service is being provided by an enterprise that is owned or controlled by persons of a non-Party and that has no substantial business activities in the territory of any Party.

    * * * * *

    Chapter Fourteen Financial Services

    Article 1401: Scope and Coverage

    1. This Chapter applies to measures adopted or maintained by a Party relating to:

    • (a) financial institutions of another Party;

    • (b) investors of another Party, and investments of such investors, in financial institutions in the Party’s territory; and

    • (c) cross-border trade in financial services.

    2. Articles 1109 through 1111, 1113, 1114 and 1211 are hereby incorporated into and made a part of this Chapter. Articles 1115 through 1138 are hereby incorporated into and made a part of this Chapter solely for breaches by a Party of Articles 1109 through 1111, 1113, and 1114, as incorporated into this Chapter.

    3. Nothing in this Chapter shall be construed to prevent a Party, including its public entities, from exclusively conducting or providing in its territory:

    • (a) activities or services forming part of a public retirement plan or statutory system of social security; or

    • (b) activities or services for the account or with the guarantee or using the financial resources of the Party, including its public entities.

    4. Annex 1401.4 applies to the Parties specified in that Annex.

    Article 1402: Self-Regulatory Organizations

    Where a Party requires a financial institution or a cross-border financial service provider of another Party to be a member of, participate in, or have access to, a self-regulatory organization to provide a financial service in or into the territory of that Party, the Party shall ensure observance of the obligations of this Chapter by such self-regulatory organization.

    Article 1403: Establishment of Financial Institutions

    1. The Parties recognize the principle that an investor of another Party should be permitted to establish a financial institution in the territory of a Party in the juridical form chosen by such investor.

    2. The Parties also recognize the principle that an investor of another Party should be permitted to participate widely in a Party’s market through the ability of such investor to:

    • (a) provide in that Party’s territory a range of financial services through separate financial institutions as may be required by that Party;

    • (b) expand geographically in that Party’s territory; and

    • (c) own financial institutions in that Party’s territory without being subject to ownership requirements specific to foreign financial institutions.

    3. Subject to Annex 1403.3, at such time as the United States permits commercial banks of another Party located in its territory to expand through subsidiaries or direct branches into substantially all of the United States market, the Parties shall review and assess market access provided by each Party in relation to the principles in paragraphs 1 and 2 with a view to adopting arrangements permitting investors of another Party to choose the juridical form of establishment of commercial banks.

    4. Each Party shall permit an investor of another Party that does not own or control a financial institution in the Party’s territory to establish a financial institution in that territory. A Party may:

    • (a) require an investor of another Party to incorporate under the Party’s law any financial institution it establishes in the Party’s territory; or

    • (b) impose terms and conditions on establishment that are consistent with Article 1405.

    5. For purposes of this Article, “investor of another Party” means an investor of another Party engaged in the business of providing financial services in the territory of that Party.

    Article 1404: Cross-Border Trade

    1. No Party may adopt any measure restricting any type of cross-border trade in financial services by cross-border financial service providers of another Party that the Party permits on the date of entry into force of this Agreement, except to the extent set out in Section B of the Party’s Schedule to Annex VII.

    2. Each Party shall permit persons located in its territory, and its nationals wherever located to purchase financial services from cross-border financial service providers of another Party located in the territory of that other Party or of another Party. This obligation does not require a Party to permit such providers to do business or solicit in its territory. Subject to paragraph 1, each Party may define “doing business” and “solicitation” for purposes of this obligation.

    3. Without prejudice to other means of prudential regulation of cross-border trade in financial services, a Party may require the registration of cross-border financial service providers of another Party and of financial instruments.

    4. The Parties shall consult on the future liberalization of cross-border trade in financial services as set out in Annex 1404.4.

    Article 1405: National Treatment

    1. Each Party shall accord to investors of another Party treatment no less favorable than that it accords to its own investors, in like circumstances, with respect to the establishment, acquisition, expansion, management, conduct, operation, and sale or other disposition of financial institutions and investments in financial institutions in its territory.

    2. Each Party shall accord to financial institutions of another Party and to investments of investors of another Party in financial institutions treatment no less favorable than that it accords to its own financial institutions and to investments of its own investors in financial institutions, in like circumstances, with respect to the establishment, acquisition, expansion, management, conduct, operation, and sale or other disposition of financial institutions and investments.

    3. Subject to Article 1404, where a Party permits the cross-border provision of a financial service it shall accord to the cross-border financial service providers of another Party treatment no less favorable than that it accords to its own financial service providers, in like circumstances, with respect to the provision of such service.

    4. The treatment that a Party is required to accord under paragraphs 1, 2, and 3 means, with respect to a measure of any state or province:

    • (a) in the case of an investor of another Party with an investment in a financial institution, an investment of such investor in a financial institution, or a financial institution of such investor, located in a state or province, treatment no less favorable than the treatment accorded to an investor of the Party in a financial institution, an investment of such investor in a financial institution, or a financial institution of such investor, located in that state or province, in like circumstances; and

    • (b) in any other case, treatment no less favorable than the most favorable treatment accorded to an investor of the Party in a financial institution, its financial institution or its investment in a financial institution in like circumstances.

    For greater certainty, in the case of an investor of another Party with investments in financial institutions or financial institutions of such investor, located in more than one state or province, the treatment required under subparagraph (a) means:

    • (c) treatment of the investor that is no less favorable than the most favorable treatment accorded to an investor of the Party with an investment located in such states, in like circumstances; and

    • (d) with respect to an investment of the investor in a financial institution or a financial institution of such investor, located in a state or province, treatment no less favorable than that accorded to an investment of an investor of the Party, or a financial institution of such investor, located in that state or province, in like circumstances.

    5. A Party’s treatment of financial institutions and cross-border financial service providers of another Party, whether different or identical to that accorded to its own institutions or providers in like circumstances, is consistent with paragraphs 1 through 3 if the treatment affords equal competitive opportunities.

    6. A Party’s treatment affords equal competitive opportunities if it does not disadvantage financial institutions and cross-border financial service providers of another Party in their ability to provide financial services as compared with the ability of the Party’s own financial institutions and financial services providers to provide such services, in like circumstances.

    7. Differences in market share, profitability or size do not in themselves establish a denial of equal competitive opportunities, but such differences may be used as evidence regarding whether a Party’s treatment affords equal competitive opportunities.

    Article 1406: Most-Favored-Nation Treatment

    1. Each Party shall accord to investors of another Party, financial institutions of another Party, investments of investors in financial institutions and cross-border financial service providers of another Party treatment no less favorable than that it accords to the investors, financial institutions, investments of investors in financial institutions and cross-border financial service providers of any other Party or of a non-Party, in like circumstances.

    2. A Party may recognize prudential measures of another Party or of a non-Party in the application of measures covered by this Chapter. Such recognition may be:

    • (a) accorded unilaterally;

    • (b) achieved through harmonization or other means; or

    • (c) based upon an agreement or arrangement with the other Party or non-Party.

    3. A Party according recognition of prudential measures under paragraph 2 shall provide adequate opportunity to another Party to demonstrate that circumstances exist in which there are or would be equivalent regulation, oversight, implementation of regulation, and if appropriate, procedures concerning the sharing of information between the Parties.

    4. Where a Party accords recognition of prudential measures under paragraph 2(c) and the circumstances set out in paragraph 3 exist, the Party shall provide adequate opportunity to another Party to negotiate accession to the agreement or arrangement, or to negotiate a comparable agreement or arrangement.

    Article 1407: New Financial Services and Data Processing

    1. Each Party shall permit a financial institution of another Party to provide any new financial service of a type similar to those services that the Party permits its own financial institutions, in like circumstances, to provide under its domestic law. A Party may determine the institutional and juridical form through which the service may be provided and may require authorization for the provision of the service. Where such authorization is required, a decision shall be made within a reasonable time and the authorization may only be refused for prudential reasons.

    2. Each party shall permit a financial institution of another Party to transfer information in electronic or other form, into and out of the Party’s territory, for data processing where such processing is required in the ordinary course of business of such an institution.

    Article 1408: Senior Management and Boards of Directors

    1. No Party may require financial institutions of another Party to engage individuals of any particular nationality as senior managerial or other essential personnel.

    2. No Party may require that more than a simple majority of the board of directors of a financial institution of another Party be composed of nationals of the Party, persons residing in the territory of the Party, or a combination thereof.

    Article 1409: Reservations and Specific Commitments

    1. Articles 1403 through 1408 do not apply to:

    • (a) Any existing non-conforming measure that is maintained by

      • (i) a Party at the federal level, as set out in Section A of its Schedule to Annex VII,

      • (ii) a state or province, for the period ending on the date specified in Annex 1409.1 for that state or province, and thereafter as described by the Party in Section A of its Schedule to Annex VII in accordance with Annex 1409.1, or

      • (iii) a local government;

    • (b) the continuation or prompt renewal of any non-conforming measure referred to in subparagraph (a); or

    • (c) an amendment to any non-conforming measure referred to in subparagraph (a) to the extent that the amendment does not decrease the conformity of the measure, as it existed before the amendment, with Articles 1403 through 1408.

    2. Articles 1403 through 1408 do not apply to any non-conforming measure that a Party adopts or maintains in accordance with Section B of its Schedule to Annex VII.

    3. Section C of each Party’s Schedule to Annex VII sets out certain specific commitments by that Party.

    4. Where a Party has set out a reservation to Article 1102, 1103, 1202 or 1203 in its Schedule to Annex I, II, III or IV, the reservation shall be deemed to constitute a reservation to Article 1405 or 1406, as the case may be, to the extent that the measure, sector, subsector or activity set out in the reservation is covered by this Chapter.

    Article 1410: Exceptions

    1. Nothing in this Part shall be construed to prevent a Party from adopting or maintaining reasonable measures for prudential reasons, such as:

    • (a) the protection of investors, depositors, financial market participants, policy-holders, policy claimants, or persons to whom a fiduciary duty is owed by a financial institution or cross-border financial service provider;

    • (b) the maintenance of the safety, soundness, integrity or financial responsibility of financial institutions or cross-border financial service providers; and

    • (c) ensuring the integrity and stability of the Party’s financial system.

    2. Nothing in this Part applies to non-discriminatory measures of general application taken by any public entity in pursuit of monetary and related credit policies or exchange rate policies. This paragraph shall not affect a Party’s obligations under Article 1106 (Investment - Performance Requirements) with respect to measures covered by Chapter Eleven (Investment) or Article 1109 (Investments - Transfers).

    3. Article 1405 shall not apply to the granting by a Party to a financial institution of an exclusive right to provide a financial service referred to in Article 1401(3)(a).

    4. Notwithstanding Article 1109(1), (2) and (3), as incorporated into this Chapter, and without limiting the applicability of Article 1109(4), as incorporated into this Chapter, a Party may prevent or limit transfers by a financial institution or cross-border financial services provider, through the equitable, non-discriminatory and good faith application of measures relating to maintenance of the safety, soundness, integrity or financial responsibility of financial institutions or cross-border financial service providers. This paragraph does not prejudice any other provision of this Agreement that permits a Party to restrict transfers.

    Article 1411: Transparency

    1. In lieu of Article 1802(2) (Publication), each Party shall, to the extent practicable, provide in advance to all interested persons any measure of general application that the Party proposes to adopt in order to allow an opportunity for such persons to comment on the measure. Such measure shall be provided:

    • (a) by means of official publication;

    • (b) in other written form; or

    • (c) in such other form as permits an interested person to make informed comments on the proposed measure.

    2. Each Party’s regulatory authorities shall make available to interested persons their requirements for completing applications relating to the provision of financial services.

    3. On the request of an applicant, the regulatory authority shall inform the applicant of the status of its application. If such authority requires additional information from the applicant, it shall notify the applicant without undue delay.

    4. A regulatory authority shall make an administrative decision on a completed application of an investor in a financial institution, a financial institution or a cross-border financial service provider of another Party relating to the provision of a financial service within 120 days, and shall promptly notify the applicant of the decision. An application shall not be considered complete until all relevant hearings are held and all necessary information is received. Where it is not practicable for a decision to be made within 120 days, the regulatory authority shall notify the applicant without undue delay and shall endeavor to make the decision within a reasonable time thereafter.

    5. Nothing in this Chapter requires a Party to furnish or allow access to:

    • (a) information related to the financial affairs and accounts of individual customers of financial institutions or cross-border financial service providers; or

    • (b) any confidential information, the disclosure of which would impede law enforcement or otherwise be contrary to the public interest or prejudice legitimate commercial interests of particular enterprises.

    6. Each Party shall maintain or establish one or more inquiry points no later than 180 days after the date of entry into force of this Agreement, to respond in writing as soon as practicable, to all reasonable inquiries from interested persons regarding measures of general application covered by this Chapter.

    Article 1412: Financial Services Committee

    1. The Parties hereby establish the Financial Services Committee. The principal representative of each Party shall be an official of the Party’s authority responsible for financial services set out in Annex 1412.1.

    2. Subject to Article 2001(2)(d)(Free Trade Commission), the Committee shall:

    • (a) supervise the implementation of this Chapter and its further elaboration;

    • (b) consider issues regarding financial services that are referred to it by a Party; and

    • (c) participate in the dispute settlement procedures in accordance with Article 1415.

    3. The Committee shall meet annually to assess the functioning of this Agreement as it applies to financial services. The Committee shall inform the Commission of the results of each annual meeting.

    Article 1413: Consultations

    1. A Party may request consultations with another Party regarding any matter arising under this Agreement that affects financial services. The other Party shall give sympathetic consideration to the request. The consulting Parties shall report the results of their consultations to the Committee at its annual meeting.

    2. Consultations under this Article shall include officials of the authorities specified in Annex 1412.1.

    3. A Party may request that regulatory authorities of another Party participate in consultations under this Article regarding the other Party’s measures of general application which may affect the operations of financial institutions or cross-border financial service providers in the requesting Party’s territory.

    4. Nothing in this Article shall be construed to require regulatory authorities participating in consultations under paragraph 3 to disclose information or take any action that would interfere with individual regulatory, supervisory, administrative or enforcement matters.

    5. Where a Party requires information for supervisory purposes concerning a financial institution in another Party’s territory or a cross-border financial services provider in another Party’s territory, the Party may approach the competent regulatory authority in the other Party’s territory to seek the information.

    6. Annex 1413.6 shall apply to further consultations and arrangements.

    Article 1414: Dispute Settlement

    1. Section B of Chapter Twenty (Institutional Arrangements and Dispute Settlement Procedures) applies as modified by this Article to the settlement of disputes arising under this Chapter.

    2. The Parties shall establish by January 1, 1994 and maintain a roster of up to 15 individuals who are willing and able to serve as financial services panelists. Financial services roster members shall be appointed by consensus for terms of three years, and may be reappointed.

    3. Financial services roster members shall:

    • (a) have expertise or experience in financial services law or practice, which may include the regulation of financial institutions;

    • (b) be chosen strictly on the basis of objectivity, reliability and sound judgment; and

    • (c) meet the qualifications set out in Article 2009(2)(b) and (c) (Roster).

    4. Where a Party claims that a dispute arises under this Chapter, Article 2011 (Panel Selection) shall apply, except that:

    • (a) where the disputing parties so agree, the panel shall be composed entirely of panelists meeting the qualifications in paragraph 3; and

    • (b) in any other case,

      • (i) each disputing Party may select panelists meeting the qualifications set out in paragraph 3 or in Article 2010(1) (Qualification of Panelists), and

      • (ii) if the Party complained against invokes Article 1410, the chair of the panel shall meet the qualifications set out in paragraph 3.

    5. In any dispute where a panel finds a measure to be inconsistent with the obligations of this Agreement and the measure affects:

    • (a) only the financial services sector, the complaining Party may suspend benefits only in the financial services sector;

    • (b) the financial services sector and any other sector, the complaining Party may suspend benefits in the financial services sector that have an effect equivalent to the effect of the measure in the Party’s financial services sector; or

    • (c) only a sector other than the financial services sector, the complaining Party may not suspend benefits in the financial services sector.

    Article 1415: Investment Disputes in Financial Services

    1. Where an investor of another Party submits a claim under Article 1116 or 1117 to arbitration under Section B of Chapter Eleven (Investment - Settlement of Disputes between a Party and an Investor of Another Party) against a Party and the disputing Party invokes Article 1410, on the request of the disputing Party, the Tribunal shall refer the matter in writing to the Committee for a decision. The Tribunal may not proceed pending receipt of a decision or report under this Article.

    2. In a referral pursuant to paragraph 1, the Committee shall decide the issue of whether and to what extent Article 1410 is a valid defense to the claim of the investor. The Committee shall transmit a copy of its decision to the Tribunal and to the Commission. The decision shall be binding on the Tribunal.

    3. Where the Committee has not decided the issue within 60 days of the receipt of the referral under paragraph 1, the disputing Party or the Party of the disputing investor may request the establishment of an arbitral panel under Article 2008 (Request for an Arbitral Panel). The panel shall be constituted in accordance with Article 1414. Further to Article 2017 (Final Report), the panel shall transmit its final report to the Committee and to the Tribunal. The report shall be binding on the Tribunal.

    4. Where no request for the establishment of a panel pursuant to paragraph 3 has been made within 10 days of the expiration of the 60-day period referred to in paragraph 3, the Tribunal may proceed to decide the matter.

    Article 1416: Definitions

    For purposes of this Chapter:

    cross-border financial service provider of a Party means a person of a Party that is engaged in the business of providing a financial service within the territory of the Party and that seeks to provide or provides financial services through the cross-border provision of such services;

    cross-border provision of a financial service or cross-border trade in financial services means the provision of a financial service:

    • (a) from the territory of a Party into the territory of another Party,

    • (b) in the territory of a Party by a person of that Party to a person of another Party, or

    • (c) by a national of a Party in the territory of another Party,

    but does not include the provision of a service in the territory of a Party by an investment in that territory;

    financial institution means any financial intermediary or other enterprise that is authorized to do business and regulated or supervised as a financial institution under the law of the Party in whose territory it is located;

    financial institution of another Party means a financial institution, including a branch, located in the territory of a Party that is controlled by persons of another Party;

    financial service means service of a financial nature, including insurance, and a service incidental or auxiliary to a service of a financial nature;

    financial service provider of a Party means a person of a Party that is engaged in the business of providing a financial service within the territory of that Party;

    investment means “investment” as defined in Article 1139 (Investment - Definitions), except that, with respect to “loans” and “debt securities” referred to in that Article:

    • (a) a loan to or debt security issued by a financial institution is an investment only where it is treated as regulatory capital by the Party in whose territory the financial institution is located; and

    • (b) a loan granted by or debt security owned by a financial institution, other than a loan to or debt security of a financial institution referred to in subparagraph (a), is not an investment;

    for greater certainty:

    • (c) a loan to, or debt security issued by, a Party or a state enterprise thereof is not an investment; and

    • (d) a loan granted by or a debt security owned by a cross-border financial service provider, other than a loan to or debt security issued by a financial institution, is an investment if such loan or debt security meets the criteria for investments set out in Article 1139;

    investor of a Party means a Party or state enterprise thereof, or a person of that Party that seeks to make, makes, or has made an investment;

    new financial service means a financial service not provided in the Party’s territory that is provided within the territory of another Party, and includes any new form of delivery of a financial service or the sale of a financial product that is not sold in the Party’s territory;

    person of a Party means “person of a Party” as defined in Chapter Two (General Definitions) and, for greater certainty, does not include a branch of an enterprise of a non-Party;

    public entity means a central bank or monetary authority of a Party, or any financial institution owned or controlled by a Party; and

    self-regulatory organization means any non-governmental body, including any securities or futures exchange or market, clearing agency, or other organization or association, that exercises its own or delegated regulatory or supervisory authority over financial service providers of financial institutions.

    Annex 1401.4 Country-Specific Commitments

    For Canada and the United States, Article 1702(1) and (2) of the Canada-United States Free Trade Agreement is hereby incorporated into and made a part of this Agreement.

    Annex 1403.3 Review of Market Access

    The review of market access referred to in Article 1403(3) shall not include the market access limitations specified in Section B of the Schedule of Mexico to Annex VII.

    Annex 1404.4 Consultations on Liberalization of Cross-Border Trade

    No later than January 1, 2000, the Parties shall consult on further liberalization of cross-border trade in financial services. In such consultations the Parties shall, with respect to insurance:

    • (a) consider the possibility of allowing a wider range of insurance services to be provided on a cross-border basis in or into their respective territories; and

    • (b) determine whether the limitations on cross-border insurance services specified in Section A of the Schedule of Mexico to Annex VII shall be maintained, modified or eliminated.

    Annex 1409.1 Provincial and State Reservations

    1. Canada may set out in Section A of its Schedule to Annex VII by the date of entry into force of this Agreement any existing nonconforming measure maintained at the provincial level.

    2. The United States may set out in Section A of its schedule to Annex VII by the date of entry into force of this Agreement any existing nonconforming measures maintained by California, Florida, Illinois, New York, Ohio and Texas. Existing non-conforming state measures of all other states may be set out by January 1, 1995.

    Annex 1412.1 Authorities Responsible for Financial Services

    The authority of each Party responsible for financial services shall be:

    • (a) for Canada, the Department of Finance of Canada;

    • (b) for Mexico, the Secretaría de Hacienda y Crédito Público; and

    • (c) for the United States, the Department of the Treasury for banking and other financial services and the Department of Commerce for insurance services.

    Annex 1413.6 Further Consultations and Arrangements

    Section A - Limited Scope Financial Institutions

    Three years after the date of entry into force of this Agreement, the Parties shall consult on the aggregate limit on limited scope financial institutions described in paragraph 8 of Section B of the Schedule of Mexico to Annex VII.

    Section B - Payments System Protection

    1. If the sum of the authorized capital of foreign commercial bank affiliates (as such term is defined in the Schedule of Mexico to Annex VII), measured as a percentage of the aggregate capital of all commercial banks in Mexico, reaches 25 percent, Mexico may request consultations with the other Parties on the potential adverse effects arising from the presence of commercial banks of the other Parties in the Mexican market and the possible need for remedial action, including further temporary limitations on market participation. The consultations shall be completed expeditiously.

    2. In considering the potential adverse effects, the Parties shall take into account:

    • (a) the threat that the Mexican payments system may be controlled by non-Mexican persons;

    • (b) the effects foreign commercial banks established in Mexico may have on Mexico’s ability to conduct monetary and exchange-rate policy effectively; and

    • (c) the adequacy of this Chapter in protecting the Mexican payments system.

    3. If no consensus is reached on the matters referred to in paragraph 1 any Party may request the establishment of an arbitral panel under Article 1414 or Article 2008 (request for an Arbitral Panel). The panel proceedings shall be conducted in accordance with the Model Rules of Procedure established under Article 2012 (Rules of Procedure). The Panel shall present its determination within 60 days after the last panelist is selected or such other period as the Parties to the proceeding may agree. Article 2018 (Implementation of Final Report) and 2019 (Non-Implementation-Suspension of Benefits) shall not apply in such proceedings.

    * * * * *

    Chapter Twenty Institutional Arrangements and Dispute Settlement Procedures

    Section A - Institutions

    Article 2001: The Free Trade Commission

    1. The Parties hereby establish the Free Trade Commission, comprising cabinet-level representatives of the Parties or their designees.

    2. The Commission shall:

    • (a) supervise the implementation of this Agreement;

    • (b) oversee its further elaboration;

    • (c) resolve disputes that may arise regarding its interpretation or application;

    • (d) supervise the work of all committees and working groups established under this Agreement, referred to in Annex 2001.2; and

    • (e) consider any other matter that may affect the operation of this Agreement.

    3. The Commission may:

    • (a) establish, and delegate responsibilities to, ad hoc or standing committees, working groups or expert groups;

    • (b) seek the advice of non-governmental persons or groups; and

    • (c) take such other action in the exercise of its functions as the Parties may agree.

    4. The Commission shall establish its rules and procedures. All decisions of the Commission shall be taken by consensus, except as the Commission may otherwise agree.

    5. The Commission shall convene at least once a year in regular session. Regular sessions of the Commission shall be chaired successively by each Party.

    Article 2002: The Secretariat

    1. The Commission shall establish and oversee a Secretariat comprising national Sections.

    2. Each Party shall:

    • (a) establish a permanent office of its Section;

    • (b) be responsible for

      • (i) the operation and costs of its Section, and

      • (ii) the remuneration and payment of expenses of panelists and members of committees and scientific review boards established under this Agreement, as set out in Annex 2002.2;

    • (c) designate an individual to serve as Secretary for its Section, who shall be responsible for its administration and management; and

    • (d) notify the Commission of the location of its Section’s office.

    3. The Secretariat shall:

    • (a) provide assistance to the Commission;

    • (b) provide administrative assistance to

      • (i) panels and committees established under Chapter Nineteen (Review and Dispute Settlement in Antidumping and Countervailing Duty Matters), in accordance with the procedures established pursuant to Article 1908, and

      • (ii) panels established under this Chapter, in accordance with procedures established pursuant to Article 2012; and

    • (c) as the Commission may direct

      • (i) support the work of other committees and groups established under this Agreement, and

      • (ii) otherwise facilitate the operation of this Agreement.

    Section B - Dispute Settlement

    Article 2003: Cooperation

    The Parties shall at all times endeavor to agree on the interpretation and application of this Agreement, and shall make every attempt through cooperation and consultations to arrive at a mutually satisfactory resolution of any matter that might affect its operation.

    Article 2004: Recourse to Dispute Settlement Procedures

    Except for the matters covered in Chapter Nineteen (Review and Dispute Settlement in Antidumping and Countervailing Duty Matters) and as otherwise provided in this Agreement, the dispute settlement provisions of this Chapter shall apply with respect to the avoidance or settlement of all disputes between the Parties regarding the interpretation or application of this Agreement or wherever a Party considers that an actual or proposed measure of another Party is or would be inconsistent with the obligations of this Agreement or cause nullification or impairment in the sense of Annex 2004.

    Article 2005: GATT Dispute Settlement

    1. Subject to paragraphs 2, 3 and 4, disputes regarding any matter arising under both this Agreement and the General Agreement on Tariffs and Trade, any agreement negotiated thereunder, or any successor agreement (GATT), may be settled in either forum at the discretion of the complaining Party.

    2. Before a Party initiates a dispute settlement proceeding in the GATT against another Party on grounds that are substantially equivalent to those available to the Party under this Agreement, that Party shall notify any third Party of its intention. If a third Party wishes to have recourse to dispute settlement procedures under this Agreement regarding the matter, it shall inform promptly the notifying Party and those Parties shall consult with a view to agreement on a single forum. If those Parties cannot agree, the dispute normally shall be settled under this Agreement.

    3. In any dispute referred to in paragraph 1 where the responding Party claims that its action is subject to Article 104 (Relation to Environment and Conservation Agreement) and requests in writing that the matter be considered under this Agreement, the complaining Party may, in respect of that matter, thereafter have recourse to dispute settlement procedures solely under this Agreement.

    4. In any dispute referred to in paragraph 1 that arises under Section B of Chapter Seven (Sanitary and Phytosanitary Measures) or Chapter Nine (Standards-Related Measures):

    • (a) concerning a measure adopted or maintained by a Party to protect its human, animal, or plant life or health, or to protect its environment, and

    • (b) that raises factual issues concerning the environment, health, safety or conservation, including directly related scientific matters,

    where the responding Party requests in writing that the matter be considered under this Agreement, the complaining Party may, in respect of that matter, thereafter have recourse to dispute settlement procedures solely under this Agreement.

    5. The responding Party shall deliver a copy of a request made pursuant to paragraph 3 or 4 to the other Parties and to its Section of the Secretariat. Where the complaining Party has initiated dispute settlement proceedings regarding any matter subject to paragraph 3 or 4, the responding Party shall deliver its request no later than 15 days thereafter. On receipt of such request, the complaining Party shall promptly withdraw from participation in those proceedings and may initiate dispute settlement procedures under Article 2007.

    6. Once dispute settlement procedures have been initiated under Article 2007 or dispute settlement proceedings have been initiated under the GATT, the forum selected shall be used to the exclusion of the other, unless a Party makes a request pursuant to paragraph 3 or 4.

    7. For purposes of this Article, dispute settlement proceedings under the GATT are deemed to be initiated by a Party’s request for a panel, such as under Article XXIII: 2 of the General Agreement on Tariffs and Trade 1947, or for a committee investigation, such as under Article 20.1 of the Customs Valuation Code.

    Consultations

    Article 2006: Consultations

    1. Any Party may request in writing consultations with any other Party regarding any actual or proposed measure or any other matter that it considers might affect the operation of this Agreement.

    2. The requesting Party shall deliver the request to the other Parties and to its Section of the Secretariat.

    3. Unless the Commission otherwise provides in its rules and procedures established under Article 2001(4), a third Party that considers it has a substantial interest in the matter shall be entitled to participate in the consultations on delivery of written notice to the other Parties and to its Section of the Secretariat.

    4. Consultations on matters regarding perishable agricultural goods shall commence within 15 days of the date of delivery of the request.

    5. The consulting Parties shall make every attempt to arrive at a mutually satisfactory resolution of any matter through consultations under this Article or other consultative provisions of this Agreement. To this end, the consulting Parties shall:

    • (a) provide sufficient information to enable a full examination of how the actual or proposed measure or other matter might affect the operation of this Agreement;

    • (b) treat any confidential or proprietary information exchanged in the course of consultations on the same basis as the Party providing the information; and

    • (c) seek to avoid any resolution that adversely affects the interests under this Agreement of any other Party.

    Initiation of Procedures

    Article 2007: Commission-Good Offices, Conciliation and Mediation

    1. If the consulting Parties fail to resolve a matter pursuant to Article 2006 within:

    • (a) 30 days of delivery of a request for consultations,

    • (b) 45 days of delivery of such request if any other Party has subsequently requested or has participated in consultations regarding the same matter,

    • (c) 15 days of delivery of a request for consultations in matters regarding perishable agricultural goods, or

    • (d) such other period as they may agree,

    any such Party may request in writing a meeting of the Commission.

    2. A Party may also request in writing a meeting of the Commission where:

    • (a) it has initiated dispute settlement proceedings under the GATT regarding any matter subject to Article 2005(3) or (4), and has received a request pursuant to Article 2005(5) for recourse to dispute settlement procedures under this Chapter; or

    • (b) consultations have been held pursuant to Article 513 (Working Group on Rules of Origin), Article 723 (Sanitary and Phytosanitary Measures - Technical Consultations) and Article 914 (Standards-Related Measures - Technical Consultations).

    3. The requesting Party shall state in the request the measure or other matter complained of and indicate the provisions of this Agreement that it considers relevant, and shall deliver the request to the Parties and to its Section of the Secretariat.

    4. Unless it decides otherwise, the Commission shall convene within 10 days of delivery of the request and shall endeavor to resolve the dispute promptly.

    5. The Commission may:

    • (a) call on such technical advisers or create such working groups or expert groups as it deems necessary,

    • (b) have recourse to good offices, conciliation, mediation or such other dispute resolution procedures, or

    • (c) make recommendations,

    as may assist the consulting Parties to reach a mutually satisfactory resolution of the dispute.

    6. Unless it decides otherwise, the Commission shall consolidate two or more proceedings before it pursuant to this Article regarding the same measure. The Commission may consolidate two or more proceedings regarding other matters before it pursuant to this Article that it determines are appropriate to be considered jointly.

    Panel Proceedings

    Article 2008: Request for an Arbitral Panel

    1. If the Commission has convened pursuant to Article 2007(4), and the matter has not been resolved within:

    • (a) 30 days thereafter,

    • (b) 30 days after the Commission has convened in respect of the matter most recently referred to it, where proceedings have been consolidated pursuant to Article 2007(6), or

    • (c) such other period as the consulting Parties may agree,

    any consulting Party may request in writing the establishment of an arbitral panel. The requesting Party shall deliver the request to the other Parties and to its Section of the Secretariat.

    2. On delivery of the request, the Commission shall establish an arbitral panel.

    3. A third Party that considers it has a substantial interests in the matter shall be entitled to join as a complaining Party on delivery of written notice of its intention to participate to the disputing Parties and its Section of the Secretariat. The notice shall be delivered at the earliest possible time, and in any event no later than seven days after the date of delivery of a request by a Party for the establishment of a panel.

    4. If a third Party does not join as a complaining Party in accordance with paragraph 3, it normally shall refrain thereafter from initiating or continuing:

    • (a) a dispute settlement procedure under this Agreement, or

    • (b) a dispute settlement proceeding in the GATT on grounds that are substantially equivalent to those available to that Party under this Agreement,

    regarding the same matter in the absence of a significant change in economic or commercial circumstances.

    5. Unless otherwise agreed by the disputing Parties, the panel shall be established and perform its functions in a manner consistent with the provisions of this Chapter.

    Article 2009: Roster

    1. The Parties shall establish by January 1, 1994 and maintain a roster of up to 30 individuals who are willing and able to serve as panelists. The roster members shall be appointed by consensus for terms of three years, and may be reappointed.

    2. Roster members shall:

    • (a) have expertise or experience in law, international trade, other matters covered by this Agreement or the resolution of disputes arising under international trade agreements, and shall be chosen strictly on the basis of objectivity, reliability and sound judgment.

    • (b) be independent of, and not be affiliated with, or take instructions from, any Party; and

    • (c) comply with a code of conduct to be established by the Commission.

    Article 2010: Qualifications of Panelists

    1. All panelists shall meet the qualifications set out in Article 2009(2).

    2. Individuals may not serve as panelists for a dispute in which they have participated pursuant to Article 2007(5).

    Article 2011: Panel Selection

    1. Where there are two disputing Parties, the following procedures shall apply:

    • (a) The panel shall comprise five members.

    • (b) The disputing Parties shall endeavor to agree on the chair of the panel within 15 days of the delivery of the request for the establishment of the panel. If the disputing Parties are unable to agree on the chair within this period, the disputing Party chosen by lot shall select within five days as chair an individual who is not a citizen of that Party.

    • (c) Within 15 days of selection of the chair, each disputing Party shall select two panelists who are citizens of the other disputing Party.

    • (d) If a disputing Party fails to select its panelists within such period, such panelists shall be selected by lot from among the roster members who are citizens of the other disputing Party.

    2. Where there are more than two disputing Parties, the following procedures shall apply:

    • (a) The panel shall comprise five members.

    • (b) The disputing Parties shall endeavor to agree on the chair of the panel within 15 days of the delivery of the request for the establishment of the panel. If the disputing Parties are unable to agree on the chair within this period, the Party or Parties on the side of the dispute chosen by lot shall select within 10 days a chair who is not a citizen of such Party or Parties.

    • (c) Within 15 days of selection of the chair, the Party complained against shall select two panelists, one of whom is a citizen of a complaining Party, and the other of whom is a citizen of another complaining Party. The complaining Parties shall select two panelists who are citizens of the Party complained against.

    • (d) If any disputing Party fails to select a panelist within such period, such panelist shall be selected by lot in accordance with the citizenship criteria of subparagraph (c).

    3. Panelists shall normally be selected from the roster. Any disputing Party may exercise a peremptory challenge against any individual not on the roster who is proposed as a panelist by a disputing Party within 15 days after the individual has been proposed.

    4. If a disputing Party believes that a panelist is in violation of the code of conduct, the disputing Parties shall consult and if they agree, the panelist shall be removed and a new panelist shall be selected in accordance with this Article.

    Article 2012: Rules of Procedure

    1. The Commission shall establish by January 1, 1994 Model Rules of Procedure, in accordance with the following principles:

    • (a) the procedures shall assure a right to at least one hearing before the panel as well as the opportunity to provide initial and rebuttal written submissions; and

    • (b) the panel’s hearings, deliberations and initial report, and all written submissions to and communications with the panel shall be confidential.

    2. Unless the disputing Parties otherwise agree, the panel shall conduct its proceedings in accordance with the Model Rules of Procedure.

    3. Unless the disputing Parties otherwise agree within 20 days from the date of the delivery of the request for the establishment of the panel, the terms of reference shall be:

    “to examine, in the light of the relevant provisions of the Agreement, the matter referred to the Commission (as set out in the request for a Commission meeting) and to make findings, determinations and recommendations as provided in Article 2016(2).”

    4. If a complaining Party wishes to argue that a matter has nullified or impaired benefits, the terms of reference shall so indicate.

    5. If a disputing Party wishes the panel to make findings as to the degree of adverse trade effects on any Party of any measure found not to conform with the obligations of the Agreement or to have caused nullification or impairment in the sense of Annex 2004, the terms of reference shall so indicate.

    Article 2013: Third Party Participation

    A Party that is not a disputing Party, on delivery of a written notice to the disputing Parties and to its Section of the Secretariat, shall be entitled to attend all hearings, to make written and oral submissions to the panel and to receive written submissions of the disputing Parties.

    Article 2014: Role of Experts

    On request of a disputing Party, or on its own initiative, the panel may seek information and technical advice from any person or body that it deems appropriate, provided that the disputing Parties so agree and subject to such terms and conditions as such Parties may agree.

    Article 2015: Scientific Review Boards

    1. On request of a disputing Party or, unless the disputing parties disapprove, on its own initiative, the panel may request a written report of a scientific review board on any factual issue concerning environmental, health, safety or other scientific matters raised by a disputing Party in a proceeding, subject to such terms and conditions as such Parties may agree.

    2. The board shall be selected by the panel from among highly qualified, independent experts in the scientific matters, after consultations with the disputing Parties and the scientific bodies set out in the Model Rules of Procedure established pursuant to Article 2012(1).

    3. The participating Parties shall be provided:

    • (a) advance notice of, and an opportunity to provide comments to the panel on, the proposed factual issues to be referred to the board; and

    • (b) a copy of the board’s report and an opportunity to provide comments on the report to the panel.

    4. The panel shall take the board’s report and any comments by the Parties on the report into account in the preparation of its report.

    Article 2016: Initial Report

    1. Unless the disputing Parties otherwise agree, the panel shall base its report on the submissions and arguments of the Parties and on any information before it pursuant to Article 2014 or 2015.

    2. Unless the disputing Parties otherwise agree, the panel shall, within 90 days after the last panelist is selected or such other period as the Model Rules of Procedure established pursuant to Article 2012(1) may provide, present to the disputing Parties an initial report containing:

    • (a) findings of fact, including any findings pursuant to a request under Article 2012(5);

    • (b) its determination as to whether the measure at issue is or would be inconsistent with the obligations of this Agreement or cause nullification or impairment in the sense of Annex 2004, or any other determination requested in the terms of reference; and

    • (c) its recommendations, if any, for resolution of the dispute.

    3. Panelists may furnish separate opinions on matters not unanimously agreed.

    4. A disputing Party may submit written comments to the panel on its initial report within 14 days of presentation of the report.

    5. In such an event, and after considering such written comments, the panel, on its own initiative or on the request of any disputing Party, may:

    • (a) request the views of any participating Party;

    • (b) reconsider its report; and

    • (c) make any further examination that it considers appropriate.

    Article 2017: Final Report

    1. The panel shall present to the disputing Parties a final report, including any separate opinions on matters not unanimously agreed, within 30 days of presentation of the initial report, unless the disputing Parties otherwise agree.

    2. No panel may, either in its initial report or its final report, disclose which panelists are associated with majority or minority opinions.

    3. The disputing Parties shall transmit to the Commission the final report of the panel, including any report of a scientific review board established under Article 2015, as well as any written views that a disputing Party desires to be appended, on a confidential basis within a reasonable period of time after it is presented to them.

    4. Unless the Commission decides otherwise, the final report of the panel shall be published 15 days after it is transmitted to the Commission.

    Implementation of Panel Reports

    Article 2018: Implementation of Final Report

    1. On receipt of the final report of a panel, the disputing Parties shall agree on the resolution of the dispute, which normally shall conform with the determinations and recommendations of the panel, and shall notify their Sections of the Secretariat of any agreed resolution of any dispute.

    2. Wherever possible, the resolution shall be non-implementation or removal of a measure not conforming with this Agreement or causing nullification or impairment in the sense of Annex 2004 or, failing such a resolution, compensation.

    Article 2019: Non-Implementation - Suspension of Benefits

    1. If in its final report a panel has determined that a measure is inconsistent with the obligations of this Agreement or causes nullification or impairment in the sense of Annex 2004 and the Party complained against has not reached agreement with any complaining Party on a mutually satisfactory resolution pursuant to Article 2018(1) within 30 days of receiving the final report, such complaining Party may suspend the application to the Party complained against of benefits of equivalent effect until such time as they have reached agreement on a resolution of the dispute.

    2. In considering what benefits to suspend pursuant to paragraph 1:

    • (a) a complaining Party should first seek to suspend benefits in the same sector or sectors as that affected by the measure or other matter that the panel has found to be inconsistent with the obligations of this Agreement or to have caused nullification or impairment in the sense of Annex 2004; and

    • (b) a complaining Party that considers it is not practicable or effective to suspend benefits in the same sector or sectors may suspend benefits in other sectors.

    3. On the written request of any disputing Party delivered to the other Parties and its Section of the Secretariat, the Commission shall establish a panel to determine whether the level of benefits suspended by a Party pursuant to paragraph 1 is manifestly excessive.

    4. The panel proceedings shall be conducted in accordance with the Model Rules of Procedure. The panel shall present its determination within 60 days after the last panelist is selected or such other period as the disputing Parties may agree.

    Section C - Domestic Proceedings and Private Commercial Dispute Settlement

    Article 2020: Referrals of Matters from Judicial or Administrative Proceedings

    1. If an issue of interpretation or application of this Agreement arises in any domestic judicial or administrative proceeding of a Party that any Party considers would merit its intervention, or if a court or administrative body solicits the views of a Party, that Party shall notify the other Parties and its Section of the Secretariat. The Commission shall endeavor to agree on an appropriate response as expeditiously as possible.

    2. The Party in whose territory the court or administrative body is located shall submit any agreed interpretation of the Commission to the court or administrative body in accordance with the rules of that forum.

    3. If the Commission is unable to agree, any Party may submit its own views to the court or administrative body in accordance with the rules of that forum.

    * * * * *

    Article 2022: Alternative Dispute Resolution

    1. Each Party shall, to the maximum extent possible, encourage and facilitate the use of arbitration and other means of alternative dispute resolution for the settlement of international commercial disputes between private parties in the free trade area.

    2. To this end, each Party shall provide appropriate procedures to ensure observance of agreements to arbitrate and for the recognition and enforcement of arbitral awards in such disputes.

    3. A Party shall be deemed to be in compliance with paragraph 2 if it is a party to and is in compliance with the 1958 United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards or the 1975 Inter-American Convention on International Commercial Arbitration.

    4. The Commission shall establish an Advisory Committee on Private Commercial Disputes comprising persons with expertise or experience in the resolution of private international commercial disputes. The Committee shall report and provide recommendations to the Commission on general issues referred to it by the Commission respecting the availability, use and effectiveness of arbitration and other procedures for the resolution of such disputes in the free trade area.

    Annex 2001.2 Committees and Working Groups

    A. Committees:

    • Committee on Trade in Goods (Article 316)

    • Committee on Trade in Worn Clothing (Annex 300-B, Section 9.1)

    • Committee on Agricultural Goods (Article 706)

      • - Advisory Committee on Private Commercial Disputes Regarding Agricultural Goods (Article 707)

    • Committee on Sanitary and Phytosanitary Measures (Article 722)

    • Committee on Standards-Related Measures (Article 913)

      • - Land Transportation Standards Subcommittee (Article 913(5))

      • - Telecommunications Standards Subcommittee (Article 913(5))

      • - Automotive Standards Council (Article 913(5))

      • - Subcommittee on Labelling of Textile and Apparel Goods (Article 913(5))

    • Committee on Small Business (Article 1021)

    • Financial Services Committee (Article 1412)

    • Advisory Committee on Private Commercial Disputes (Article 2022(4))

    B. Working Groups:

    • Working Group on Rules of Origin (Article 513)

      • - Customs Subgroup (Article 513(6))

    • Working Group on Agricultural Subsidies (Article 705(6))

    • Bilateral Working Group (Mexico - United States) (Annex 703.2 (A)(25))

    • Bilateral Working Group (Canada - Mexico) (Annex 703.2(B)(13))

    • Working Group on Trade and Competition (Article 1504)

    • Temporary Entry Working Group (Article 1605)

    C. Other Committees and Working Groups Established Under This Agreement

    Annex 2002.2 Remuneration and Payment of Expenses

    1. The Commission shall establish the amounts of remuneration and expenses that will be paid to the panelists, committee members and members of scientific review boards.

    2. The remuneration of panelists or committee members and their assistants, members of scientific review boards, their travel and lodging expenses, and all general expenses of panels, committees or scientific review boards shall be borne equally by:

    • (a) in the case of panels or committees established under Chapter Nineteen (Review and Dispute Settlement in Antidumping and Countervailing Duty Matters), the involved Parties, as they are defined in Article 1911; or

    • (b) in the case of panels and scientific review boards established under this Chapter, the disputing Parties.

    3. Each panelist or committee member shall keep a record and render a final account of the person’s time and expenses, and the panel, committee or scientific review board shall keep a record and render a final account of all general expenses. The Commission shall establish amounts of remuneration and expenses that will be paid to panelists and committee members.

    Annex 2004 Nullification and Impairment

    1. If any Party considers that any benefit it could reasonably have expected to accrue to it under any provision of:

    • (a) Part Two (Trade in Goods), except for those provisions of Annex 300-A (Automotive Sector) or Chapter Six (Energy) relating to investment,

    • (b) Part Three (Technical Barriers to Trade),

    • (c) Chapter Twelve (Cross-Border Trade in Services), or

    • (d) Part Six (Intellectual Property),

    is being nullified or impaired as a result of the application of any measure that is not inconsistent with this Agreement, the Party may have recourse to dispute settlement under this Chapter.

    2. A Party may not invoke:

    • (a) paragraph 2(a) or (b), to the extent that the benefit arises from any cross-border trade in services provision of Part Two, or

    • (b) paragraph 1(c) or (d)

    with respect to any measure subject to an exception under Article 2101 (General Exceptions).

    Chapter Twenty-One Exceptions

    * * * * *

    Article 2104: Balance of Payments

    1. Nothing in this Agreement shall be construed to prevent a Party from adopting or maintaining measures that restrict transfers where the Party experiences serious balance of payments difficulties, or the threat thereof, and such restrictions are consistent with paragraphs 2 through 4 and are:

    • (a) consistent with paragraph 5 to the extent they are imposed on other transfers than cross-border trade in financial services; or

    • (b) consistent with paragraphs 6 and 7 to the extent they are imposed on cross-border trade in financial services.

    General Rules

    2. As soon as practicable after a party imposes a measure under this Article, the Party shall:

    • (a) submit any current account exchange restrictions to the IMF for review under Article VIII of the Article of Agreement of the IMF;

    • (b) enter into good faith consultations with the IMF on economic adjustment measures to address the fundamental underlying economic problems causing the difficulties; and

    • (c) adopt or maintain economic policies consistent with such consultations.

    3. A measure adopted or maintained under this Article shall:

    • (a) avoid unnecessary damage to the commercial, economic or financial interests of another Party;

    • (b) not be more burdensome than necessary to deal with the balance of payments difficulties or threat thereof;

    • (c) be temporary and be phased out progressively as the balance of payments situation improves;

    • (d) be consistent with paragraph 2(c) and with the Articles of Agreement of the IMF; and

    • (e) be applied on a national treatment or most-favored-nation treatment basis, whichever is better.

    4. A Party may adopt or maintain a measure under this Article that gives priority to services that are essential to its economic program, provided that a Party may not impose a measure for the purpose of protecting a specific industry or sector unless the measure is consistent with paragraph 2(c) and with Article VIII(3) of the Articles of Agreement of the IMF.

    Restrictions on Transfers Other than Cross-Border Trade in Financial Services

    5. Restrictions imposed on transfers, other than on cross-border trade in financial services:

    • (a) where imposed on payments for current international transactions, shall be consistent with Article VIII(3) of the Articles of Agreement of the IMF;

    • (b) where imposed on international capital transactions, shall be consistent with Article VI of the Articles of Agreement of the IMF and be imposed only in conjunction with measures imposed on current international transactions under paragraph 2(a);

    • (c) where imposed on transfers covered by Article 1109 (Investment-Transfers) and transfers related to trade in goods, may not substantially impede transfers from being made in a freely usable currency at a market rate of exchange; and

    • (d) may not take the form of tariff surcharges, quotas, licenses or similar measures.

    Restrictions on Cross-Border Trade in Financial Services

    6. A Party imposing a restriction on cross-border trade in financial services:

    • (a) may not impose more than one measure on any transfer, unless consistent with paragraph 2(c) and with Article VIII(3) of the Articles of Agreement of the IMF; and

    • (b) shall promptly notify and consult with the other parties to assess the balance of payments situation of the Party and the measures it has adopted, taking into account among other elements

      • (i) the nature and extent of the balance of payments difficulties of the Party,

      • (ii) the external economic and trading environment of the Party, and

      • (iii) alternative corrective measures that may be available.

    7. In consultations under paragraph 6(b), the Parties shall:

    • (a) consider if measures adopted under this Article comply with paragraph 3, in particular paragraph 3(c); and

    • (b) accept all findings of statistical and other facts presented by the IMF relating to foreign exchange, monetary reserves and balance of payments, and shall base their conclusions on the assessment by the IMF of the balance of payments situation of the Party adopting the measures.

    * * * * *

    Article 2107: Definitions

    For purposes of this Chapter:

    * * * * *

    international capital transactions means “international capital transactions” as defined under the Articles of Agreement of the IMF;

    IMF means the International Monetary Fund;

    payments for current international transactions means “payments for current international transactions” as defined under the Articles of Agreement of the IMF;

    tax convention means a convention for the avoidance of double taxation or other international taxation agreement or arrangement;

    taxes and taxation measures do not include:

    • (a) a “customs duty” as defined in Article 318 (Market Access Definitions); or

    • (b) the measures listed in exceptions (b), (c), (d) and (e) of that definition; and

    transfers means international transactions and related international transfers and payments.

    * * * * *

    Appendix II International Financial Materials

    Appendix II 1 International Foreign Exchange Master Agreement (IFEMA)

    INTERNATIONAL FOREIGN EXCHANGE MASTER AGREEMENT1

    MASTER AGREEMENT dated as of ___, 19__, by and between ________, a ___, and ______, a ______.

    SECTION 1. DEFINITIONS

    Unless otherwise required by the context, the following terms shall have the following meanings in the Agreement:

    “Agreement” has the meaning given to it in Section 2.2.

    “Base Currency” means as to a Party the Currency agreed as such in relation to it in Part VIII of the Schedule hereto.

    “Base Currency Rate” means as to a Party and any amount the cost (expressed as a percentage rate per annum) at which that Party would be able to fund that amount from such sources and for such periods as it may in its reasonable discretion from time to time decide, as determined in good faith by it.

    “Business Day” means (i) a day which is a Local Banking Day for the applicable Designated Office of both Parties, or (ii) solely in relation to delivery of a Currency, a day which is a Local Banking Day in relation to that Currency.

    “Close-Out Amount” has the meaning given to it in Section 5.1.

    “Close-Out Date” means a day on which, pursuant to the provisions of Section 5.1, the Non-Defaulting Party closes out and liquidates Currency Obligations or such a close-out and liquidation occurs automatically.

    “Closing Gain” means, as to the Non-Defaulting Party, the difference described as such in relation to a particular Value Date under the provisions of Section 5.1.

    “Closing Loss” means, as to the Non-Defaulting Party, the difference described as such in relation to a particular Value Date under the provisions of Section 5.1.

    “Confirmation” means a writing (including telex, facsimile or other electronic means from which it is possible to produce a hard copy) evidencing an FX Transaction governed by the Agreement which shall specify (i) the Parties thereto and their Designated Offices through which they are respectively acting, (ii) the amounts of the Currencies being bought or sold and by which Party, (iii) the Value Date, and (iv) any other term generally included in such a writing in accordance with the practice of the relevant foreign exchange market.

    “Credit Support Document” means, as to a Party (the “first Party”), a guaranty, hypothecation agreement, margin of security agreement or document, or any other document containing an obligation of a third party (“Credit Support Provider”) or of the first Party in favor of the other Party supporting any obligations of the first Party hereunder.

    “Credit Support Provider” has the meaning given to it in the definition of Credit Support Document.

    “Currency” means money denominated in the lawful currency of any country or the Ecu.

    “Currency Obligation” means any obligation of a Party to deliver a Currency pursuant to an FX Transaction governed by the Agreement, or pursuant to the application of Sections 3.3(a) or 3.3(b).

    “Custodian” has the meaning given to it in the definition of Event of Default.

    “Defaulting Party” has the meaning given to it in the definition of Event of Default.

    “Designated Office(s)” means, as to a Party, the office(s) specified in Part II of the Schedule hereto, as such Schedule may be modified from time to time by agreement of the Parties.

    “Effective Date” means the date of this Master Agreement.

    “Event of Default” means the occurrence of any of the following with respect to a Party (the “Defaulting Party,” the other Party being the “Non-Defaulting Party”):

    (i) the Defaulting Party shall default in any payment under the Agreement to the Non-Defaulting Party with respect to any sum when due under any Currency Obligation or pursuant to the Agreement and such failure shall continue for two (2) Business Days after written notice of non-payment given by the Non-Defaulting Party to the Defaulting Party;

    (ii) the Defaulting Party shall commence a voluntary case or other proceeding seeking liquidation, reorganization or other similar relief with respect to itself or to its debts under any bankruptcy, insolvency or similar law, or seeking the appointment of a trustee, receiver, liquidator, conservator, administrator, custodian or other similar official (each, a “Custodian”) of it or any substantial part or its assets; or shall take any corporate action to authorize any of the foregoing;

    (iii) an involuntary case of other proceeding shall be commenced against the Defaulting Party seeking liquidation, reorganization or other similar relief with respect to it or its debts under any bankruptcy, insolvency or similar law or seeking the appointment of a Custodian of it or any substantial part of its assets, and such involuntary case or other proceeding is not dismissed within five (5) days of its institution or presentation;

    (iv) the Defaulting Party is bankrupt or insolvent, as defined under any bankruptcy or insolvency law applicable to such Party;

    (v) the Defaulting Party shall otherwise be unable to pay its debts as they become due;

    (vi) the Defaulting Party or any Custodian acting on behalf of the Defaulting Party shall disaffirm, disclaim or repudiate any Currency Obligation;

    (vii) (a) any representation or warranty made or deemed made by the Defaulting Party pursuant to the Agreement or pursuant to any Credit Support Document shall prove to have been false or misleading in any material respect as at the time it was made or given and one (1) Business Day has elapsed after the Non-Defaulting Party has given the Defaulting Party written notice thereof, or (b) the Defaulting Party fails to perform or comply with any obligation assumed by it under the Agreement (other than an obligation to make payment of the kind referred to in Clause (i) of this definition of Event of Default), and such failure is continuing thirty (30) days after the Non-Defaulting Party has given the Defaulting Party written notice thereof;

    (viii) the Defaulting Party consolidates or amalgamates with or merges into or transfers all or substantially all its assets to another entity and (a) the creditworthiness of the resulting, surviving or transferee entity is materially weaker than that of the Defaulting Party prior to such action, or (b) at the time of such consolidation, amalgamation, merger or transfer the resulting, surviving or transferee entity fails to assume all the obligations of the Defaulting Party under the Agreement by operation of Law or pursuant to an agreement satisfactory to the Non-Defaulting Party;

    (ix) by reason of any default, or event of default or other similar condition or event, any Specified Indebtedness (being Specified Indebtedness of an amount which, when expressed in the Currency of the Threshold Amount, is in aggregate equal to or in excess of the Threshold Amount) of the Defaulting Party or any Credit Support Provider in relation to it: (a) is not paid on the due date therefor and remains unpaid after any applicable grace period has elapsed, or (b) becomes, or becomes capable at any time of being declared, due and payable under agreements or instruments evidencing such Specified Indebtedness before it would otherwise have been due and payable.

    (x) the Defaulting Party is in breach of or default under any Specified Transaction and any applicable grace period has elapsed, and there occurs any liquidation or early termination of, or acceleration of obligations under that Specified Transaction of the Defaulting Party (or any Custodian on its behalf) disaffirms, disclaims or repudiates the whole or any part of a Specified Transaction; or

    (xi) (a) any Credit Support Provider in relation to the Defaulting Party or the Defaulting Party itself fails to comply with or perform any agreement or obligation to be complied with or performed by it in accordance with the applicable Credit Support Document and such failure is continuing after any applicable grace period has elapsed; (b) any Credit Support Document relating to the Defaulting Party expires or ceases to be in full force and effect prior to the satisfaction of all obligations of the Defaulting Party under the Agreement, unless otherwise agreed in writing by the Non-Defaulting Party; (c) the Defaulting Party or its Credit Support Provider (or, in either case, any Custodian acting on its behalf) disaffirms, disclaims or repudiates, in whole or in part, or challenges the validity of, the Credit Support Document; (d) any representation or warranty made or deemed made by any Credit Support Provider pursuant to any Credit Support Document shall prove to have been false or misleading in any material respect as at the time it was made or given or deemed made or given and one (1) Business Day has elapsed after the Non-Defaulting Party has given the Defaulting Party written notice thereof; or (e) any event set out in (ii) to (vi) or (viii) to (x) above occurs in respect of the Credit Support Provider.

    “FX Transaction” means any transaction between the Parties for the purchase by one Party of an agreed amount in one Currency against the sale by it to the other of an agreed amount in another Currency both such amounts being deliverable on the same Value Date, and in respect of which transaction the Parties have agreed (whether orally, electronically or in writing): the Currencies involved, the amounts of such Currencies to be purchased and sold, which Party will purchase which Currency and the Value Date.

    “Local Banking Day” means (i) for any Currency, a day on which commercial banks effect deliveries of that Currency in accordance with the market practice of the relevant foreign exchange market, and (ii) for any Party, a day in the location of the applicable Designated Office of such Party on which commercial banks in that location are not authorized or required by law to close.

    “Master Agreement” means the terms and conditions set forth in this master agreement.

    “Matched Pair Novation Netting Office(s)” means in respect of a Party the Designated Office(s) specified in Part V of the Schedule, as such Schedule may be modified from time to time by agreement of the Parties.

    “Non-Defaulting Party” has the meaning given to it in the definition of Event of Default.

    “Novation Netting Office(s)” means in respect of a Party the Designated Office(s) specified in Part IV of the Schedule, as such Schedule may be modified from time to time by agreement of the Parties.

    “Parties” means the parties to the Agreement and shall include their successors and permitted assigns (but without prejudice to the application of Clause (viii) of the definition of Event of Default); and the term “Party” shall mean whichever of the Parties is appropriate in the context in which such expression may be used.

    “Proceedings” means any suit, action or other proceedings relating to the Agreement.

    “Settlement Netting Office(s)” means, in respect of a Party, the Designated Office(s) specified in Part III of the Schedule, as such Schedule may be modified from time to time by agreement of the Parties.

    “Specified Indebtedness” means any obligation (whether present or future, contingent or otherwise, as principal or surety or otherwise) in respect of borrowed money, other than in respect of deposits received.

    “Specified Transaction” means any transaction (including an agreement with respect thereto) between one Party to the Agreement (or any Credit Support Provider of such Party) and the other Party to the Agreement (or any Credit Support Provider of such Party) which is a rate swap transaction, basis swap, forward rate transaction, commodity sweep, commodity option, equity or equity linked swap, equity or equity index option, bond option, interest rate option, foreign exchange transaction, cap transaction, floor transaction, collar transaction, currency swap transaction, cross-currency rate swap transaction, currency option or any other similar transaction (including any option with respect to any of these transactions) or any combination of any of the foregoing transactions.

    “Split Settlement” has the meaning given to it in the definition of Value Date.

    “Threshold Amount” means the amount specified as such for each Party in Part IX of the Schedule.

    “Value Date” means, with respect to any FX Transaction, the Business Day (or where market practice in the relevant foreign exchange market in relation to the two Currencies involved provides for delivery of one Currency on one date which is a Local Banking Day in relation to that Currency but not to the other Currency and for delivery of the other Currency on the next Local Banking Day in relation to that other Currency (“Split Settlement”) the two Local Banking Days in accordance with that market practice) agreed by the Parties for delivery of the Currencies to be purchased and sold pursuant to such FX Transaction, and, with respect to any Currency Obligation, the Business Day (or, in the case of Split Settlement, Local Banking Day) upon which the obligation to deliver Currency pursuant to such Currency Obligation is to be performed.

    SECTION 2. FX TRANSACTIONS

    2.1. Scope of the Agreement, (a) Unless otherwise agreed in writing by the Parties, each FX Transaction entered into between two Designated Offices of the Parties on or after the Effective Date shall be governed by the Agreement, (b) All FX Transactions between any two Designated Offices of the Parties outstanding on the Effective Date which are identified in Part I of the Schedule shall be FX Transactions governed by the Agreement and every obligation of the Parties thereunder to deliver a Currency shall be a Currency Obligation under the Agreement.

    2.2. Single Agreement. This Master Agreement, the particular terms agreed between the Parties in relation to each and every FX Transaction governed by this Master Agreement (and, insofar as such terms are recorded in a Confirmation, each such Confirmation), the Schedule to this Master Agreement and all amendments to any of such items shall together form the agreement between the Parties (the “Agreement”) and shall together constitute a single agreement between the Parties. The Parties acknowledge that all FX Transactions governed by the Agreement are entered into in reliance upon the fact that all items constitute a single agreement between the Parties.

    2.3. Confirmations. FX Transactions governed by the Agreement shall be promptly confirmed by the Parties by Confirmations exchanged by mail, telex, facsimile or other electronic means. The failure by a Party to issue a Confirmation shall not prejudice or invalidate the terms of any FX Transaction governed by the Agreement.

    SECTION 3. SETTLEMENT AND NETTING

    3.1. Settlement. Subject to Section 3.2, each Party shall deliver to the other Party the amount of the Currency to be delivered by it under each Currency Obligation on the Value Date for such Currency Obligation.

    3.2. Net Settlement/Payment Netting. If on any Value Date more than one delivery of a particular Currency is to be made between a pair of Settlement Netting Offices, then each Party shall aggregate the amounts of such Currency deliverable by it and only the difference between these aggregate amounts shall be delivered by the Party owing the larger aggregate amount to the other Party, and, if the aggregate amounts are equal, no delivery of the Currency shall be made.

    3.3. Novation Netting.

    (a) By Currency. If the Parties enter into an FX Transaction governed by the Agreement through a pair of Novation Netting Offices giving rise to a Currency Obligation for the same Value Date and in the same Currency as a then existing Currency Obligation between the same pair of Novation Netting Offices, then immediately upon entering into such FX Transaction, each such Currency Obligation shall automatically and without further action be individually cancelled and simultaneously replaced by a new Currency Obligation for such Value Date determined as follows: the amounts of such Currency that would otherwise have been deliverable by each Party on such Value Date shall be aggregated and the Party with the larger aggregate amount shall have a new Currency Obligation to deliver to the other Party the amount of such Currency by which its aggregate amount exceeds the other Party’s aggregate amount, provided that if the aggregate amounts are equal, no new Currency Obligation shall arise. This Clause (a) shall not affect any other Currency Obligation of a Party to deliver any different Currency on the same Value Date.

    (b) By Matched Pair. If the Parties enter into an FX Transaction governed by the Agreement between a pair of Matched Pair Novation Netting Offices then the provisions of Section 3.3(a) shall apply only in respect of Currency Obligations arising by virtue of FX Transactions governed by the Agreement entered into between such pair of Matched Pair Novation Netting Offices and involving the same pair of Currencies and the same Value Date.

    3.4. General.

    (a) Inapplicability of Sections 3.2 and 3.3. The provisions of Sections 3.2 and 3.3 shall not apply if a Close-Out Date has occurred or an involuntary case of other proceeding of the kind described in Clause (iii) of the definition of Event of Default has occurred without being dismissed in relation to either Party.

    (b) Failure to Record. The provisions of Section 3.3 shall apply notwithstanding that either Party may fail to record the new Currency Obligations in its books.

    (c) Cutoff Date and Time. The provisions of Section 3.3 are subject to any cut-off date and cut-off time agreed between the applicable Novation Netting Offices and Matched Pair Novation Netting Offices of the Parties.

    SECTION 4. REPRESENTATIONS, WARRANTIES AND COVENANTS

    4.1. Representations and Warranties. Each Party represents and warrants to the other Party as of the date of the Agreement and as of the date of each FX Transaction governed by the Agreement that: (i) it has authority to enter into the Agreement and such FX Transaction; (ii) the persons executing the Agreement and entering into such FX Transaction have been duly authorized to do so; (iii) the Agreement and the Currency Obligations created under the Agreement are binding upon it and enforceable against it in accordance with their terms (subject to applicable principles of equity) and do not and will not violate the terms of any agreements to which such Party is bound; (iv) no Event of Default has occurred and is continuing with respect to it; and (v) it acts as principal in entering into each and every FX Transaction governed by the Agreement.

    4.2. Covenants. Each Party covenants to the other Party that: (i) it will at all times obtain and comply with the terms of and do all that is necessary to maintain in full force and effect all authorizations, approvals, licenses and consents required to enable it to lawfully perform its obligations under the Agreement; and (ii) it will promptly notify the other Party of the occurrence of any Event of Default with respect to itself or any Credit Support Provider in relation to it.

    SECTION 5. CLOSE-OUT AND LIQUIDATION

    5.1. Circumstances of Close-Out and Liquidation. If an Event of Default has occurred and is continuing, then the Non-Defaulting Party shall have the right to close-out and liquidate in the manner described below all, but not less than all, outstanding Currency Obligations (except to the extent that in the good faith opinion of the Non-Defaulting Party certain of such Currency Obligations may not be closed-out and liquidated under applicable law), by notice to the Defaulting Party. If “Automatic Termination” is specified as applying to a Party in Part VI of the Schedule, then, in the case of an Event of Default specified in Clauses (ii) or (iii) of the definition thereof with respect to such Party, such close-out and liquidation shall be automatic as to all outstanding Currency Obligations. Where such close-out and liquidation is to be effected, it shall be effected by:

    (i) closing out each outstanding Currency Obligation (including any Currency Obligation which has not been performed and in respect of which the Value Date is on or precedes the Close-Out Date) so that each such Currency Obligation is canceled and the Non-Defaulting Party shall calculate in good faith with respect to each such canceled Currency Obligation, the Closing Gain or, as appropriate, the Closing Loss, as follows:

    • (x) for each Currency Obligation in a Currency other than the Non-Defaulting Party’s Base Currency calculate a “Close-Out Amount” by converting:

      • (A) in the case of a Currency Obligation whose Value Date is the same as or is later than the Close-Out Date, the amount of such Currency Obligation; or

      • (B) in the case of a Currency Obligation whose Value Date precedes the Close-Out Date, the amount of such Currency Obligation increased, to the extent permitted by applicable law, by adding interest thereto from the Value Date to the Close-Out Date at the rate representing the cost (expressed as a percentage rate per annum) at which the Non-Defaulting Party would have been able, on such Value Date, to fund the amount of such Currency Obligation for the period from the Value Date to the Close-Out Date

      into such Base Currency at the rate of exchange at which the Non-Defaulting Party can buy or sell, as appropriate, such Base Currency with or against the Currency of such Currency Obligation for delivery on the Value Date of that Currency Obligation, or if such Value Date precedes the Close-Out Date, for delivery on the Close-Out Date; and

    • (y) determine in relation to each Value Date: (A) the sum of all Close-Out Amounts relating to Currency Obligations under which, and of all Currency Obligations in the Non-Defaulting Party’s Base Currency under which, the Non-Defaulting Party would otherwise have been obliged to deliver the relevant amount to the Defaulting Party on that Value Date, adding (to the extent permitted by applicable law), in the case of a Currency Obligation in the Non-Defaulting Party’s Base Currency whose Value Date preceeds the Close-Out Date, interest for the period from the Value Date to the Close-Out Date at the Non-Defaulting Party’s Base Currency Rate as at such Value Date for such period; and (B) the sum of all Close-Out Amounts relating to Currency Obligations under which, and of all Currency Obligations in the Non-Defaulting Party’s Base Currency under which, the Non-Defaulting Party would otherwise have been entitled to receive the relevant amount on that Value Date, adding (to the extent permitted by applicable law), in the case of a Currency Obligation in the Non-Defaulting Party’s Base Currency whose Value Date precedes the Close-Out-Date, interest for the period from the Value Date to the Close-Out Date at the Non-Defaulting Party’s Base Currency Rate as at such Value Date for such period;

    • (z) if the sum determined under (y)(A) is greater than the sum determined under (y)(B), the difference shall be the Closing Loss for such Value Date; if the sum determined under (y)(A) is less than the sum determined under (y)(B), the difference shall be the Closing Gain for such Value Date;

    (ii) to the extent permitted by applicable law, adjusting the Closing Gain or Closing Loss for each Value Date falling after the Close-Out Date to present value by discounting the Closing Gain or Closing Loss from the Value Date to the Close-Out Date, at the Non-Defaulting Party’s Base Currency Rate, or at such other rate as may be prescribed by applicable law;

    (iii) aggregating the following amounts so that all such amounts are netted into a single liquidated amount payable by or to the Non-Defaulting Party: (x) the sum of the Closing Gains for all Value Dates (discounted to present value, where appropriate, in accordance with the provisions of Clause (ii) of this Section 5.1)(which for the purposes of this aggregation shall be a positive figure) and (y) the sum of the Closing Losses for all Value Dates (discounted to present value, where appropriate, in accordance with the provisions of Clause (ii) of this Section 5.1)(which for the purposes of the aggregation shall be a negative figure); and

    (iv) if the resulting net amount is positive, it shall be payable by the Defaulting Party to the Non-Defaulting Party, and if it is negative, then the absolute value of such amount shall be payable by the Non-Defaulting Party to the Defaulting Party.

    5.2. Calculation of Interest. Any addition of interest or discounting required under Clause (i) or (ii) of Section 5.1 shall be calculated on the basis of the actual number of days elapsed and of a year of such number of days as is customary for transactions involving the relevant Currency in the relevant foreign exchange market.

    5.3. Other FX Transactions. Where close-out and liquidation occurs in accordance with Section 5.1, the Non-Defaulting Party shall also be entitled to close-out and liquidate, to the extent permitted by applicable law, any other FX Transactions entered into between the Parties which are then outstanding in accordance with the provisions of Section 5.1, as if each obligation of a Party to deliver a Currency thereunder were a Currency Obligation.

    5.4. Payment and Late Interest. The amount payable by one Party to the other Party pursuant to the provisions of Sections 5.1 and 5.3 shall be paid by the close of business on the Business Day following such close-out and liquidation (converted as required by applicable law into any other Currency, any costs of such conversion to be borne by, and deducted from any payment to, the amounts required to be paid under Sections 5.1 or 5.3 and not paid on the due date therefor, shall bear interest at the Non-Defaulting Party’s Base Currency Rate plus 1% per annum (or, if conversion is required by applicable law into some other Currency, either (x) the average rate at which overnight deposits in such other Currency are offered by major banks in the London interbank market as of 11:00 a.m. (London time) plus 1% per annum or (y) such other rate as may be prescribed by such applicable law) for each day for which such amount remains unpaid.

    5.5. Suspension of Obligations. Without prejudice to the foregoing, so long as a Party shall be in default in payment or performance to the Non-Defaulting Party under the Agreement and so long as the Non-Defaulting Party has not exercised its rights under Section 5.1, the Non-Defaulting Party may, at its election and without penalty, suspend its obligation to perform under the Agreement.

    5.6. Expenses. The Defaulting Party shall reimburse the Non-Defaulting Party in respect of all out-of-pocket expenses incurred by the Non-Defaulting Party (including fees and disbursements of counsel, including attorneys who may be employees of the Non-Defaulting Party) in connection with any reasonable collection or other enforcement proceedings related to the payments required under this Section 5.

    5.7. Reasonable Pre-Estimate. The Parties agree that the amounts recoverable under this Section 5 are a reasonable pre-estimate of loss and not a penalty. Such amounts are payable for the loss of bargain and the loss of protection against future risks and, except as otherwise provided in the Agreement, neither Party will be entitled to recover any additional damages as a consequence of such losses.

    5.8. No Limitation of Other Rights; Set-Off. The Non-Defaulting Party’s rights under this Section 5 shall be in addition to, and not in limitation or exclusion of, any other rights which the Non-Defaulting Party may have (whether by agreement, operation of law or otherwise). To the extent not prohibited by applicable law, the Non-Defaulting Party shall have a general right of set-off with respect to all amounts owed by each Party to the other Party, whether due and payable or not due and payable (provided that any amount not due and payable at the time of such setoff shall, if appropriate, be discounted to present value in a commercially reasonable manner by the Non-Defaulting Party). The Non-Defaulting Party’s rights under this Section 5.8 are subject to Section 5.7.

    SECTION 6. ILLEGALITY, IMPOSSIBILITY AND FORCE MAJEURE

    If either Party is prevented from or hindered or delayed by reason of force majeure or act of State in the delivery or receipt of any Currency in respect of a Currency Obligation or if it becomes or, in the good faith judgment of one of the Parties, may become unlawful or impossible for either Party to deliver or receive any Currency which is the subject of a Currency Obligation, then either Party may, by notice to the other Party, require the close-out and liquidation of each affected Currency Obligation in accordance with the provisions of Sections 5.1, 5.2 and 5.4 and, for the purposes of enabling the calculations prescribed by Sections 5.1, 5.2 and 5.4 to be effected, the Party unaffected by such force majeure, act of State, illegality or impossibility (or if both Parties are so affected, whichever Party gave the relevant notice) shall effect the relevant calculations as if it were the Non-Defaulting Party. Nothing in this Section 6 shall be taken as indicating that the Party treated as the Defaulting Party for the purposes of calculations required hereby has committed any breach of default.

    SECTION 7. PARTIES TO RELY ON THEIR OWN EXPERTISE

    Each Party shall enter into each FX Transaction governed by the Agreement in reliance only upon its own judgment. Neither Party holds itself out as advising, or any of its employees or agents as having the authority to advise, the other Party as to whether or not it should enter into any such FX Transaction or as to any subsequent actions relating thereto or on any other commercial matters concerned with any FX Transaction governed by the Agreement, and neither Party shall have any responsibility or liability whatsoever in respect of any advice of this nature given, or views expressed, by it or any of such persons to the other Party, whether or not such advice is given or such views are expressed at the request of the other Party.

    SECTION 8. MISCELLANEOUS

    8.1. Currency Indemnity. The receipt or recovery by either Party (the “first Party”) of any amount in respect of an obligation of the other Party (the “second Party”) in a Currency other than that in which such amount was due, whether pursuant to a judgment of any court or pursuant to Section 5 or 6, shall discharge such obligation only to the extent that on the first day on which the first Party is open for business immediately following such receipt, the first Party shall be able, in accordance with normal banking practice, to purchase the Currency in which such amount was due with the Currency received. If the amount so purchasable shall be less than the original amount of the Currency in which such amount was due, the second Party shall, as a separate obligation and notwithstanding any judgment of any court, indemnify the first Party against any loss sustained by it. The second Party shall in any event indemnify the first Party against any costs incurred by it in making any such purchase of Currency.

    8.2. Assignments. Neither Party may assign, transfer or charge, or purport to assign, transfer or charge, its rights or its obligations under the Agreement or any interest therein without the prior written consent of the other Party, and any purported assignment, transfer or charge in violation of this Section 8.2 shall be void.

    8.3. Telephonic Recording. The Parties agree that each may electronically record all telephonic conversations between them and that any such tape recordings may be submitted in evidence in any Proceedings relating to the Agreement. In the event of any dispute between the Parties as to the terms of an FX Transaction governed by the Agreement of the Currency Obligations thereby created the Parties may use electronic recordings between the persons who entered into such FX Transaction as the preferred evidence of the terms of such FX Transaction, notwithstanding the existence of any writing to the contrary.

    8.4. No Obligation. Neither Party to this Agreement shall be required to enter into any FX Transaction with the other.

    8.5. Notices. Unless otherwise agreed, all notices, instructions and other communications to be given to a Party under the Agreement shall be given to the address, telex (if confirmed by the appropriate answer-back), facsimile (confirmed if requested) or telephone number and to the individual or department specified by such Party in Part VII of the Schedule attached hereto. Unless otherwise specified, any notice, instruction or other communication given in accordance with this Section 8.5 shall be effective upon receipt.

    8.6. Termination. Each of the Parties hereto may terminate this Agreement at any time by seven days’ prior written notice to the other Party delivered as prescribed above, and termination shall be effective at the end of such seventh day; provided, however, that any such termination shall not affect any outstanding Currency Obligations, and the provisions of the Agreement shall continue to apply until all the obligations of each Party to the other under the Agreement have been fully performed.

    8.7. Severability. In the event any one or more of the provisions contained in the Agreement should be held invalid, illegal or unenforceable in any respect under the law of any jurisdiction, the validity, legality and enforceability of the remaining provisions under the law of such jurisdiction, and the validity, legality and enforceability of such and any other provisions under the law of any other jurisdiction, shall not in any way be affected or impaired thereby.

    8.8. Waiver. No indulgence or concession granted by a Party and no omission or delay on the part of a Party in exercising any right, power or privilege under the Agreement shall operate as a waiver thereof, nor shall any single or partial exercise of any such right, power or privilege preclude any other or further exercise thereof or the exercise of any other right, power or privilege.

    8.9. Master Agreement. Where one of the Parties to the Agreement is domiciled in the United States, the Parties intend that the Agreement shall be a master agreement, as defined in 11 U.S.C. Section 101(55)(C) and 12 U.S.C. Section 1821(e)(8)(D)(vii).

    8.10. Time of Essence. Time shall be of the essence in the Agreement.

    8.11. Headings. Headings in the Agreement are for ease of reference only.

    8.12. Wire Transfers. Every payment or delivery of Currency to be made by a Party under the Agreement shall be made by wire transfer, or its equivalent, of same day (or immediately available) and freely transferable funds to die bank account designated by the other Party for such purpose.

    8.13. Adequate Assurances. If the Parties have so agreed in Part X of the Schedule, the failure by a Party (“first Party”) to give adequate assurances of its ability to perform any of its obligations under the Agreement within two (2) Business Days of a written request to do so when the other Party (“second Party”) has reasonable grounds for insecurity shall be an Event of Default under the Agreement, in which case during the pendency of a reasonable request by the second Party to the first Party for adequate assurances of the first Party’s ability to perform its obligations under the Agreement, the second Party may, at its election and without penalty, suspend its obligations under the Agreement.

    8.14. FDICIA Representation. If the Parties have so agreed in Part XI of the Schedule, each Party represents and warrants to the other Party that it is a financial institution under the provisions of Title IV of the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), and the Parties agree that this Agreement shall be a netting contract, as defined in FDICIA, and each receipt or payment or delivery obligation under the Agreement shall be a covered contractual payment entitlement or covered contractual payment obligation, respectively, as defined in and subject to FDICIA.

    8.15. Confirmation Procedures. In relation to Confirmations, unless either Party objects to the terms contained in any Confirmation within three (3) Business Days of receipt thereof, or such shorter time as may be appropriate given the Value Date of the FX Transaction, the terms of such Confirmation shall be deemed correct and accepted absent manifest error, unless a corrected Confirmation is sent by a Party within such three Business Days, or shorter period, as appropriate, in which case the Party receiving such corrected Confirmation shall have three (3) Business Days, or shorter period, as appropriate, after receipt thereof to object to the terms contained in such corrected Confirmation. In the event of any conflict between the terms of a Confirmation and this Master Agreement, the terms of the Master Agreement shall prevail, and the Confirmation shall not modify the terms of this Master Agreement.

    8.16. Amendments. No amendment, modification or waiver of the Agreement will be effective unless in writing executed by each of the Parties.

    SECTION 9. LAW AND JURISDICTION

    9.1. Governing Law. The Agreement shall be governed by, and construed in accordance with the laws of [the State of New York][England and Wales] without giving effect to conflict of laws provisions.

    9.2. Consent to Jurisdiction. With respect to any Proceedings, each Party irrevocably (i) [submits to the non-exclusive jurisdiction of the courts of the State of New York and the United States District Court located in the Borough of Manhattan in New York City,][agrees for the benefit of the other Party that the courts of England shall have jurisdiction to determine any Proceedings and irrevocably submits to the jurisdiction of the English courts], and (ii) waives any objection which it may have at any time to the laying of venue of any Proceedings brought in any such court, waives any claim that such Proceedings have been brought in an inconvenient forum and further waives the right to object, with respect to such Proceedings, that such court does not have jurisdiction over such Party. Nothing in the Agreement precludes either Party from bringing Proceedings in any other jurisdiction nor will the bringing of Proceedings in any one or more jurisdictions preclude the bringing of Proceedings in any other jurisdiction.

    9.3. Waiver of Immunities. Each Party irrevocably waives to the fullest extent permitted by applicable law, with respect to itself and its revenues and assets (irrespective of their use or intended use) all immunity on the grounds of sovereignty or other similar grounds from (i) suit, (ii) jurisdiction of any courts, (iii) relief by way of injunction, order for specific performance or for recovery of property, (iv) attachment of its assets (whether before or after judgment) and (v) execution or enforcement of any judgment to which it or its revenues or assets might otherwise be entitled in any Proceedings in the courts of any jurisdiction, and irrevocably agrees to the extent permitted by applicable law that it will not claim any such immunity in any Proceedings. Each Party consents generally in respect of any Proceedings to the giving of any relief or the issue of any process in connection with such Proceedings, including, without limitation, the making, enforcement or execution against any property whatsoever of any order or judgment which may be made or given in such Proceedings.

    9.4. Waiver of Jury Trial. Each Party hereby irrevocably waives any and all right to trial by jury in any Proceedings.

    IN WITNESS WHEREOF, the Parties have caused the Agreement to be duly executed by their respective authorized officers as of the first date written above.

    ______________________

    By ___________________

    Name:

    Title:

    ______________________

    By ___________________

    Name:

    Title:

    Schedule

    Part I.Scope of Agreement
    The Agreement shall apply to [all][the following] FX Transactions outstanding between any two Designated Offices of the Parties on the Effective Date.
    Part II:Designated Offices
    Each of the following shall be a Designated Office:
    Part III:Settlement Netting Offices
    Net settlement provisions of Section 3.2 shall apply to the following Settlement Netting Offices:
    Part IV:Novation Netting Offices
    Netting by novation provisions of Section 3.3(a) shall apply to the following Novation Netting Offices and shall apply to [all FX Transactions][FX Transactions with a Value Date more than two Business Days after the day on which the Parties enter into an FX Transaction]:
    Part V:Matched Pair Novation Netting Offices
    Matched pair netting by novation provisions of Section 3.3(b) shall apply to the following Matched Pair Novation Netting Offices and shall apply to [all FX Transactions][FX Transactions with a Value Date more than two Business Days after the day on which the Parties enter into an FX Transaction]:
    Part VI:Automatic Termination
    The “Automatic Termination” provision in Section 5.1 ______[shall][shall not] apply to ______and [shall][shall not] apply to______
    Part VI:Notices
    Address:
    Telephone Numbers:
    Telex Number:
    Facsimile Numbers:
    Name of Individual of Department to Whom Notices Are to Be Sent:
    Part VII:Base Currency
    Part IX:Threshold Amount
    The Threshold Amount applicable to ______ shall be:
    The Threshold Amount applicable to ______ shall be:
    Part X:Adequate Assurances
    The provisions of Section 8.13 [shall][shall not] apply to the Agreement.
    Part XI:FDICIA Representations
    The provisions of Section 8.14 [shall][shall not] apply to the Agreement.

    Appendix II 2 International Currency Options Market (ICOM) Master Agreement

    INTERNATIONAL CURRENCY OPTIONS MARKET MASTER AGREEMENT1

    MASTER AGREEMENT dated as of ______, 19__, by and between ________, a ________, and____________, a ________.

    1. DEFINITIONS

    In this Agreement, unless otherwise required by the context, the following terms shall have the following meanings:

    “American Style Option”An Option which may be exercised on any Business Day up to and including the Expiration Time;
    “Base Currency”The currency specified as such by a Party in Part IV of the Schedule hereto;
    “Base Currency Rate”For any day, the average rate at which overnight deposits in the Base Currency are offered by major banks in the London interbank market as of 11:00 a.m. (London time) on such day or such other rate as shall be agreed by the Parties, in either case as determined in good faith by the Non-Defaulting Party;
    “Business Day”For purposes of: (i) Section 4.2 hereof, a day which is a Local Banking Day for the applicable Designated Office of the Buyer; (ii) Section 5.1 hereof and the definition of American Style Option and Exercise Date, a day which is a Local Banking Day for the applicable Designated Office of the Seller; (iii) the definition of Event of Default, a day which is a Local Banking Day for the Non-Defaulting Party; and (iv) any other provision hereof, a day which is a Local Banking Day for the applicable Designated Office of both Parties; provided, however, that neither Saturday nor Sunday shall be considered a Business Day hereunder for any purpose;
    “Buyer”The owner of an Option;
    “Call”An option entitling, but not obligating, the Buyer to purchase from the Seller at the Strike Price a specified quantity of the Call Currency;
    “Call Currency”The currency agreed as such at the time an Option is entered into;
    “Confirmation”A confirmation of an Option substantially in the form of Exhibit I hereto, which confirmation shall be in writing (which shall include telex or other electronic means from which it is possible to produce a hard copy);
    “Currency Pair”The two currencies which may be potentially exchanged upon the exercise of an Option, one of which shall be the Put Currency and the other the Call Currency;
    “Designated Office”As to either Party, the office or offices specified on Part I of the Schedule hereto and any other office specified from time to time by one Party and agreed to by the other as an amendment hereto as a Designated Office on Part I of the Schedule hereto;
    “European Style Option”An Option for which Notice of Exercise may be given only on the Option’s Expiration Date up to and including the Expiration Time, unless otherwise agreed;
    “Event of Default”The occurrence of any of the following with respect to a Party (the “Defaulting Party”): (i) the Defaulting Party shall default in any payment hereunder (including, but not limited to, a Premium payment) to the other Party (the “Non-Defaulting Party”) with respect to any Option and such failure shall continue for two (2) Business Days after written notice of non-payment by the Non-Defaulting Party; (ii) the Defaulting Party shall commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or to its debts under any bankruptcy, insolvency or similar law, or seeking the appointment of a trustee, receiver, liquidator, conservator, administrator, custodian or other similar official (each, a “Custodian”) of it or any substantial part of its assets; or shall take any corporate action to authorize any of the foregoing; (iii) an involuntary case or other proceeding shall be commenced against the Defaulting Party seeking liquidation, reorganization or other relief with respect to it or its debts under any bankruptcy, insolvency or other similar law or seeking the appointment of a Custodian of it or any substantial part of its assets; (iv) the Defaulting Party is bankrupt or insolvent; (v) the Defaulting Party shall otherwise be unable to pay its debts as they become due; (vi) the failure by the Defaulting Party to give adequate assurances of its ability to perform its obligations with respect to an Option within two (2) Business Days of a written request to do so when the Non- Defaulting Party has reasonable grounds for insecurity; (vii) the Defaulting Party of any Custodian acting on behalf of the Defaulting Party shall disaffirm or repudiate any Option; or (viii) any representation or warranty made or deemed made pursuant to Section 3 of this Agreement by the Defaulting Party shall prove to have been false or misleading in any material respect as at the time it was made or given or deemed made or given and the Non-Defaulting Party shall have given the Defaulting Party one (1) Business Day’s prior written notice thereof;
    “Exercise Date”The Business Day on which a Notice of Exercise received by the applicable Designated Office of the Seller becomes effective pursuant to Section 5.1;
    “Expiration Date”The date specified as such in a Confirmation;
    “Expiration Time”The latest time on the Expiration Date on which the Seller must accept a Notice of Exercise as specified in a Confirmation;
    “In-the-money Amount”(i) In the case of a Call, the excess of the Spot Price over the Strike Price, multiplied by the aggregate amount of the Call Currency to be purchased under the Call, where both prices are quoted in terms of the amount of the Put Currency to be paid for one unit of the Call Currency; and (ii) in the case of a Put, the excess of the Strike Price over the Spot Price, multiplied by the aggregate amount of the Put Currency to be sold under the Put, where both prices are quoted in terms of the amount of the Call Currency to be paid for one unit of the Put Currency;
    “Local Banking Day”For any currency or Party, a day on which commercial banks in the principal banking center of the country of issuance of such currency or in the location of the applicable Designated Office of such Party, respectively, are not authorized or required by law to close;
    “Notice of Exercise”Telex, telephonic or other electronic notification (excluding facsimile transmission), providing assurance of receipt, given by the Buyer prior to or at the Expiration Time, of the exercise of an Option, which notification shall be irrevocable;
    “Option”A Put or a Call, as the case may be, including any unexpired Put or Call previously entered into by the Parties, which shall be or become subject to this Agreement unless otherwise agreed;
    “Parties”The parties to this Agreement; and the term “Party” shall mean whichever of the Parties is appropriate in the context in which such expression may be used;
    “Premium”The purchase price of the Option as agreed upon by the Parties, and payable by the Buyer to the Seller thereof;
    “Premium Payment Date”The date specified as such in the Confirmation;
    “Put”An option entitling, but not obligating, the Buyer to sell to the Seller at the Strike Price a specified quantity of the Put Currency;
    “Put Currency”The currency agreed as such at the time an Option is entered into;
    “Seller”The Party granting an Option;
    “Settlement Date”In respect of: (i) an American Style Option, the Spot Date of the Currency Pair on the Exercise Date of such Option; and (ii) a European Style Option, the Spot Date of the Currency Pair on the Expiration Date of such Option;
    “Spot Date”The spot delivery day for the relevant Currency Pair as generally used by the foreign exchange market;
    “Spot Price”The price at the time at which such price is to be determined for foreign exchange transactions in the relevant Currency Pair for value on the Spot Date, as determined in good faith: (i) by the Seller, for purposes of Section 5 hereof; and (ii) by the Non-Defaulting Party, for purposes of Section 8 hereof;
    “Strike Price”The price specified in a Confirmation at which the Currency Pair may be exchanged.

    2. GENERAL

    • 2.1 The Parties (through their respective Designated Offices) may enter into Options (neither being obliged to do so) for such Premiums, with such Expiration Dates, at such Strike Prices and for the purchase or sale of such quantities of such currencies, as may be agreed subject to the terms hereof.

    • 2.2 Each Option shall be governed by the terms and conditions set forth in this Master Agreement and in the Confirmation relating to such Option. Each Confirmation shall supplement and form a part of this Master Agreement and shall be read and construed as one with this Master Agreement and with each other Confirmation, so that this Master Agreement and all Confirmations, Schedules and amendments hereto constitute a single agreement between the Parties (collectively referred to as this “Agreement”). The Parties acknowledge that all Options are entered into in reliance upon such fact, it being understood that the Parties would not otherwise enter into any Option.

    • 2.3 Options shall be promptly confirmed by the Parties by Confirmations exchanged by mail, telex, facsimile or other electronic means. Unless either Party objects to the terms contained in any Confirmation within the earlier of (i) the time period recognized by local market practice or (ii) three (3) Business Days of receipt thereof, the terms of such Confirmation shall be deemed correct absent manifest error, unless a corrected Confirmation is sent by a Party within such three day period, in which case the Party receiving such corrected Confirmation shall have three (3) Business Days after receipt thereof to object to the terms contained in such corrected Confirmation. Failure by either Party to issue a Confirmation shall not alter the rights and obligations of either Party under an Option to which the Parties have agreed. In the event of any conflict between the terms of a Confirmation and this Agreement, such Confirmation shall prevail, except for purposes of this Section 2.3 and Section 6 hereof.

    • 2.4 Neither Party may assign its rights nor delegate its obligations under any Option to a third party without the prior written consent of the other Party.

    3. REPRESENTATIONS AND WARRANTIES; CONTRACTUAL STATUS

    Each Party represents and warrants to the other Party as of the date hereof and as of the date of each Option that: (i) it has authority to enter into this Master Agreement and such Option; (ii) the persons executing this Master Agreement and entering into such Option on its behalf have been duly authorized to do so; (iii) this Master Agreement and such Option are binding upon it and enforceable against it in accordance with their respective terms and do not and will not violate the terms of any agreements to which such Party is bound; (iv) no Event of Default, or event which, with notice or lapse of time or both, would constitute an Event of Default has occurred and is continuing with respect to it; and (v) it acts as principal in entering into and exercising each and every Option.

    4. THE PREMIUM

    • 4.1 Unless otherwise agreed in writing by the Parties, the Premium related to an Option shall be paid on its Premium Payment Date.

    • 4.2 If any Premium is not received on the Premium Payment Date, the Seller may elect either: (i) to accept a late payment of such Premium; (ii) to give written notice of such non-payment and, if such payment shall not be received within two (2) Business Days of such notice, treat the related Option as void; or (iii) to give written notice of such non-payment and, if such payment shall not be received within two (2) Business Days of such notice, treat such non-payment as an Event of Default under clause (i) of the definition of Event of Default. If the Seller elects to act under either clause (i) or (ii) of the preceding sentence, the Buyer shall pay all out-of-pocket costs and actual damages incurred in connection with such unpaid or late Premium or void Option, including, without limitation, interest on such Premium in the same currency as such Premium at the then prevailing market rate and any other costs or expenses incurred by the Seller in covering its obligations (including, without limitation, a delta hedge) with respect to such Option.

    5. EXERCISE AND SETTLEMENT OF OPTIONS

    • 5.1 The Buyer may exercise an Option by delivery to the Seller of a Notice of Exercise. Subject to Section 5.4 hereof, if an Option has not been exercised prior to or at the Expiration Time, it shall expire and become void and of no effect. Any Notice of Exercise shall (unless otherwise agreed): (i) if received prior to 3:00 p.m. on a Business Day, be effective upon receipt thereof by the Seller; and (ii) if received after 3:00 p.m. on a Business Day, be effective only as of the opening of business of the Seller on the first Business Day subsequent to its receipt.

    • 5.2 An exercised Option shall settle on its Settlement Date. Subject to Sections 5.3 and 5.4 hereof, on the Settlement Date, the Buyer shall pay the Put Currency to the Seller for value on the Settlement Date and the Seller shall pay the Call Currency to the Buyer for value on the Settlement Date.

    • 5.3 An Option shall be settled at its In-the-money Amount if so agreed by the Parties at the time such Option is entered into. In such case, the In-the-money Amount shall be determined based upon the Spot Price at the time of exercise or as soon thereafter as possible. The sole obligations of the Parties with respect to such Option shall be to deliver or receive the In-the-money Amount of such Option on the Settlement Date.

    • 5.4 Unless the Seller is otherwise instructed by the Buyer, if an Option has an In-the-money Amount at its Expiration Time that equals or exceeds the product of (x) 1% of the Strike Price and (y) the amount of the Call or Put Currency, as appropriate, then the Option shall be deemed automatically exercised. In such case, the Seller may elect to settle such Option either in accordance with Section 5.2 of this Agreement or by payment to the Buyer on the Settlement Date for such Option of the In-the-money Amount, as determined at the Expiration Time or as soon thereafter as possible. In the latter case, the sole obligations of the Parties with respect to such Option shall be to deliver or receive the In-the-money Amount of such Option on the Settlement Date. The Seller shall notify the Buyer of its election of the method of settlement of an automatically exercised Option as soon as practicable after the Expiration Time.

      5.5 Unless otherwise agreed by the Parties, an Option may be exercised only in whole.

    6. DISCHARGE AND TERMINATION OF OPTIONS

    Unless otherwise agreed, any Call Option or any Put Option written by a Party will automatically be terminated and discharged, in whole or in part, as applicable, against a Call Option or a Put Option, respectively, written by the other Party, such termination and discharge to occur automatically upon the payment in full of the last Premium payable in respect of such Options; provided that such termination and discharge may only occur in respect of Options:

    • (a) each being with respect to the same Put Currency and the same Call Currency;

    • (b) each having the same Expiration Date and Expiration Time;

    • (c) each being of the same style, i.e. either both being American Style Options or both being European Style Options;

    • (d) each having the same Strike Price; and

    • (e) neither of which shall have been exercised by delivery of a Notice of Exercise;

    and, upon the occurrence of such termination and discharge, neither Party shall have any further obligation to the other Party in respect of the relevant Options or, as the case may be, parts thereof so terminated and discharged. In the case of a partial termination and discharge (i.e., where the relevant Options are for different amounts of the Currency Pair), the remaining portion of the Option which is partially discharged and terminated shall continue to be an Option for all purposes of this Agreement, including this Section 6.

    7. PAYMENT NETTING

    • 7.1 If, on any date, and unless otherwise mutually agreed by the Parties, Premiums would otherwise be payable hereunder in the same currency between respective Designated Offices of the Parties, then, on such date, each Party’s obligation to make payment of any such Premium will be automatically satisfied and discharged and, if the aggregate Premium(s) that would otherwise have been payable by such Designated Office of one Party exceeds the aggregate Premium(s) that would otherwise have been payable by such Designated Office of the other Party, replaced by an obligation upon the Party by whom the larger aggregate Premium(s) would have been payable to pay the other Party the excess of the larger aggregate Premium(s) over the smaller aggregate Premium(s).

    • 7.2 If, on any date, and unless otherwise mutually agreed by the Parties, amounts other than Premium payments would otherwise be payable hereunder in the same currency between respective Designated Offices of the Parties, then, on such date, each Party’s obligation to make payment of any such amount will be automatically satisfied and discharged and, if the aggregate amount that would otherwise have been payable by such Designated Office of one Party exceeds the aggregate amount that would otherwise have been payable by such Designated Office of the other Party, replaced by an obligation upon the Party by whom the larger aggregate amount would have been payable to pay the other Party the excess of the larger aggregate amount over the smaller aggregate amount.

    8. DEFAULT

    • 8.1 If an Event of Default has occurred and is continuing, then the Non-Defaulting Party shall have the right to liquidate and/or to deem to liquidate all, but not less than all (except to the extent that in the good faith opinion of the Non-Defaulting Party certain of such Options may not be liquidated under applicable law), outstanding Options by notice to the Defaulting Party. The previous sentence notwithstanding, in the case of an Event of Default specified in clauses (ii), (iii) or (iv) of the definition thereof, such liquidation and/or deemed liquidation shall be automatic as to all outstanding Options, except where the relevant voluntary or involuntary case or other proceeding or bankruptcy or insolvency giving rise to such Event of Default is governed by a system of law which contains express provisions enabling close-out in the manner described in clauses (i) to (iv) below (or a manner equivalent thereto) to take place after the occurrence of the relevant Event of Default in the absence of automatic liquidation. Such liquidation and/or deemed liquidation shall be effected by:

      • (i) closing out each such Option at the same time of liquidation so that each such Option is canceled and market damages for each Party are calculated equal to the aggregate of (a) with respect to each Option purchased by such Party, the current market premium for such Option, (b) with respect to each Option sold by such Party, any unpaid Premium and, to the extent permitted by applicable law, interest on any unpaid Premium in the same currency as such Premium at the then prevailing market rate, (c) with respect to any exercised Option, any unpaid amount due in settlement of such Option and, to the extent permitted by applicable law, interest thereon from the applicable Settlement Date to the day of close-out at the average rate at which overnight deposits in the currency in which such unpaid amount was due are offered by major banks in the London interbank market as of 11:00 a.m. (London time) on each such day plus 1% per annum, and (d) any costs or expenses incurred by the Non-Defaulting Party in covering its obligations (including a delta hedge) with respect to such Option, all as determined in good faith by the Non-Defaulting Party;

      • (ii) converting any damages calculated in accordance with clause (i) above in a currency other than the Non-Defaulting Party’s Base Currency into such Base Currency at the Spot Price at which, at the time of liquidation, the Non-Defaulting Party could enter into a contract in the foreign exchange market to buy the Base Currency in exchange for such currency;

      • (iii) netting such damage payments with respect to each Party so that all such amounts are netted to a single liquidated amount payable by one Party to the other Party as a settlement payment; and

      • (iv) setting off the net payment calculated in accordance with clause (iii) above which the Non-Defaulting Party owes to the Defaulting Party, if any, and, at the option of the Non-Defaulting Party, any margin or other collateral (“Margin”) held by the Non-Defaulting Party (including the liquidated value of any non-cash Margin) in respect of the Defaulting Party’s obligations hereunder against the net payment calculated in accordance with clause (iii) above which the Defaulting Party owes to the Non-Defaulting Party, if any, and, at the option of the Non-Defaulting Party, any Margin held by the Defaulting Party (including the liquidated value of any non-cash Margin) in respect of the Non-Defaulting Party’s obligations hereunder; provided, that, for purposes of such set-off, any Margin denominated in a currency other than the Non-Defaulting Party’s Base Currency shall be converted into such currency at the rate specified in clause (ii) above.

    • 8.2 The net amount payable by one Party to the other Party pursuant to the provisions of Section 8.1 above shall be paid by the close of business on the Business Day following such liquidation and/or deemed liquidation of all such Options (converted as required by applicable law into any other currency, any such costs of conversion to be borne by, and deducted from any payment to, the Defaulting Party). To the extent permitted by applicable law, any amounts owed but not paid when due under this Section 8 shall bear interest at the Base Currency Rate plus 1% per annum (or, if conversion is required by applicable law into some other currency, either (x) the average rate at which overnight deposits in such other currency are offered by major banks in the London interbank market as of 11:00 a.m. (London time) plus 1% per annum or (y) such other rate as may be prescribed by such applicable law) for each day for which such amount remains unpaid.

    • 8.3 Without prejudice to the foregoing, so long as a Party shall be in default in payment or performance to the other Party hereunder or under any Option and the Non-Defaulting Party has not exercised its rights under this Section 8, or during the pendency of a reasonable request to a Party for adequate assurances of its ability to perform its obligations hereunder or under any Option, the other Party may, at its election and without penalty, suspend its obligation to perform hereunder or under any Option.

    • 8.4 The Party required to make a payment to the other Party pursuant to Sections 8.1 and 8.2 above shall pay to the other Party all out-of-pocket expenses incurred by such other Party (including fees and disbursements of counsel and time charges of attorneys who may be employees of such other Party) in connection with any reasonable collection or other enforcement proceedings related to such required payment.

    • 8.5 The Parties agree that the amounts recoverable under this Section 8 are a reasonable pre-estimate of loss and not a penalty. Such amounts are payable for the loss of bargain and the loss of protection against future risks and, except as otherwise provided in this Agreement, neither Party will be entitled to recover any additional damages as a consequence of such losses.

    • 8.6 The Non-Defaulting Party’s rights under this Section 8 shall be in addition to, and not in limitation or exclusion of, any other rights which the Non-Defaulting Party may have (whether by agreement, operation of law or otherwise), and the Non-Defaulting Party shall have a general right of set-off with respect to all amounts owed by each party to the other Party, whether due or not due (provided that any amount not due at the time of such set-off shall be discounted to present value in a commercially reasonable manner by the Non-Defaulting Party).

    9. PARTIES TO RELY ON THEIR OWN EXPERTISE

    Each Option shall be deemed to have been entered into by each Party in reliance only upon its judgment. Neither Party holds out itself as advising, or any of its employees or agents as having its authority to advise, the other Party as to whether or not it should enter into any such Option (whether as Seller or Buyer) or as to any subsequent actions relating thereto or on any other commercial matters concerned with any currency options or transactions, and neither Party shall have any responsibility or liability whatsoever in respect of any advice of this nature given, or views expressed, by it or any of such persons to the other Party, whether or not such advice is given or such views are expressed at the request of the other Party.

    10. ILLEGALITY, IMPOSSIBILITY AND FORCE MAJEURE

    If either Party is prevented from or hindered or delayed by reason of force majeure or act of State in the delivery or payment of any currency in respect of an Option or if it becomes unlawful or impossible for either Party to make or receive any payment in respect of an Option, then the Party for whom such performance has been prevented, hindered or delayed or has become illegal or impossible shall promptly give notice thereof to the other Party and either Party may, by notice to the other Party, require the liquidation and close-out of each affected Option in accordance with the provisions of Section 8 hereof and, for such purposes, the Party unaffected by such force majeure, act of State, illegality or impossibility shall be considered the Non-Defaulting Party and, for purposes of this Section 10, such Non-Defaulting Party shall perform the calculation required under Section 8.

    11. MISCELLANEOUS

    • 11.1 Unless otherwise specified, the times referred to herein shall in each case refer to the local time of the relevant Designated Office of the Seller of the relevant Option.

    • 11.2 Unless otherwise specified, all notices, instructions and other communications to be given to a Party hereunder shall be given to the address, telex (if confirmed by the appropriate answerback), facsimile (confirmed if requested) or telephone number and to the individual or Department specified by such Party in Part II of the Schedule attached hereto. Unless otherwise specified, any notice, instruction or other communication, shall be effective upon receipt if given in accordance with this Section 11.2.

    • 11.3 All payments to be made hereunder shall be made in same day (or immediately available) and freely transferable funds and, unless otherwise specified, shall be delivered to such office of such bank and in favor of such account as shall be specified by the Party entitled to receive such payment in Part III of the Schedule attached hereto or as specified by such Party by notice given in accordance with Section 11.2. Time shall be of the essence in this Agreement.

    • 11.4 The receipt or recovery by either Party of any amount in respect of an obligation of the other Party in a currency other than the Base Currency (other than receipt by the Defaulting Party pursuant to Sections 8.1 and 8.2 of a payment in the Non-Defaulting Party’s Base Currency), whether pursuant to a judgment of any court or pursuant to Section 8 hereof, shall discharge such obligation only to the extent that, on the first day on which such party is open for business immediately following such receipt, the recipient shall be able, in accordance with normal banking procedures, to purchase the Base Currency with the currency received. If the amount of the Base Currency purchasable shall be less than the original Base Currency amount calculated pursuant to Section 8 hereof, the obligor shall, as a separate obligation and notwithstanding any judgment of any court, indemnify the recipient against any loss sustained by it. The obligor shall in any event indemnify the recipient against any costs incurred by it in making any such purchase of the Base Currency.

    • 11.5 The Parties agree that each may electronically record all telephonic conversations between them and that any such recordings may be submitted in evidence to any court or in any proceeding for the purpose of establishing any matters pertinent to any Option.

    • 11.6 This Agreement shall supersede any other agreement between the Parties with respect to the subject matter hereof and all outstanding Options between the Parties on the date hereof shall be subject hereto, unless otherwise expressly agreed by the Parties.

    • 11.7 A margin agreement between the Parties may apply to obligations governed by this Agreement. If the Parties have executed a margin agreement, such margin agreement shall be subject to the terms hereof and is hereby incorporated by reference herein. In the event of any conflict between a margin agreement and this Agreement, this Agreement shall prevail, except for any provision in such margin agreement in respect of governing law.

    • 11.8 In the event any one or more of the provisions contained in this Agreement should be held invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein shall not in any way be affected or impaired thereby. The Parties shall endeavor in good faith negotiations to replace the invalid, illegal or unenforceable provisions with valid provisions the economic effect of which comes as close as possible to that of the invalid, illegal or unenforceable provisions.

    12. LAW AND JURISDICTION

    • 12.1 This Agreement shall be governed by, and construed in accordance with, the laws of [the State of New York] [England and Wales] without giving effect to conflicts of law principles.

    • 12.2 With respect to any suit, action or proceedings (“Proceedings”) relating to any Option or this Agreement, each Party irrevocably (i) [submits to the non-exclusive jurisdiction of the courts of the State of New York and the United States District Court located in the Borough of Manhattan in New York City,] [agrees for the benefit of the other Party that the courts of England shall have jurisdiction to determine any Processing and irrevocably submits to the jurisdiction of the English courts] and (ii) waives any objection which it may have at any time to the laying of venue of any Proceedings brought in any such court, waives any claim that such Proceedings have been brought in an inconvenient forum and further waives the right to object, with respect to such Proceedings, that such court does not have jurisdiction over such Party. Nothing in this Agreement precludes either Party from bringing Proceedings in any other jurisdiction nor will the bringing of Proceedings in any one or more jurisdictions preclude the bringing of Proceedings in any other jurisdiction.

    • 12.3 Each Party hereby irrevocably waives any and all right to trial by jury in any legal proceeding arising out of or relating to this Agreement or any Option.

    • 12.4 Each Party hereby irrevocably waives, to the fullest extent permitted by applicable law, with respect to itself and its revenues and assets (irrespective of their use or intended use), all immunity on the grounds of sovereignty or other similar grounds from (i) suit, (ii) jurisdiction of any court, (iii) relief by way of injunction, order for specific performance or for recovery of property, (iv) attachment of its assets (whether before or after judgment) and (v) execution or enforcement of any judgment to which it or its revenues or assets might otherwise be entitled in any Proceedings (as defined in Section 12.2 hereof) in the courts of any jurisdiction and irrevocably agrees, to the extent permitted by applicable law, that it will not claim any such immunity in any Proceedings.

    IN WITNESS WHEREOF, the Parties have caused this Agreement to be duly executed by their respective authorized officers as of the date first written above.

    ________________

    By:_____________

    Title:__________

    ________________

    By:_____________

    Title:__________

    EXHIBIT I CURRENCY OPTION CONFIRMATION

    To:________________

    ___________________hereby confirms the following terms of a currency option:

    Reference:

    Trade Date (DD/MMM/YY):

    Buyer:

    Seller:

    Option Style (European or American):

    Option Type (Put or Call):

    Put Currency and Amount:

    Call Currency and Amount:

    Strike Price:

    Expiration Date (DD/MMM/YY):

    Expiration Time:

    Expiration Settlement Date (DD/MMM/YY):

    Premium:

    Price:

    Premium Payment Date (DD/MMM/YY):

    Premium Payment Instructions:

    Other terms and conditions:

    This Option is subject to the International Currency Options Market Master Agreement between [us] [____________ and ___________, dated as of ______________, 19__].

    Please confirm to us by return telex, mail, facsimile or other electronic transmission that the above details are correct.

    SCHEDULE

    Part I: Designated Offices

    • Each of the following shall be a Designated Office:

    Part II: Notices

    • Address

    • Telephone Number

    • Telex Number

    • Facsimile Number

    • Name of Individual or Department to Whom Notices Are to Be Sent

    Part III: Payment Instructions

    • Name of Bank and Office, Account Number and Reference with Respect to Relevant Currencies

    Part IV: Base Currency

    Appendix II 3 International Swap Dealers Association (ISDA) Master Agreement

    (Multicurrency—Cross Border)

    ISDA®

    International Swap Dealers Association, Inc.

    MASTER AGREEMENT

    dated as of ..................

    .............................. and ................................................ have entered and/or anticipate entering into one or more transactions (each a “Transaction”) that are or will be governed by this Master Agreement, which includes the schedule (the “Schedule”), and the documents and other confirming evidence (each a “Confirmation”) exchanged between the parties confirming those Transactions.

    Accordingly, the parties agree as follows:—

    1. Interpretation

    (a) Definitions. The terms defined in Section 14 and in the Schedule will have the meanings therein specified for the purpose of this Master Agreement.

    (b) Inconsistency. In the event of any inconsistency between the provisions of the Schedule and the other provisions of this Master Agreement, the Schedule will prevail. In the event of any inconsistency between the provisions of any Confirmation and this Master Agreement (including the Schedule), such Confirmation will prevail for the purpose of the relevant Transaction.

    (c) Single Agreement. All Transactions are entered into in reliance on the fact that this Master Agreement and all Confirmations form a single agreement between the parties (collectively referred to as this “Agreement”), and the parties would not otherwise enter into any Transactions.

    2. Obligations

    (a) General Conditions.

    • (i) Each party will make each payment or delivery specified in each Confirmation to be made by it, subject to the other provisions of this Agreement.

    • (ii) Payments under this Agreement will be made on the due date for value on that date in the place of the account specified in the relevant Confirmation or otherwise pursuant to this Agreement, in freely transferable funds and in the manner customary for payments in the required currency. Where settlement is by delivery (that is, other than by payment), such delivery will be made for receipt on the due date in the manner customary for the relevant obligation unless otherwise specified in the relevant Confirmation or elsewhere in this Agreement.

    • (iii) Each obligation of each party under Section 2(a)(i) is subject to (1) the condition precedent that no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing, (2) the condition precedent that no Early Termination Date in respect of the relevant Transaction has occurred or been effectively designated and (3) each other applicable condition precedent specified in this Agreement.

    Copyright © 1992 by International Swap Dealers Association, Inc.

    (b) Change of Account Either party may change its account for receiving a payment or delivery by giving notice to the other party at least five Local Business Days prior to the scheduled date for the payment or delivery to which such change applies unless such other party gives timely notice of a reasonable objection to such change.

    (c) Netting. If on any date amounts would otherwise be payable:—

    • (i) in the same currency; and

    • (ii) in respect of the same Transaction,

    by each party to the other, then, on such date, each party’s obligation to make payment of any such amount will be automatically satisfied and discharged and, if the aggregate amount that would otherwise have been payable by one party exceeds the aggregate amount that would otherwise have been payable by the other party, replaced by an obligation upon the party by whom the larger aggregate amount would have been payable to pay to the other party the excess of the larger aggregate amount over the smaller aggregate amount.

    The parties may elect in respect of two or more Transactions that a net amount will be determined in respect of all amounts payable on the same date in the same currency in respect of such Transactions, regardless of whether such amounts are payable in respect of the same Transaction. The election may be made in the Schedule or a Confirmation by specifying that subparagraph (ii) above will not apply to the Transactions identified as being subject to the election, together with the starting date (in which case subparagraph (ii) above will not, or will cease to, apply to such Transactions from such date). This election may be made separately for different groups of Transactions and will apply separately to each pairing of Offices through which the parties make and receive payments or deliveries.

    (d) Deduction or Withholding for Tax.

    • (i) Gross-Up. All payments under this Agreement will be made without any deduction or withholding for or on account of any Tax unless such deduction or withholding is required by any applicable law, as modified by the practice of any relevant governmental revenue authority, then in effect. If a party is so required to deduct or withhold, then that party (“X”) will:—

      • (1) promptly notify the other party (“Y”) of such requirement;

      • (2) pay to the relevant authorities the full amount required to be deducted or withheld (including the full amount required to be deducted or withheld from any additional amount paid by X to Y under this Section 2(d)) promptly upon the earlier of determining that such deduction or withholding is required or receiving notice that such amount has been assessed against Y;

      • (3) promptly forward to Y an official receipt (or a certified copy), or other documentation reasonably acceptable to Y, evidencing such payment to such authorities; and

      • (4) if such Tax is an Indemnifiable Tax, pay to Y, in addition to the payment to which Y is otherwise entitled under this Agreement, such additional amount as is necessary to ensure that the net amount actually received by Y (free and clear of Indemnifiable Taxes, whether assessed against X or Y) will equal the full amount Y would have received had no such deduction or withholding been required. However, X will not be required to pay any additional amount to Y to the extent that it would not be required to be paid but for:—

        • (A) the failure by Y to comply with or perform any agreement contained in Section 4(a)(i), 4(a)(iii) or 4(d); or

        • (B) the failure of a representation made by Y pursuant to Section 3(0 to be accurate and true unless such failure would not have occurred but for (I) any action taken by a taxing authority, or brought in a court of competent jurisdiction, on or after the date on which a Transaction is entered into (regardless of whether such action is taken or brought with respect to a party to this Agreement) or (II) a Change in Tax Law.

    • (ii) Liability. If:—

      • (1) X is required by any applicable law, as modified by the practice of any relevant governmental revenue authority, to make any deduction or withholding in respect of which X would not be required to pay an additional amount to Y under Section 2(d)(i)(4);

      • (2) X does not so deduct or withhold; and

      • (3) a liability resulting from such Tax is assessed directly against X,

      then, except to the extent Y has satisfied or then satisfies the liability resulting from such Tax, Y will promptly pay to X the amount of such liability (including any related liability for interest, but including any related liability for penalties only if Y has failed to comply with or perform any agreement contained in Section 4(a)(i), 4(a)(iii) or 4(d)).

    (e) Default Interest; Other Amounts. Prior to the occurrence or effective designation of an Early Termination Date in respect of the relevant Transaction, a party that defaults in the performance of any payment obligation will, to the extent permitted by law and subject to Section 6(c), be required to pay interest (before as well as after judgment) on the overdue amount to the other party on demand in the same currency as such overdue amount, for the period from (and including) the original due date for payment to (but excluding) the date of actual payment, at the Default Rate. Such interest will be calculated on the basis of daily compounding and the actual number of days elapsed. If, prior to the occurrence or effective designation of an Early Termination Date in respect of the relevant Transaction, a party defaults in the performance of any obligation required to be settled by delivery, it will compensate the other party on demand if and to the extent provided for in the relevant Confirmation or elsewhere in this Agreement.

    3. Representations

    Each party represents to the other party (which representations will be deemed to be repeated by each party on each date on which a Transaction is entered into and, in the case of the representations in Section 3(f), at all times until the termination of this Agreement) that:—

    (a) Basic Representations.

    • (i) Status. It is duly organised and validly existing under the laws of the jurisdiction of its organisation or incorporation and, if relevant under such laws, in good standing;

    • (ii) Powers. It has the power to execute this Agreement and any other documentation relating to this Agreement to which it is a party, to deliver this Agreement and any other documentation relating to this Agreement that it is required by this Agreement to deliver and to perform its obligations under this Agreement and any obligations it has under any Credit Support Document to which it is a party and has taken all necessary action to authorise such execution, delivery and performance;

    • (iii) No Violation or Conflict. Such execution, delivery and performance do not violate or conflict with any law applicable to it, any provision of its constitutional documents, any order or judgment of any court or other agency of government applicable to it or any of its assets or any contractual restriction binding on or affecting it or any of its assets;

    • (iv) Consents. All governmental and other consents that are required to have been obtained by it with respect to this Agreement or any Credit Support Document to which it is a party have been obtained and are in full force and effect and all conditions of any such consents have been complied with; and

    • (v) Obligations Binding. Its obligations under this Agreement and any Credit Support Document to which it is a party constitute its legal, valid and binding obligations, enforceable in accordance with their respective terms (subject to applicable bankruptcy, reorganisation, insolvency, moratorium or similar laws affecting creditors’ rights generally and subject, as to enforceability, to equitable principles of general application (regardless of whether enforcement is sought in a proceeding in equity or at law)).

    (b) Absence of Certain Events. No Event of Default or Potential Event of Default or, to its knowledge, Termination Event with respect to it has occurred and is continuing and no such event or circumstance would occur as a result of its entering into or performing its obligations under this Agreement or any Credit Support Document to which it is a party.

    (c) Absence of Litigation. There is not pending or, to its knowledge, threatened against it or any of its Affiliates any action, suit or proceeding at law or in equity or before any court, tribunal, governmental body, agency or official or any arbitrator that is likely to affect the legality, validity or enforceability against it of this Agreement or any Credit Support Document to which it is a party or its ability to perform its obligations under this Agreement or such Credit Support Document.

    (d) Accuracy of Specified Information. All applicable information that is furnished in writing by or on behalf of it to the other party and is identified for the purpose of this Section 3(d) in the Schedule is, as of the date of the information, true, accurate and complete in every material respect.

    (e) Payer Tax Representation. Each representation specified in the Schedule as being made by it for the purpose of this Section 3(e) is accurate and true.

    (f) Payee Tax Representations. Each representation specified in the Schedule as being made by it for the purpose of this Section 3(f) is accurate and true.

    4. Agreements

    Each party agrees with the other that, so long as either party has or may have any obligation under this Agreement or under any Credit Support Document to which it is a party:—

    (a) Furnish Specified Information. It will deliver to the other party or, in certain cases under subparagraph (iii) below, to such government or taxing authority as the other party reasonably directs:—

    • (i) any forms, documents or certificates relating to taxation specified in the Schedule or any Confirmation;

    • (ii) any other documents specified in the Schedule or any Confirmation; and

    • (iii) upon reasonable demand by such other party, any form or document that may be required or reasonably requested in writing in order to allow such other party or its Credit Support Provider to make a payment under this Agreement or any applicable Credit Support Document without any deduction or withholding for or on account of any Tax or with such deduction or withholding at a reduced rate (so long as the completion, execution or submission of such form or document would not materially prejudice the legal or commercial position of the party in receipt of such demand), with any such form or document to be accurate and completed in a manner reasonably satisfactory to such other party and to be executed and to be delivered with any reasonably required certification,

    in each case by the date specified in the Schedule or such Confirmation or, if none is specified, as soon as reasonably practicable.

    (b) Maintain Authorisations. It will use all reasonable efforts to maintain in full force and effect all consents of any governmental or other authority that are required to be obtained by it with respect to this Agreement or any Credit Support Document to which it is a party and will use all reasonable efforts to obtain any that may become necessary in the future.

    (c) Comply with Laws. It will comply in all material respects with all applicable laws and orders to which it may be subject if failure so to comply would materially impair its ability to perform its obligations under this Agreement or any Credit Support Document to which it is a party.

    (d) Tax Agreement. It will give notice of any failure of a representation made by it under Section 3(f) to be accurate and true promptly upon learning of such failure.

    (e) Payment of Stamp Tax. Subject to Section 11, it will pay any Stamp Tax levied or imposed upon it or in respect of its execution or performance of this Agreement by a jurisdiction in which it is incorporated, organised, managed and controlled, or considered to have its seat, or in which a branch or office through which it is acting for the purpose of this Agreement is located (“Stamp Tax Jurisdiction”) and will indemnify the other party against any Stamp Tax levied or imposed upon the other party or in respect of the other party’s execution or performance of this Agreement by any such Stamp Tax Jurisdiction which is not also a Stamp Tax Jurisdiction with respect to the other party.

    5. Events of Default and Termination Events

    (a) Events of Default. The occurrence at any time with respect to a party or, if applicable, any Credit Support Provider of such party or any Specified Entity of such party of any of the following events constitutes an event of default (an “Event of Default”) with respect to such party:—

    • (i) Failure to Pay or Deliver. Failure by the party to make, when due, any payment under this Agreement or delivery under Section 2(a)(i) or 2(e) required to be made by it if such failure is not remedied on or before the third Local Business Day after notice of such failure is given to the party;

    • (ii) Breach of Agreement. Failure by the party to comply with or perform any agreement or obligation (other than an obligation to make any payment under this Agreement or delivery under Section 2(a)(i) or 2(e) or to give notice of a Termination Event or any agreement or obligation under Section 4(a)(i), 4(a)(iii) or 4(d)) to be complied with or performed by the party in accordance with this Agreement if such failure is not remedied on or before the thirtieth day after notice of such failure is given to the party;

    • (iii) Credit Support Default.

      • (1) Failure by the party or any Credit Support Provider of such party to comply with or perform any agreement or obligation to be complied with or performed by it in accordance with any Credit Support Document if such failure is continuing after any applicable grace period has elapsed;

      • (2) the expiration or termination of such Credit Support Document or the failing or ceasing of such Credit Support Document to be in full force and effect for the purpose of this Agreement (in either case other than in accordance with its terms) prior to the satisfaction of all obligations of such party under each Transaction to which such Credit Support Document relates without the written consent of the other party; or

      • (3) the party or such Credit Support Provider disaffirms, disclaims, repudiates or rejects, in whole or in part, or challenges the validity of, such Credit Support Document;

    • (iv) Misrepresentation. A representation (other than a representation under Section 3(e) or (f) made or repeated or deemed to have been made or repeated by the party or any Credit Support Provider of such party in this Agreement or any Credit Support Document proves to have been incorrect or misleading in any material respect when made or repeated or deemed to have been made or repeated;

    • (v) Default under Specified Transaction. The party, any Credit Support Provider of such party or any applicable Specified Entity of such party (1) defaults under a Specified Transaction and, after giving effect to any applicable notice requirement or grace period, there occurs a liquidation of, an acceleration of obligations under, or an early termination of, that Specified Transaction, (2) defaults, after giving effect to any applicable notice requirement or grace period, in making any payment or delivery due on the last payment, delivery or exchange date of, or any payment on early termination of, a Specified Transaction (or such default continues for at least three Local Business Days if there is no applicable notice requirement or grace period) or (3) disaffirms, disclaims, repudiates or rejects, in whole or in part, a Specified Transaction (or such action is taken by any person or entity appointed or empowered to operate it or act on its behalf);

    • (vi) Cross Default. If “Cross Default” is specified in the Schedule as applying to the party, the occurrence or existence of (1) a default, event of default or other similar condition or event (however described) in respect of such party, any Credit Support Provider of such party or any applicable Specified Entity of such party under one or more agreements or instruments relating to Specified Indebtedness of any of them (individually or collectively) in an aggregate amount of not less than the applicable Threshold Amount (as specified in the Schedule) which has resulted in such Specified Indebtedness becoming, or becoming capable at such time of being declared, due and payable under such agreements or instruments, before it would otherwise have been due and payable or (2) a default by such party, such Credit Support Provider or such Specified Entity (individually or collectively) in making one or more payments on the due date thereof in an aggregate amount of not less than the applicable Threshold Amount under such agreements or instruments (after giving effect to any applicable notice requirement or grace period);

    • (vii) Bankruptcy. The party, any Credit Support Provider of such party or any applicable Specified Entity of such party:—

      (1) is dissolved (other than pursuant to a consolidation, amalgamation or merger); (2) becomes insolvent or is unable to pay its debts or fails or admits in writing its inability generally to pay its debts as they become due; (3) makes a general assignment, arrangement or composition with or for the benefit of its creditors; (4) institutes or has instituted against it a proceeding seeking a judgment of insolvency or bankruptcy or any other relief under any bankruptcy or insolvency law or other similar law affecting creditors’ rights, or a petition is presented for its winding-up or liquidation, and, in the case of any such proceeding or petition instituted or presented against it, such proceeding or petition (A) results in a judgment of insolvency or bankruptcy or the entry of an order for relief or the making of an order for its winding-up or liquidation or (B) is not dismissed, discharged, stayed or restrained in each case within 30 days of the institution or presentation thereof; (5) has a resolution passed for its winding-up, official management or liquidation (other than pursuant to a consolidation, amalgamation or merger); (6) seeks or becomes subject to the appointment of an administrator, provisional liquidator, conservator, receiver, trustee, custodian or other similar official for it or for all or substantially all its assets; (7) has a secured party take possession of all or substantially all its assets or has a distress, execution, attachment, sequestration or other legal process levied, enforced or sued on or against all or substantially all its assets and such secured party maintains possession, or any such process is not dismissed, discharged, stayed or restrained, in each case within 30 days thereafter; (8) causes or is subject to any event with respect to it which, under the applicable laws of any jurisdiction, has an analogous effect to any of the events specified in clauses (1) to (7) (inclusive); or (9) takes any action in furtherance of, or indicating its consent to, approval of, or acquiescence in, any of the foregoing acts; or

    • (viii) Merger Without Assumption. The party or any Credit Support Provider of such party consolidates or amalgamates with, or merges with or into, or transfers all or substantially all its assets to, another entity and, at the time of such consolidation, amalgamation, merger or transfer:—

      • (1) the resulting, surviving or transferee entity fails to assume all the obligations of such party or such Credit Support Provider under this Agreement or any Credit Support Document to which it or its predecessor was a party by operation of law or pursuant to an agreement reasonably satisfactory to the other party to this Agreement; or

      • (2) the benefits of any Credit Support Document fail to extend (without the consent of the other party) to the performance by such resulting, surviving or transferee entity of its obligations under this Agreement.

    (b) Termination Events. The occurrence at any time with respect to a party or, if applicable, any Credit Support Provider of such party or any Specified Entity of such party of any event specified below constitutes an Illegality if the event is specified in (i) below, a Tax Event if the event is specified in (ii) below or a Tax Event Upon Merger if the event is specified in (iii) below, and, if specified to be applicable, a Credit Event Upon Merger if the event is specified pursuant to (iv) below or an Additional Termination Event if the event is specified pursuant to (v) below:—

    • (i) Illegality. Due to the adoption of, or any change in, any applicable law after the date on which a Transaction is entered into, or due to the promulgation of, or any change in, the interpretation by any court, tribunal or regulatory authority with competent jurisdiction of any applicable law after such date, it becomes unlawful (other than as a result of a breach by the party of Section 4(b)) for such 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;

    • (ii) Tax Event. Due to (x) any action taken by a taxing authority, or brought in a court of competent jurisdiction, on or after the date on which a Transaction is entered into (regardless of whether such action is taken or brought with respect to a party to this Agreement) or (y) a Change in Tax Law, the party (which will be the Affected Party) will, or there is a substantial likelihood that it will, on the next succeeding Scheduled Payment Date (1) be required to pay to the other party an additional amount in respect of an Indemnifiable Tax under Section 2(d)(i)(4) (except in respect of interest under Section 2(e), 6(d)(ii) or 6(e)) or (2) receive a payment from which an amount is required to be deducted or withheld for or on account of a Tax (except in respect of interest under Section 2(e), 6(d)(ii) or 6(e)) and no additional amount is required to be paid in respect of such Tax under Section 2(d)(i)(4) (other than by reason of Section 2(d)(i)(4)(A) or (B));

    • (iii) Tax Event Upon Merger. The party (the “Burdened Party”) on the next succeeding Scheduled Payment Date will either (1) be required to pay an additional amount in respect of an Indemnifiable Tax under Section 2(d)(i)(4) (except in respect of interest under Section 2(e), 6(d)(ii) or 6(e)) or (2) receive a payment from which an amount has been deducted or withheld for or on account of any Indemnifiable Tax in respect of which the other party is not required to pay an additional amount (other than by reason of Section 2(d)(i)(4)(A) or (B)), in either case as a result of a party consolidating or amalgamating with, or merging with or into, or transferring all or substantially all its assets to, another entity (which will be the Affected Party) where such action does not constitute an event described in Section 5(a)(viii);

    • (iv) Credit Event Upon Merger. If “Credit Event Upon Merger” is specified in the Schedule as applying to the party, such party (“X”), any Credit Support Provider of X or any applicable Specified Entity of X consolidates or amalgamates with, or merges with or into, or transfers all or substantially all its assets to, another entity and such action does not constitute an event described in Section 5(a)(viii) but the creditworthiness of the resulting, surviving or transferee entity is materially weaker than that of X, such Credit Support Provider or such Specified Entity, as the case may be, immediately prior to such action (and, in such event, X or its successor or transferee, as appropriate, will be the Affected Party); or

    • (v) Additional Termination Event. If any “Additional Termination Event” is specified in the Schedule or any Confirmation as applying, the occurrence of such event (and, in such event, the Affected Party or Affected Parties shall be as specified for such Additional Termination Event in the Schedule or such Confirmation).

    (c) Event of Default and Illegality. If an event or circumstance which would otherwise constitute or give rise to an Event of Default also constitutes an Illegality, it will be treated as an Illegality and will not constitute an Event of Default.

    6. Early Termination

    (a) Right to Terminate Following Event of Default. If at any time an Event of Default with respect to a party (the “Defaulting Party”) has occurred and is then continuing, the other party (the “Non-defaulting Party”) may, by not more than 20 days notice to the Defaulting Party specifying the relevant Event of Default, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect of all outstanding Transactions. If, however, “Automatic Early Termination” is specified in the Schedule as applying to a party, then an Early Termination Date in respect of all outstanding Transactions will occur immediately upon the occurrence with respect to such party of an Event of Default specified in Section 5(a)(vii)(l), (3), (5), (6) or, to the extent analogous thereto, (8), and as of the time immediately preceding the institution of the relevant proceeding or the presentation of the relevant petition upon the occurrence with respect to such party of an Event of Default specified in Section 5(a)(vii)(4) or, to the extent analogous thereto, (8).

    (b) Right to Terminate Following Termination Event.

    • (i) Notice. If a Termination Event occurs, an Affected Party will, promptly upon becoming aware of it, notify the other party, specifying the nature of that Termination Event and each Affected Transaction and will also give such other information about that Termination Event as the other party may reasonably require.

    • (ii) Transfer to Avoid Termination Event. If either an Illegality under Section 5(b)(i)(l) or a Tax Event occurs and there is only one Affected Party, or if a Tax Event Upon Merger occurs and the Burdened Party is the Affected Party, the Affected Party will, as a condition to its right to designate an Early Termination Date under Section 6(b)(iv), use all reasonable efforts (which will not require such party to incur a loss, excluding immaterial, incidental expenses) to transfer within 20 days after it gives notice under Section 6(b)(i) all its rights and obligations under this Agreement in respect of the Affected Transactions to another of its Offices or Affiliates so that such Termination Event ceases to exist.

      If the Affected Party is not able to make such a transfer it will give notice to the other party to that effect within such 20 day period, whereupon the other party may effect such a transfer within 30 days after the notice is given under Section 6(b)(i).

      Any such transfer by a party under this Section 6(b)(ii) will be subject to and conditional upon the prior written consent of the other party, which consent will not be withheld if such other party’s policies in effect at such time would permit it to enter into transactions with the transferee on the terms proposed.

    • (iii) Two Affected Parties. If an Illegality under Section 5(b)(i)(1) or a Tax Event occurs and there are two Affected Parties, each party will use all reasonable efforts to reach agreement within 30 days after notice thereof is given under Section 6(b)(i) on action to avoid that Termination Event.

    • (iv) Right to Terminate. If:—

      • (1) a transfer under Section 6(b)(ii) or an agreement under Section 6(b)(iii), as the case may be, has not been effected with respect to all Affected Transactions within 30 days after an Affected Party gives notice under Section 6(b)(i); or

      • (2) an Illegality under Section 5(b)(i)(2), a Credit Event Upon Merger or an Additional Termination Event occurs, or a Tax Event Upon Merger occurs and the Burdened Party is not the Affected Party,

      either party in the case of an Illegality, the Burdened Party in the case of a Tax Event Upon Merger, any Affected Party in the case of a Tax Event or an Additional Termination Event if there is more than one Affected Party, or the party which is not the Affected Party in the case of a Credit Event Upon Merger or an Additional Termination Event if there is only one Affected Party may, by not more than 20 days notice to the other party and provided that the relevant Termination Event is then continuing, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect of all Affected Transactions.

    (c) Effect of Designation.

    • (i) If notice designating an Early Termination Date is given under Section 6(a) or (b), the Early Termination Date will occur on the date so designated, whether or not the relevant Event of Default or Termination Event is then continuing.

    • (ii) Upon the occurrence or effective designation of an Early Termination Date, no further payments or deliveries under Section 2(a)(i) or 2(e) in respect of the Terminated Transactions will be required to be made, but without prejudice to the other provisions of this Agreement. The amount, if any, payable in respect of an Early Termination Date shall be determined pursuant to Section 6(e).

    (d) Calculations.

    • (i) Statement. On or as soon as reasonably practicable following the occurrence of an Early Termination Date, each party will make the calculations on its part, if any, contemplated by Section 6(e) and will provide to the other party a statement (1) showing, in reasonable detail, such calculations (including all relevant quotations and specifying any amount payable under Section 6(e)) and (2) giving details of the relevant account to which any amount payable to it is to be paid. In the absence of written confirmation from the source of a quotation obtained in determining a Market Quotation, the records of the party obtaining such quotation will be conclusive evidence of the existence and accuracy of such quotation.

    • (ii) Payment Date. An amount calculated as being due in respect of any Early Termination Date under Section 6(e) will be payable on the day that notice of the amount payable is effective (in the case of an Early Termination Date which is designated or occurs as a result of an Event of Default) and on the day which is two Local Business Days after the day on which notice of the amount payable is effective (in the case of an Early Termination Date which is designated as a result of a Termination Event). Such amount will be paid together with (to the extent permitted under applicable law) interest thereon (before as well as after judgment) in the Termination Currency, from (and including) the relevant Early Termination Date to (but excluding) the date such amount is paid, at the Applicable Rate. Such interest will be calculated on the basis of daily compounding and the actual number of days elapsed.

    (e) Payments on Early Termination. If an Early Termination Date occurs, the following provisions shall apply based on the parties’ election in the Schedule of a payment measure, either “Market Quotation” or “Loss”, and a payment method, either the “First Method” or the “Second Method”. If the parties fail to designate a payment measure or payment method in the Schedule, it will be deemed that “Market Quotation” or the “Second Method”, as the case may be, shall apply. The amount, if any, payable in respect of an Early Termination Date and determined pursuant to this Section will be subject to any Set-off.

    • (i) Events of Default. If the Early Termination Date results from an Event of Default:—

      • (1) First Method and Market Quotation. If the First Method and Market Quotation apply, the Defaulting Party will pay to the Non-defaulting Party the excess, if a positive number, of (A) the sum of the Settlement Amount (determined by the Non-defaulting Party) in respect of the Terminated Transactions and the Termination Currency Equivalent of the Unpaid Amounts owing to the Non-defaulting Party over (B) the Termination Currency Equivalent of the Unpaid Amounts owing to the Defaulting Party.

      • (2) First Method and Loss. If the First Method and Loss apply, the Defaulting Party will pay to the Non-defaulting Party, if a positive number, the Non-defaulting Party’s Loss in respect of this Agreement.

      • (3) Second Method and Market Quotation. If the Second Method and Market Quotation apply, an amount will be payable equal to (A) the sum of the Settlement Amount (determined by the Non-defaulting Party) in respect of the Terminated Transactions and the Termination Currency Equivalent of the Unpaid Amounts owing to the Non-defaulting Party less (B) the Termination Currency Equivalent of the Unpaid Amounts owing to the Defaulting Party. If that amount is a positive number, the Defaulting Party will pay it to the Non-defaulting Party; if it is a negative number, the Non-defaulting Party will pay the absolute value of that amount to the Defaulting Party.

      • (4) Second Method and Loss. If the Second Method and Loss apply, an amount will be payable equal to the Non-defaulting Party’s Loss in respect of this Agreement. If that amount is a positive number, the Defaulting Party will pay it to the Non-defaulting Party; if it is a negative number, the Non-defaulting Party will pay the absolute value of that amount to the Defaulting Party.

    • (ii) Termination Events. If the Early Termination Date results from a Termination Event:—

      • (1) One Affected Party. If there is one Affected Party, the amount payable will be determined in accordance with Section 6(e)(i)(3), if Market Quotation applies, or Section 6(e)(i)(4), if Loss applies, except that, in either case, references to the Defaulting Party and to the Non-defaulting Party will be deemed to be references to the Affected Party and the party which is not the Affected Party, respectively, and, if Loss applies and fewer than all the Transactions are being terminated, Loss shall be calculated in respect of all Terminated Transactions.

      • (2) Two Affected Parties. If there are two Affected Parties:—

        • (A) if Market Quotation applies, each party will determine a Settlement Amount in respect of the Terminated Transactions, and an amount will be payable equal to (I) the sum of (a) one-half of the difference between the Settlement Amount of the party with the higher Settlement Amount (“X”) and the Settlement Amount of the party with the lower Settlement Amount (“Y”) and (b) the Termination Currency Equivalent of the Unpaid Amounts owing to X less (II) the Termination Currency Equivalent of the Unpaid Amounts owing to Y; and

        • (B) if Loss applies, each party will determine its Loss in respect of this Agreement (or, if fewer than all the Transactions are being terminated, in respect of all Terminated Transactions) and an amount will be payable equal to one-half of the difference between the Loss of the party with the higher Loss (“X”) and the Loss of the party with the lower Loss (“Y”).

        If the amount payable is a positive number, Y will pay it to X; if it is a negative number, X will pay the absolute value of that amount to Y.

    • (iii) Adjustment for Bankruptcy. In circumstances where an Early Termination Date occurs because “Automatic Early Termination” applies in respect of a party, the amount determined under this Section 6(e) will be subject to such adjustments as are appropriate and permitted by law to reflect any payments or deliveries made by one party to the other under this Agreement (and retained by such other party) during the period from the relevant Early Termination Date to the date for payment determined under Section 6(d)(ii).

    • (iv) Pre-Estimate. The parties agree that if Market Quotation applies an amount recoverable under this Section 6(e) is a reasonable pre-estimate of loss and not a penalty. Such amount is payable for the loss of bargain and the loss of protection against future risks and except as otherwise provided in this Agreement neither party will be entitled to recover any additional damages as a consequence of such losses.

    7. Transfer

    Subject to Section 6(b)(ii), neither this Agreement nor any interest or obligation in or under this Agreement may be transferred (whether by way of security or otherwise) by either party without the prior written consent of the other party, except that:—

    (a) a party may make such a transfer of this Agreement pursuant to a consolidation or amalgamation with, or merger with or into, or transfer of all or substantially all its assets to, another entity (but without prejudice to any other right or remedy under this Agreement); and

    (b) a party may make such a transfer of all or any part of its interest in any amount payable to it from a Defaulting Party under Section 6(e).

    Any purported transfer that is not in compliance with this Section will be void.

    8. Contractual Currency

    (a) Payment in the Contractual Currency. Each payment under this Agreement will be made in the relevant currency specified in this Agreement for that payment (the “Contractual Currency”). To the extent permitted by applicable law, any obligation to make payments under this Agreement in the Contractual Currency will not be discharged or satisfied by any tender in any currency other than the Contractual Currency, except to the extent such tender results in the actual receipt by the party to which payment is owed, acting in a reasonable manner and in good faith in converting the currency so tendered into the Contractual Currency, of the full amount in the Contractual Currency of all amounts payable in respect of this Agreement. If for any reason the amount in the Contractual Currency so received falls short of the amount in the Contractual Currency payable in respect of this Agreement, the party required to make the payment will, to the extent permitted by applicable law, immediately pay such additional amount in the Contractual Currency as may be necessary to compensate for the shortfall. If for any reason the amount in the Contractual Currency so received exceeds the amount in the Contractual Currency payable in respect of this Agreement, the party receiving the payment will refund promptly the amount of such excess.

    (b) Judgments. To the extent permitted by applicable law, if any judgment or order expressed in a currency other than the Contractual Currency is rendered (i) for the payment of any amount owing in respect of this Agreement, (ii) for the payment of any amount relating to any early termination in respect of this Agreement or (iii) in respect of a judgment or order of another court for the payment of any amount described in (i) or (ii) above, the party seeking recovery, after recovery in full of the aggregate amount to which such party is entitled pursuant to the judgment or order, will be entitled to receive immediately from the other party the amount of any shortfall of the Contractual Currency received by such party as a consequence of sums paid in such other currency and will refund promptly to the other party any excess of the Contractual Currency received by such party as a consequence of sums paid in such other currency if such shortfall or such excess arises or results from any variation between the rate of exchange at which the Contractual Currency is converted into the currency of the judgment or order for the purposes of such judgment or order and the rate of exchange at which such party is able, acting in a reasonable manner and in good faith in converting the currency received into the Contractual Currency, to purchase the Contractual Currency with the amount of the currency of the judgment or order actually received by such party. The term “rate of exchange” includes, without limitation, any premiums and costs of exchange payable in connection with the purchase of or conversion into the Contractual Currency.

    (c) Separate Indemnities. To the extent permitted by applicable law, these indemnities constitute separate and independent obligations from the other obligations in this Agreement, will be enforceable as separate and independent causes of action, will apply notwithstanding any indulgence granted by the party to which any payment is owed and will not be affected by judgment being obtained or claim or proof being made for any other sums payable in respect of this Agreement.

    (d) Evidence of Loss. For the purpose of this Section 8, it will be sufficient for a party to demonstrate that it would have suffered a loss had an actual exchange or purchase been made.

    9. Miscellaneous

    (a) Entire Agreement This Agreement constitutes the entire agreement and understanding of the parties with respect to its subject matter and supersedes all oral communication and prior writings with respect thereto.

    (b) Amendments. No amendment, modification or waiver in respect of this Agreement will be effective unless in writing (including a writing evidenced by a facsimile transmission) and executed by each of the parties or confirmed by an exchange of telexes or electronic messages on an electronic messaging system.

    (c) Survival of Obligations. Without prejudice to Sections 2(a)(iii) and 6(c)(ii), the obligations of the parties under this Agreement will survive the termination of any Transaction.

    (d) Remedies Cumulative. Except as provided in this Agreement, the rights, powers, remedies and privileges provided in this Agreement are cumulative and not exclusive of any rights, powers, remedies and privileges provided by law.

    (e) Counterparts and Confirmations.

    • (i) This Agreement (and each amendment, modification and waiver in respect of it) may be executed and delivered in counterparts (including by facsimile transmission), each of which will be deemed an original.

    • (ii) The parties intend that they are legally bound by the terms of each Transaction from the moment they agree to those terms (whether orally or otherwise). A Confirmation shall be entered into as soon as practicable and may be executed and delivered in counterparts (including by facsimile transmission) or be created by an exchange of telexes or by an exchange of electronic messages on an electronic messaging system, which in each case will be sufficient for all purposes to evidence a binding supplement to this Agreement. The parties will specify therein or through another effective means that any such counterpart, telex or electronic message constitutes a Confirmation.

    (f) No Waiver of Rights. A failure or delay in exercising any right, power or privilege in respect of this Agreement will not be presumed to operate as a waiver, and a single or partial exercise of any right, power or privilege will not be presumed to preclude any subsequent or further exercise, of that right, power or privilege or the exercise of any other right, power or privilege.

    (g) Headings. The headings used in this Agreement are for convenience of reference only and are not to affect the construction of or to be taken into consideration in interpreting this Agreement.

    10. Offices; Multibranch Parties

    (a) If Section 10(a) is specified in the Schedule as applying, each party that enters into a Transaction through an Office other than its head or home office represents to the other party that, notwithstanding the place of booking office or jurisdiction of incorporation or organisation of such party, the obligations of such party are the same as if it had entered into the Transaction through its head or home office. This representation will be deemed to be repeated by such party on each date on which a Transaction is entered into.

    (b) Neither party may change the Office through which it makes and receives payments or deliveries for the purpose of a Transaction without the prior written consent of the other party.

    (c) If a party is specified as a Multibranch Party in the Schedule, such Multibranch Party may make and receive payments or deliveries under any Transaction through any Office listed in the Schedule, and the Office through which it makes and receives payments or deliveries with respect to a Transaction will be specified in the relevant Confirmation.

    11. Expenses

    A Defaulting Party will, on demand, indemnify and hold harmless the other party for and against all reasonable out-of-pocket expenses, including legal fees and Stamp Tax, incurred by such other party by reason of the enforcement and protection of its rights under this Agreement or any Credit Support Document to which the Defaulting Party is a party or by reason of the early termination of any Transaction, including, but not limited to, costs of collection.

    12. Notices

    (a) Effectiveness. Any notice or other communication in respect of this Agreement may be given in any manner set forth below (except that a notice or other communication under Section 5 or 6 may not be given by facsimile transmission or electronic messaging system) to the address or number or in accordance with the electronic messaging system details provided (see the Schedule) and will be deemed effective as indicated:—

    • (i) if in writing and delivered in person or by courier, on the date it is delivered;

    • (ii) if sent by telex, on the date the recipient’s answerback is received;

    • (iii) if sent by facsimile transmission, on the date that transmission is received by a responsible employee of the recipient in legible form (it being agreed that the burden of proving receipt will be on the sender and will not be met by a transmission report generated by the sender’s facsimile machine);

    • (iv) if sent by certified or registered mail (airmail, if overseas) or the equivalent (return receipt requested), on the date that mail is delivered or its delivery is attempted; or

    • (v) if sent by electronic messaging system, on the date that electronic message is received,

    unless the date of that delivery (or attempted delivery) or that receipt, as applicable, is not a Local Business Day or that communication is delivered (or attempted) or received, as applicable, after the close of business on a Local Business Day, in which case that communication shall be deemed given and effective on the first following day that is a Local Business Day.

    (b) Change of Addresses. Either party may by notice to the other change the address, telex or facsimile number or electronic messaging system details at which notices or other communications are to be given to it.

    13. Governing Law and Jurisdiction

    (a) Governing Law. This Agreement will be governed by and construed in accordance with the law specified in the Schedule.

    (b) Jurisdiction. With respect to any suit, action or proceedings relating to this Agreement (“Proceedings”), each party irrevocably:—

    • (i) submits to the jurisdiction of the English courts, if this Agreement is expressed to be governed by English law, or to the non-exclusive jurisdiction of the courts of the State of New York and the United States District Court located in the Borough of Manhattan in New York City, if this Agreement is expressed to be governed by the laws of the State of New York; and

    • (ii) waives any objection which it may have at any time to the laying of venue of any Proceedings brought in any such court, waives any claim that such Proceedings have been brought in an inconvenient forum and further waives the right to object, with respect to such Proceedings, that such court does not have any jurisdiction over such party.

    Nothing in this Agreement precludes either party from bringing Proceedings in any other jurisdiction (outside, if this Agreement is expressed to be governed by English law, the Contracting States, as defined in Section 1(3) of the Civil Jurisdiction and Judgments Act 1982 or any modification, extension or re-enactment thereof for the time being in force) nor will the bringing of Proceedings in any one or more jurisdictions preclude the bringing of Proceedings in any other jurisdiction.

    (c) Service of Process. Each party irrevocably appoints the Process Agent (if any) specified opposite its name in the Schedule to receive, for it and on its behalf, service of process in any Proceedings. If for any reason any party’s Process Agent is unable to act as such, such party will promptly notify the other party and within 30 days appoint a substitute process agent acceptable to the other party. The parties irrevocably consent to service of process given in the manner provided for notices in Section 12. Nothing in this Agreement will affect the right of either party to serve process in any other manner permitted by law.

    (d) Waiver of Immunities. Each party irrevocably waives, to the fullest extent permitted by applicable law, with respect to itself and its revenues and assets (irrespective of their use or intended use), all immunity on the grounds of sovereignty or other similar grounds from (i) suit, (ii) jurisdiction of any court, (iii) relief by way of injunction, order for specific performance or for recovery of property, (iv) attachment of its assets (whether before or after judgment) and (v) execution or enforcement of any judgment to which it or its revenues or assets might otherwise be entitled in any Proceedings in the courts of any jurisdiction and irrevocably agrees, to the extent permitted by applicable law, that it will not claim any such immunity in any Proceedings.

    14. Definitions

    As used in this Agreement:—

    “Additional Termination Event” has the meaning specified in Section 5(b).

    “Affected Party” has the meaning specified in Section 5(b).

    “Affected Transactions” means (a) with respect to any Termination Event consisting of an Illegality, Tax Event or Tax Event Upon Merger, all Transactions affected by the occurrence of such Termination Event and (b) with respect to any other Termination Event, all Transactions.

    “Affiliate” means, subject to the Schedule, in relation to any person, any entity controlled, directly or indirectly, by the person, any entity that controls, directly or indirectly, the person or any entity directly or indirectly under common control with the person. For this purpose, “control” of any entity or person means ownership of a majority of the voting power of the entity or person.

    “Applicable Rate” means:—

    (a) in respect of obligations payable or deliverable (or which would have been but for Section 2(a)(iii)) by a Defaulting Party, the Default Rate;

    (b) in respect of an obligation to pay an amount under Section 6(e) of either party from and after the date (determined in accordance with Section 6(d)(ii)) on which that amount is payable, the Default Rate;

    (c) in respect of all other obligations payable or deliverable (or which would have been but for Section 2(a)(iii)) by a Non-defaulting Party, the Non-default Rate; and

    (d) in all other cases, the Termination Rate.

    “Burdened Party” has the meaning specified in Section 5(b).

    “Change in Tax Law” means the enactment, promulgation, execution or ratification of, or any change in or amendment to, any law (or in the application or official interpretation of any law) that occurs on or after the date on which the relevant Transaction is entered into.

    “consent” includes a consent, approval, action, authorisation, exemption, notice, filing, registration or exchange control consent.

    “Credit Event Upon Merger” has the meaning specified in Section 5(b).

    “Credit Support Document” means any agreement or instrument that is specified as such in this Agreement.

    “Credit Support Provider” has the meaning specified in the Schedule.

    “Default Rate” means a rate per annum equal to the cost (without proof or evidence of any actual cost) to the relevant payee (as certified by it) if it were to fund or of funding the relevant amount plus 1 % per annum.

    “Defaulting Party” has the meaning specified in Section 6(a).

    “Early Termination Date” means the date determined in accordance with Section 6(a) or 6(b)(iv).

    “Event of Default” has the meaning specified in Section 5(a) and, if applicable, in the Schedule.

    “Illegality” has the meaning specified in Section 5(b).

    “Indemnifiable Tax” means any Tax other than a Tax that would not be imposed in respect of a payment under this Agreement but for a present or former connection between the jurisdiction of the government or taxation authority imposing such Tax and the recipient of such payment or a person related to such recipient (including, without limitation, a connection arising from such recipient or related person being or having been a citizen or resident of such jurisdiction, or being or having been organised, present or engaged in a trade or business in such jurisdiction, or having or having had a permanent establishment or fixed place of business in such jurisdiction, but excluding a connection arising solely from such recipient or related person having executed, delivered, performed its obligations or received a payment under, or enforced, this Agreement or a Credit Support Document).

    “law” includes any treaty, law, rule or regulation (as modified, in the case of tax matters, by the practice of any relevant governmental revenue authority) and “lawful” and “unlawful” will be construed accordingly.

    “Local Business Day” means, subject to the Schedule, a day on which commercial banks are open for business (including dealings in foreign exchange and foreign currency deposits) (a) in relation to any obligation under Section 2(a)(i), in the place(s) specified in the relevant Confirmation or, if not so specified, as otherwise agreed by the parties in writing or determined pursuant to provisions contained, or incorporated by reference, in this Agreement, (b) in relation to any other payment, in the place where the relevant account is located and, if different, in the principal financial centre, if any, of the currency of such payment, (c) in relation to any notice or other communication, including notice contemplated under Section 5(a)(i), in the city specified in the address for notice provided by the recipient and, in the case of a notice contemplated by Section 2(b), in the place where the relevant new account is to be located and (d) in relation to Section 5(a)(v)(2), in the relevant locations for performance with respect to such Specified Transaction.

    “Loss” means, with respect to this Agreement or one or more Terminated Transactions, as the case may be, and a party, the Termination Currency Equivalent of an amount that party reasonably determines in good faith to be its total losses and costs (or gain, in which case expressed as a negative number) in connection with this Agreement or that Terminated Transaction or group of Terminated Transactions, as the case may be, including any loss of bargain, cost of funding or, at the election of such party but without duplication, loss or cost incurred as a result of its terminating, liquidating, obtaining or reestablishing any hedge or related trading position (or any gain resulting from any of them). Loss includes losses and costs (or gains) in respect of any payment or delivery required to have been made (assuming satisfaction of each applicable condition precedent) on or before the relevant Early Termination Date and not made, except, so as to avoid duplication, if Section 6(e)(i)(l) or (3) or 6(e)(ii)(2)(A) applies. Loss does not include a party’s legal fees and out-of-pocket expenses referred to under Section 11. A party will determine its Loss as of the relevant Early Termination Date, or, if that is not reasonably practicable, as of the earliest date thereafter as is reasonably practicable. A party may (but need not) determine its Loss by reference to quotations of relevant rates or prices from one or more leading dealers in the relevant markets.

    “Market Quotation” means, with respect to one or more Terminated Transactions and a party making the determination, an amount determined on the basis of quotations from Reference Market-makers. Each quotation will be for an amount, if any, that would be paid to such party (expressed as a negative number) or by such party (expressed as a positive number) in consideration of an agreement between such party (taking into account any existing Credit Support Document with respect to the obligations of such party) and the quoting Reference Market-maker to enter into a transaction (the “Replacement Transaction”) that would have the effect of preserving for such party the economic equivalent of any payment or delivery (whether the underlying obligation was absolute or contingent and assuming the satisfaction of each applicable condition precedent) by the parties under Section 2(a)(i) in respect of such Terminated Transaction or group of Terminated Transactions that would, but for the occurrence of the relevant Early Termination Date, have been required after that date. For this purpose, Unpaid Amounts in respect of the Terminated Transaction or group of Terminated Transactions are to be excluded but, without limitation, any payment or delivery that would, but for the relevant Early Termination Date, have been required (assuming satisfaction of each applicable condition precedent) after that Early Termination Date is to be included. The Replacement Transaction would be subject to such documentation as such party and the Reference Market-maker may, in good faith, agree. The party making the determination (or its agent) will request each Reference Market-maker to provide its quotation to the extent reasonably practicable as of the same day and time (without regard to different time zones) on or as soon as reasonably practicable after the relevant Early Termination Date. The day and time as of which those quotations are to be obtained will be selected in good faith by the party obliged to make a determination under Section 6(e), and, if each party is so obliged, after consultation with the other. If more than three quotations are provided, the Market Quotation will be the arithmetic mean of the quotations, without regard to the quotations having the highest and lowest values. If exactly three such quotations are provided, the Market Quotation will be the quotation remaining after disregarding the highest and lowest quotations. For this purpose, if more than one quotation has the same highest value or lowest value, then one of such quotations shall be disregarded. If fewer than three quotations are provided, it will be deemed that the Market Quotation in respect of such Terminated Transaction or group of Terminated Transactions cannot be determined.

    “Non-default Rate” means a rate per annum equal to the cost (without proof or evidence of any actual cost) to the Non-defaulting Party (as certified by it) if it were to fund the relevant amount.

    “Non-defaulting Party” has the meaning specified in Section 6(a).

    “Office” means a branch or office of a party, which may be such party is head or home office.

    “Potential Event of Default” means any event which, with the giving of notice or the lapse of time or both, would constitute an Event of Default.

    “Reference Market-makers” means four leading dealers in the relevant market selected by the party determining a Market Quotation in good faith (a) from among dealers of the highest credit standing which satisfy all the criteria that such party applies generally at the time in deciding whether to offer or to make an extension of credit and (b) to the extent practicable, from among such dealers having an office in the same city.

    “Relevant Jurisdiction” means, with respect to a party, the jurisdictions (a) in which the party is incorporated, organised, managed and controlled or considered to have its seat, (b) where an Office through which the party is acting for purposes of this Agreement is located, (c) in which the party executes this Agreement and (d) in relation to any payment, from or through which such payment is made.

    “Scheduled Payment Date” means a date on which a payment or delivery is to be made under Section 2(a)(i) with respect to a Transaction.

    “Set-off means set-off, offset, combination of accounts, right of retention or withholding or similar right or requirement to which the payer of an amount under Section 6 is entitled or subject (whether arising under this Agreement, another contract, applicable law or otherwise) that is exercised by, or imposed on, such payer.

    “Settlement Amount” means, with respect to a party and any Early Termination Date, the sum of:—

    (a) the Termination Currency Equivalent of the Market Quotations (whether positive or negative) for each Terminated Transaction or group of Terminated Transactions for which a Market Quotation is determined; and

    (b) such party’s Loss (whether positive or negative and without reference to any Unpaid Amounts) for each Terminated Transaction or group of Terminated Transactions for which a Market Quotation cannot be determined or would not (in the reasonable belief of the party making the determination) produce a commercially reasonable result.

    “Specified Entity” has the meaning specified in the Schedule.

    “Specified Indebtedness” means, subject to the Schedule, any obligation (whether present or future, contingent or otherwise, as principal or surety or otherwise) in respect of borrowed money.

    “Specified Transaction” means, subject to the Schedule, (a) any transaction (including an agreement with respect thereto) now existing or hereafter entered into between one party to this Agreement (or any Credit Support Provider of such party or any applicable Specified Entity of such party) and the other party to this Agreement (or any Credit Support Provider of such other party or any applicable Specified Entity of such other party) which is a rate swap transaction, basis swap, forward rate transaction, commodity swap, commodity option, equity or equity index swap, equity or equity index option, bond option, interest rate option, foreign exchange transaction, cap transaction, floor transaction, collar transaction, currency swap transaction, cross-currency rate swap transaction, currency option or any other similar transaction (including any option with respect to any of these transactions), (b) any combination of these transactions and (c) any other transaction identified as a Specified Transaction in this Agreement or the relevant confirmation.

    “Stamp Tax” means any stamp, registration, documentation or similar tax.

    “Tax” means any present or future tax, levy, impost, duty, charge, assessment or fee of any nature (including interest, penalties and additions thereto) that is imposed by any government or other taxing authority in respect of any payment under this Agreement other than a stamp, registration, documentation or similar tax.

    “Tax Event” has the meaning specified in Section 5(b).

    “Tax Event Upon Merger” has the meaning specified in Section 5(b).

    “Terminated Transactions” means with respect to any Early Termination Date (a) if resulting from a Termination Event, all Affected Transactions and (b) if resulting from an Event of Default, all Transactions (in either case) in effect immediately before the effectiveness of the notice designating that Early Termination Date (or, if “Automatic Early Termination” applies, immediately before that Early Termination Date).

    “Termination Currency” has the meaning specified in the Schedule.

    “Termination Currency Equivalent” means, in respect of any amount denominated in the Termination Currency, such Termination Currency amount and, in respect of any amount denominated in a currency other than the Termination Currency (the “Other Currency”), the amount in the Termination Currency determined by the party making the relevant determination as being required to purchase such amount of such Other Currency as at the relevant Early Termination Date, or, if the relevant Market Quotation or Loss (as the case may be), is determined as of a later date, that later date, with the Termination Currency at the rate equal to the spot exchange rate of the foreign exchange agent (selected as provided below) for the purchase of such Other Currency with the Termination Currency at or about 11:00 a.m. (in the city in which such foreign exchange agent is located) on such date as would be customary for the determination of such a rate for the purchase of such Other Currency for value on the relevant Early Termination Date or that later date. The foreign exchange agent will, if only one party is obliged to make a determination under Section 6(e), be selected in good faith by that party and otherwise will be agreed by the parties.

    “Termination Event” means an Illegality, a Tax Event or a Tax Event Upon Merger or, if specified to be applicable, a Credit Event Upon Merger or an Additional Termination Event.

    “Termination Rate” means a rate per annum equal to the arithmetic mean of the cost (without proof or evidence of any actual cost) to each party (as certified by such party) if it were to fund or of funding such amounts.

    “Unpaid Amounts” owing to any party means, with respect to an Early Termination Date, the aggregate of (a) in respect of all Terminated Transactions, the amounts that became payable (or that would have become payable but for Section 2(a)(iii)) to such party under Section 2(a)(i) on or prior to such Early Termination Date and which remain unpaid as at such Early Termination Date and (b) in respect of each Terminated Transaction, for each obligation under Section 2(a)(i) which was (or would have been but for Section 2(a)(iii)) required to be settled by delivery to such party on or prior to such Early Termination Date and which has not been so settled as at such Early Termination Date, an amount equal to the fair market value of that which was (or would have been) required to be delivered as of the originally scheduled date for delivery, in each case together with (to the extent permitted under applicable law) interest, in the currency of such amounts, from (and including) the date such amounts or obligations were or would have been required to have been paid or performed to (but excluding) such Early Termination Date, at the Applicable Rate. Such amounts of interest will be calculated on the basis of daily compounding and the actual number of days elapsed. The fair market value of any obligation referred to in clause (b) above shall be reasonably determined by the party obliged to make the determination under Section 6(e) or, if each party is so obliged, it shall be the average of the Termination Currency Equivalents of the fair market values reasonably determined by both parties.

    IN WITNESS WHEREOF the parties have executed this document on the respective dates specified below with effect from the date specified on the first page of this document.

    ............................................................
    (Name of Party)(Name of Party)
    By: ..............................By: ..............................
    Name:Name:
    Title:Title:
    Date:Date:

    ISDA®

    (Multicurrency—Cross Border)

    International Swap Dealers Association, Inc.

    SCHEDULE to the Master Agreement

    dated as of . . . . . . . . . . . . . . . . . . . . . . . . . . .

    between . . . . . . . . . . . . . . . . . . . . . . . . . . . and . . . . . . . . . . . . . . . . . . . . . . . . . . .

    (“Party A”) (“Party B”)

    Part 1. Termination Provisions.

    (a) “Specified Entity” means in relation to Party A for the purpose of:—

    Section 5(a)(v), . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Section 5(a)(vi), . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Section 5(a)(vii), . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Section 5(b)(iv), . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    and in relation to Party B for the purpose of:—

    Section 5(a)(v), . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Section 5(a)(vi), . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Section 5(a)(vii), . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Section 5(b)(iv) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    (b) “Specified Transaction” will have the meaning specified in Section 14 of this Agreement unless another meaning is specified here . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    (c) The “Cross Default” provisions of Section 5(a)(vi) will/will not * apply to Party A

    will/will not * apply to Party B

    If such provisions apply:—

    “Specified Indebtedness” will have the meaning specified in Section 14 of this Agreement unless another meaning is specified here. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    “Threshold Amount” means. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    (d) The “Credit Event Upon Merger” provisions of Section 5(b)(iv) will/will not * apply to Party A

    will/will not * apply to Party B

    (e) The “Automatic Early Termination” provision of Section 6(a) will/will not * apply to Party A

    will/will not * apply to Party B

    (f) Payments on Early Termination. For the purpose of Section 6(e) of this Agreement:—

    (i) Market Quotation/Loss * will apply,

    (ii) The First Method/The Second Method * will apply.

    (g) “Termination Currency” means .. . . . . . . . . . . . . . . . . . . . . . . . . . . , if such currency is specified and freely available, and otherwise United States Dollars.

    (h) Additional Termination Event will/will not apply*. The following shall constitute an Additional Termination Event:— . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    For the purpose of the foregoing Termination Event, the Affected Party or Affected Parties shall be:— . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Part 2. Tax Representations.

    (a) Payer Representations. For the purpose of Section 3(e) of this Agreement, Party A will/will not* make the following representation and Party B will/will not* make the following representation:—

    It is not required by any applicable law, as modified by the practice of any relevant governmental revenue authority, of any Relevant Jurisdiction to make any deduction or withholding for or on account of any Tax from any payment (other than interest under Section 2(e), 6(d)(ii) or 6(e) of this Agreement) to be made by it to the other party under this Agreement. In making this representation, it may rely on (i) the accuracy of any representations made by the other party pursuant to Section 3(0 of this Agreement, (ii) the satisfaction of the agreement contained in Section 4(a)(i) or 4(a)(iii) of this Agreement and the accuracy and effectiveness of any document provided by the other party pursuant to Section 4(a)(i) or 4(a)(iii) of this Agreement and (iii) the satisfaction of the agreement of the other party contained in Section 4(d) of this Agreement, provided that it shall not be a breach of this representation where reliance is placed on clause (ii) and the other party does not deliver a form or document under Section 4(a)(iii) by reason of material prejudice to its legal or commercial position.

    (b) Payee Representations. For the purpose of Section 3(f) of this Agreement, Party A and Party B make the representations specified below, if any:

    (i) The following representation will/will not* apply to Party A and will/will not* apply to Party B:—

    It is fully eligible for the benefits of the “Business Profits” or “Industrial and Commercial Profits” provision, as the case may be, the “Interest” provision or the “Other Income” provision (if any) of the Specified Treaty with respect to any payment described in such provisions and received or to be received by it in connection with this Agreement and no such payment is attributable to a trade or business carried on by it through a permanent establishment in the Specified Jurisdiction.

    If such representation applies, then:—

    “Specified Treaty” means with respect to Party A .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    “Specified Jurisdiction” means with respect to Party A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    “Specified Treaty” means with respect to Party B .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    “Specified Jurisdiction” means with respect to Party B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    (ii) The following representation will/will not* apply to Party A and will/will not* apply to Party B:—

    Each payment received or to be received by it in connection with this Agreement will be effectively connected with its conduct of a trade or business in the Specified Jurisdiction.

    If such representation applies, then:—

    “Specified Jurisdiction” means with respect to Party A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    “Specified Jurisdiction” means with respect to Party B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    (iii) The following representation will/will not* apply to Party A and will/will not* apply to Party B:—

    (A) It is entering into each Transaction in the ordinary course of its trade as, and is, either (1) a recognised U.K. bank or (2) a recognised U.K. swaps dealer (in either case (1) or (2), for purposes of the United Kingdom Inland Revenue extra statutory concession C17 on interest and currency swaps dated March 14, 1989), and (B) it will bring into account payments made and received in respect of each Transaction in computing its income for United Kingdom tax purposes.

    (iv) Other Payee Representations:— . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    N.B. The above representations may need modification if either party is a Multibranch Party.

    Part 3. Agreement to Deliver Documents.

    For the purpose of Sections 4(a)(i) and (ii) of this Agreement, each party agrees to deliver the following documents, as applicable:—

    (a) Tax forms, documents or certificates to be delivered are:—

    Party required to
    deliver document
    Form/Document/
    Certificate
    Date by which
    to be delivered
    . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
    . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
    . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
    . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
    . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    (b) Other documents to be delivered are:—

    Party required to
    deliver document
    Form/Document/
    Certificate
    Date by which
    to be delivered
    Covered by
    Section 3(d)
    Representation
    . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Yes/No*
    . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Yes/No*
    . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Yes/No*
    . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Yes/No*
    . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Yes/No*

    Part 4. Miscellaneous.

    (a) Addresses for Notices. For the purpose of Section 12(a) of this Agreement:—

    Address for notices or communications to Party A:—

    Address: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Attention: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Telex No.: . . . . . . . . . . . . . . . . . . . . . . . . . . . Answerback: . . . . . . . . . . . . . . . . . . . . . . . . .

    Facsimile No.: . . . . . . . . . . . . . . . . . . . . . . . Telephone No.: . . . . . . . . . . . . . . . . . . . . . .

    Electronic Messaging System Details: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Address for notices or communications to Party B:—

    Address: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Attention: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Telex No.: . . . . . . . . . . . . . . . . . . . . . . . . . . . Answerback: . . . . . . . . . . . . . . . . . . . . . . . . .

    Facsimile No.: . . . . . . . . . . . . . . . . . . . . . . . Telephone No.: . . . . . . . . . . . . . . . . . . . . . .

    Electronic Messaging System Details: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    (b) Process Agent. For the purpose of Section 13(c) of this Agreement:—

    Party A appoints as its Process Agent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Party B appoints as its Process Agent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..

    (c) Offices. The provisions of Section 10(a) will/will not* apply to this Agreement.

    (d) Multibranch Party. For the purpose of Section 10(c) of this Agreement:—

    Party A is/is not* a Multibranch Party and, if so, may act through the following Offices:—

    . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . .
    . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . .

    Party B is/is not* a Multibranch Party and, if so, may act through the following Offices:—

    . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . .
    . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . .

    (e) Calculation Agent. The Calculation Agent is . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . , unless otherwise specified in a Confirmation in relation to the relevant Transaction.

    (f) Credit Support Document. Details of any Credit Support Document:— . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    (g) Credit Support Provider. Credit Support Provider means in relation to Party A, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Credit Support Provider means in relation to Party B, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    (h) Governing Law. This Agreement will be governed by and construed in accordance with English law/the laws of the State of New York (without reference to choice of law doctrine) *.

    (i) Netting of Payments. Subparagraph (ii) of Section 2(c) of this Agreement will not apply to the following Transactions or groups of Transactions (in each case starting from the date of this Agreement/in each case starting from . . . . . . . . . . . . . . . . . . . .*). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    (j) “Affiliate” will have the meaning specified in Section 14 of this Agreement unless another meaning is specified here . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

    Part 5. Other Provisions.

    Appendix II 4 Group of Thirty Recommendations on Derivatives

    Recommendations1

    Recommendations for Dealers and End-Users

    These recommendations are addressed to participants in derivatives activity, both dealers and end-users. The terms “dealer” and “end-user” do not refer to particular types of institution, but rather to the nature of their derivatives activity. A bank, for instance, may participate both as a dealer and as an end-user. Likewise, some corporate end-users of derivatives may also by involved as dealers. (For information about who uses derivatives and why, see Section II of the Overview of Derivatives Activity.)

    General Policies

    Recommendation 1: The Role of Senior Management

    Dealers and end-users should use derivatives in a manner consistent with the overall risk management and capital policies approved by their boards of directors. These policies should be reviewed as business and market circumstances change. Policies governing derivatives use should be clearly defined, including the purposes for which these transactions are to be undertaken. Senior management should approve procedures and controls to implement these policies, and management at all levels should enforce them.

    Derivatives activities merit senior management attention because they can generate significant benefits or costs for any firm. A firm’s policies for derivatives should be an integral part of its overall policies for risk taking and management, either in its underlying business (if it is an end-user) or its other lines of business (if it is a dealer). Periodic reviews will help ensure that these policies reflect changing circumstances and innovations.

    Valuation and Market Risk Management

    Recommendation 2: Marking to Market

    Dealers should mark their derivatives positions to market, on at least a daily basis, for risk management purposes.

    Marking to market is the only valuation technique that correctly reflects the current value of derivatives cash flows to be managed and provides information about market risk and appropriate hedging actions. Lower-of-cost-or-market accounting, and accruals accounting, are not appropriate for risk management.

    The Survey of Industry Practice shows that the practice of marking to market daily is widespread among dealers, reflecting the importance of the information it provides to risk managers. Intraday or even real time valuation can help greatly, especially in managing the market risk of some option portfolios.

    Recommendation 3: Market Valuation Methods

    Derivatives portfolios of dealers should be valued based on mid-market levels less specific adjustments, or on appropriate bid or offer levels. Mid-market valuation adjustments should allow for expected future costs such as unearned credit spread, close-out costs, investing and funding costs, and administrative costs.

    Marking to mid-market less adjustments specifically defines and quantifies adjustments that are implicitly assumed in the bid or offer method. Using the mid-market valuation method without adjustment would over-state the value of a portfolio by not deferring income to meet future costs and to provide a credit spread.

    Two adjustments to mid-market are necessary even for a perfectly matched portfolio: the “unearned credit spread adjustment” to reflect the credit risk in the portfolio; and the “administrative costs adjustment” for costs that will be incurred to administer the portfolio. The unearned credit spread adjustment represents amounts set aside to cover expected credit losses and to provide compensations for credit exposure. Expected credit losses should be based upon expected exposure to counterparties (taking into account netting arrangements), expected default experience, and overall portfolio diversification. The unearned credit spread should preferably be adjusted dynamically as these factors change. It can be calculated on a transaction basis, on a portfolio basis, or across all activities with a given client.

    Two additional adjustments are necessary for portfolios that are not perfectly matched: the “close-out costs adjustment” which factors in the cost of eliminating their market risk; and the “investing and funding costs adjustment” relating to the cost of funding and investing cash flow mismatches at rates different from the LIBOR rate which models typically assume.

    The Survey reveals a wide range of practice concerning the mark-to-market method and the use of adjustments to mid-market value. The most commonly used adjustments are for credit and administrative costs.

    Recommendation 4: Identifying Revenue Sources

    Dealers should measure the components of revenue regularly and in sufficient detail to understand the sources of risk.

    By identifying and isolating individual sources of revenue, dealers develop a more refined understanding of the risks and returns of derivatives activities. Components of revenue generally include origination revenue, credit spread revenue, if applicable, and other trading revenue. It is useful, though complex, to split other trading revenue among components of market risk.

    The Survey of Industry Practice indicates that few dealers identify individual sources of revenue. This should become a more common practice.

    Recommendation 5: Measuring Market Risk

    Dealers should use a consistent measure to calculate daily the market risk of their derivatives positions and compare it to market risk limits.

    • Market risk is best measured as “value at risk” using probability analysis based upon a common confidence interval (e.g., two standard deviations) and time horizon (e.g., a one-day exposure).

    • Components of market risk that should be considered across the term structure include: absolute price or rate change (delta); convexity (gamma); volatility (vega); time decay (theta); basis or correlation; and discount rate (rho).

    Reducing market risks across derivatives to a single common denominator makes aggregation, comparison, and risk control easier. “Value at risk” is the expected loss from an adverse market movement with a specified probability over a particular period of time. For example, with 97.5% probability (that is, a “confidence interval” of 97.5%), corresponding to calculations using about two standard deviations, it can be determined that any change in portfolio value over one day resulting from an adverse market movement will not exceed a specific amount. Conversely, there is a 2.5% probability of experiencing an adverse change in excess of the calculated amount.

    Value at risk should encompass changes in all major market risk components listed in the recommendation. The difficulty in applying the technique of value at risk increases with the complexity of the risks being managed. For comparability, value at risk should be calculated to a common confidence interval and time horizon.

    For most portfolios without options, once the expected loss is known for events with a given probability, the loss for a more likely or less likely scenario can easily be deduced. Therefore, for such portfolios, the choice of confidence interval is of no great significance. For option-based portfolios, however, this does not hold true. In their case, it would also be useful to calculate the loss from more and less likely scenarios.

    A time horizon of one day is consistent with Recommendation 2 for daily marking to market, which allows management to know and decide daily any change of the risk profile.

    Once a method of risk measurement is in place, market risk limits must be decided based on factors such as: management tolerance for low probability extreme losses versus higher probability modest losses; capital resources; market liquidity; expected profitability; trader experience; and business strategy.

    The Survey suggests that most dealers know and consider some or all of the components of market risk. However, the use of one consistent measure of market risk, such as value at risk, is more prevalent among large dealers.

    Recommendation 6: Stress Simulations

    Dealers should regularly perform simulations to determine how their portfolios would perform under stress conditions.

    Simulations of improbable market environments are important in risk analysis because many assumptions that are valid for normal markets may no longer hold true in abnormal markets.

    These simulations should reflect both historical events and future possibilities. Stress scenarios should include not only abnormally large market swings but also periods of prolonged inactivity. The tests should consider the effect of price changes on the mid-market value of the portfolio, as well as changes in the assumptions about the adjustments to mid-market (such as the impact that decreased liquidity would have on close-out costs). Dealers should evaluate the results of stress tests and develop contingency plans accordingly.

    The Survey indicates that some stress testing is being conducted, mainly by large dealers, and that broader usage is planned.

    Recommendation 7: Investing and Funding Forecasts

    Dealers should periodically forecast the cash investing and funding requirements arising from their derivatives portfolios.

    The frequency and precision of forecasts should be determined by the size and nature of mismatches. A detailed forecast should determine surpluses and funding needs, by currency, over time. It also should examine the potential impact of contractual unwind provisions or other credit provisions that produce cash or collateral receipts or payments.

    The Survey indicates that at present, half of responding dealers are conducting forecasts of cash investing and funding requirements. This type of forecast should become a more common practice.

    Recommendation 8: Independent Market Risk Management

    Dealers should have a market risk management function, with clear independence and authority, to ensure that the following responsibilities are carried out:

    • The development of risk limit policies and the monitoring of transactions and positions for adherence to these policies. (See Recommendation 5.)

    • The design of stress scenarios to measure the impact of market conditions, however improbable, that might cause market gaps, volatility swings, or disruptions of major relationships, or might reduce liquidity in the face of unfavorable market linkages, concentrated market making, or credit exhaustion. (See Recommendation 6.)

    • The design of revenue reports quantifying the contribution of various risk components, and of market risk measures such as value at risk. (See Recommendations 4 and 5.)

    • The monitoring of variance between the actual volatility of portfolio value and that predicted by the measure of market risk.

    • The review and approval of pricing models and valuation systems used by front- and back-office personnel, and the development of reconciliation procedures if different systems are used.

    The growth of activities in derivatives and other financial instruments has led many firms to establish market (and credit) risk management functions to assist senior management in establishing consistent policies and procedures applicable to various activities. Market risk management is typically headed by a board level or near board level executive.

    The market risk management function acts as a catalyst for the development of sound market risk management systems, models and procedures. Its review of trading performance typically answers the question: Are results consistent with those suggested by analysis of value at risk? The risk management function is rarely involved in actual risk-taking decisions.

    According to the Survey, a large majority of dealers already have such a function in place and over 50% of those that do not, plan to establish one in the near future.

    Recommendation 9: Practices by End- Users

    As appropriate to the nature, size, and complexity of their derivatives activities, end-users should adopt the same valuation and market risk management practices that are recommended for dealers. Specifically, they should consider: regularly marking to market their derivatives transactions for risk management purposes; periodically forecasting the cash investing and funding requirements arising from their derivatives transactions; and establishing a clearly independent and authoritative function to design and assure adherence to prudent risk limits.

    While many end-users do not expect significant change in the combined value of their derivatives positions and the underlying positions, others do. Derivatives are customer-specific transactions, often designed to offset precisely the market risk of an end-user’s business position (e.g., buying a commodity as a raw material). End-users should establish the performance assessment and control procedures that are appropriate for their derivatives activities.

    Less than half of those end-users surveyed currently mark their derivatives hedges to market for risk management purposes. About half plan to do so.

    Credit Risk Measurement and Management

    Recommendation 10: Measuring Credit Exposure

    Dealers and end-users should measure credit exposure on derivatives in two ways:

    • Current exposure, which is the replacement cost of derivatives transactions, that is, their market value.

    • Potential exposure, which is an estimate of the future replacement cost of derivatives transactions. It should be calculated using probability analysis based upon broad confidence intervals (e.g., two standard deviations) over the remaining terms of the transactions.

    To assess credit risk, a dealer or end-user should ask two questions. If a counterparty were to default today, what would it cost to replace the derivatives transaction? If a counterparty defaults in the future, what is a reasonable estimate of the future replacement cost?

    Current exposure is an accurate measure of credit risk that addresses the first question. It simply evaluates the replacement cost of outstanding derivatives commitments. The result can be positive or negative. It is an important measure of credit risk as it represents the actual risk to a counterparty at any point in time. The regular calculation of current exposure is a broadly accepted practice today.

    Potential exposure is more difficult to assess, and the methods used to determine it vary. The most rigorous methods use either simulation analysis or option valuation models. The analysis generally involves a statistical modeling or option valuation models. The analysis generally involves a statistical modeling of the effects on the value of the derivatives of movement in the prices of the underlying variables (such as interest rates, exchange rates, equity prices, or commodity prices). These techniques are often used to generate two measures of potential exposure: expected exposure; and maximum or “worst case” exposure.

    Dealers and end-users that cannot justify the simulation and statistical systems needed to perform such potential exposure calculations should use tables of factors developed under the same principles. The factors used should differentiate appropriately by type and maturity of transaction and be adjusted periodically for changes in market conditions.

    The Survey shows that dealers use several different methods for calculating credit exposures. These include: the BIS original and current exposure methods, used by one-third of all dealers; methods based on worst-case scenarios applied to each transaction, used by about a quarter of dealers and expected to become the most common in the future; and methods that rely upon tables of factors, used by almost 40% of dealers. End-users tend to rely on simpler methods primarily based on notional amounts.

    Recommendation 11: Aggregating Credit Exposures

    Credit exposures on derivatives, and all other credit exposures to a counterparty, should be aggregated taking into consideration enforceable netting arrangements. Credit exposures should be calculated regularly and compared to credit limits.

    In calculating the current credit exposure for a portfolio of transactions with a counterparty, the first question is whether netting applies. If it does, the current exposure is simply the sum of positive and negative exposures on transactions in the portfolio.

    The calculation of potential exposure is more complicated. Simply summing the potential exposures of all transactions will in most cases dramatically overstate the actual exposure, even if netting does not apply. This is because a straight summation fails to take into account transactions in the portfolio that offset each other or that have peak potential exposures at different times. The most accurate calculation of potential exposure simulates the entire portfolio. Although portfolio-level simulation is not commonly used by dealers at present, they should pursue it more widely to avoid overstating aggregate exposure.

    Credit exposures should be calculated regularly. In particular, dealers should monitor current exposures daily; they can generally measure potential exposures less frequently. End-users with derivative portfolios should also periodically assess credit exposures. For them, the appropriate frequency will depend upon how material their credit exposures are.

    Credit exposures should also be regularly compared to credit limits, and systems should be in place to monitor when limits are approached or exceeded, so that management can take appropriate actions.

    By aggregating credit exposures on derivatives as described above, participants will have a consistent basis for comparison with other credit exposures including those resulting from on-balance-sheet activity. This would permit a more effective evaluation of the adequacy of credit reserves relative to overall credit exposure.

    The Survey suggests that most dealers monitor gross credit use against limits. Aggregating current and potential exposures by counterparty on a net basis is not common among dealers, although some who do not net at present plan to in the future. Frequent monitoring of credit exposure is widespread among dealers, with three-quarters of respondents doing it either intraday or overnight. The majority of end-users monitor credit exposures at least once a month.

    Recommendation 12: Independent Credit Risk Management

    Dealers and end-users should have a credit risk management function with clear independence and authority, and with analytical capabilities in derivatives, responsible for:

    • Approving credit exposure measurement standards.

    • Setting credit limits and monitoring their use.

    • Reviewing credits and concentrations of credit risk.

    • Reviewing and monitoring risk reduction arrangements.

    For dealers, credit exposures should be monitored by an independent credit risk management group. According to the Survey, most dealers and some end-users have such a group. For end-users, this role may not necessarily be performed by a separate group; however, the credit risk should be managed independently from dealing personnel. This separation of responsibility is intended to prevent conflicts of interest and to ensure that credit exposure is assessed objectively. The credit risk management function should approve exposure management standards, and should establish credit limits for counterparties consistent with these standards. Specifically, it should conduct an internal credit review before engaging in transactions with a counterparty, and should guide the use of documentation and credit support tools. Credit limits and guidelines should ensure that only those potential counterparties that meet the appropriate credit standards, with or without credit support, become actual counterparties.

    The credit risk management function should continually review the creditworthiness of counterparties and their credit limits.

    Recommendation 13: Master Agreements

    Dealers and end-users are encouraged to use one master agreement as widely as possible with each counterparty to document existing and future derivatives transactions, including foreign exchange forwards and options. Master agreements should provide for payments netting and close-out netting, using a full two-way payments approach.

    Participants should use one master agreement with each counterparty. That agreement should provide for close-out and settlement netting as widely as possible to document derivatives transactions. In particular, there is substantial scope for reducing credit risk by including foreign exchange forwards and options under master agreements along with other derivatives transactions.

    A single master agreement that documents transactions between two parties creates the greatest legal certainty that credit exposure will be netted. The use of multiple master agreements between two parties introduces the risk of “cherry-picking” among master agreements (rather than among individual transactions); and the risk that the right to set off amounts due under different master agreements might be delayed. Dealers and end-users will be well served by using a single master agreement with counterparties to document as many derivatives transactions as law or regulation permit. The practices of using separate agreements for each transaction between two parties, or standard terms that do not constitute a master agreement, are not good practices and should be discontinued. According to the Survey, two-fifths of all dealers now document derivatives transactions under a multi-product master, and more plan to do so in the future.

    Full two-way payments, as opposed to limited two-way payments, is now the preferred payments approach in master agreements. Under full-two-way payments, the net amount calculated through the netting provisions in a bilateral master agreement is due regardless of whether it is to, or from, the defaulting party. Under limited two-way payments, the defaulting party is not entitled to receive anything, even if the net amount is in its favor. This discourages default and enhances cross-product and cross-affiliate set-off. However, when master agreements cover a wide range of derivatives transactions, the benefits created by increasing the certainty about the value of a net position under full two-way payments outweigh any possible benefits under limited two-way payments.

    Recommendation 14: Credit Enhancement

    Dealers and end-users should assess both the benefits and costs of credit enhancement and related risk-reduction arrangements. Where it is proposed that credit downgrades would trigger early termination or collateral requirements, participants should carefully consider their own capacity and that of their counterparts to meet the potentially substantial funding needs that might result.

    Credit risk reduction arrangements can be useful in the management of counterparty credit risk. These include collateral and margin arrangements; third-party credit enhancement such as guarantees or letters of credit; and structural credit enhancement though the establishment of special-purpose vehicles to conduct derivatives business.

    The Survey indicates that about two-thirds of dealers are prepared to accept credit enhancement with cash or securities as collateral, and over three-quarters accept a third-party guarantee or enhancement. Reflecting strong dealer credit ratings, only one-third are prepared to provide cash or securities collateral and only 10% or so will offer a third-party guarantee.

    Enforceability

    Recommendation 15: Promoting Enforceability

    Dealers and end-users should work together on a continuing basis to identify and recommend solutions for issues of legal enforceability, both within and across jurisdictions, as activities evolve and new types of transactions are developed.

    Dealers regularly develop new types of transactions, and new technologies are developed to confirm them. These developments may not fit clearly within the current legal framework in the jurisdictions where transactions occur. Therefore, dealers and end-users should continue to work together to evaluate the developments in light of existing laws to assess what legal issues may arise. They should take the initiative to ensure that risks arising from these developments can be properly handled through analysis, market practices, documentation and, when necessary, legislation.

    Enforceability of netting provisions is considered a serious concern by 43% of dealer senior management responding to the Survey, and another 45% consider it to be of some concern. It also is considered a serious issue by management of many end-users.

    Systems, Operations, and Controls

    Recommendation 16: Professional Expertise

    Dealers and end-users must ensure that their derivatives activities are undertaken by professionals in sufficient number and with the appropriate experience, skill levels, and degrees of specialization. These professionals include specialists who transact and manage the risks involved, their supervisors, and those responsible for processing, reporting, controlling, and auditing the activities.

    To establish good management, derivatives activities must be staffed by talented, well-trained and responsible professionals. There is a danger, however, in relying on a few specialists, and it is essential that their managers understand not only derivatives but also the broader business context.

    Derivatives support functions are technical and generally require a level of expertise higher than for other financial instruments or activities. Respondents to the Survey expressed concern that, while they are satisfied with the quality of staff in line derivatives activities, the quality of support staff lags. Developing expertise through training programs and appropriate standards of professionalism is encouraged.

    The Survey indicates that, for the majority of respondent dealers, senior management is confident about the general quality of its derivatives professionals. To the extent it is concerned about issues of professionalism, it is more worried about its own lack of understanding, about insufficient understanding of derivatives by other functions, and about overreliance on a few specialists.

    Recommendation 17: Systems

    Dealers and end-users must ensure that adequate systems for data capture, processing, settlement, and management reporting are in place so that derivatives transactions are conducted in an orderly and efficient manner in compliance with management policies. Dealers should have risk management systems that measure the risks incurred in their derivatives activities including market and credit risks. End-users should have risk management systems that measure the risks incurred in their derivatives activities based upon their nature, size and complexity.

    The size and scope of the required systems will depend upon the nature and scale of an organization’s derivatives transactions.

    For dealers, operating efficiency and reliability are enhanced through the development of systems that minimize manual intervention. Those benefits are particularly significant for dealers with a large volume of activity and a high degree of customization of transactions. At the moment, confirmations of transactions, for example, are automated for about 40% of dealers, some 10% are partially automated, and another 45% rely on manual systems. Eighty percent plan to automate their confirmations completely. In addition, large dealers have made significant investments to integrate back- and front-office systems for derivatives with their firms’ other management information systems. Dealers that have done so have found that the integration further enhances operating efficiency and reliability.

    While end-users may invest less extensively in their systems than dealers do, these should still be sufficient to group exposures and analyze aggregated risk in a meaningful and useful way.

    Recommendation 18: Authority

    Management of dealers and end-users should designate who is authorized to commit their institutions to derivatives transactions.

    Authority may be delegated to certain individuals or to persons holding certain positions within the firm. Management may choose to limit authority to certain types of transactions, for example to certain maturities, amounts or types of underlying risks. It is essential that this information be understood within the firm.

    Participants should communicate information on which individuals have the authority to commit to counterparties. They should recognize, however, that the legal doctrine of “apparent authority” may govern transactions they enter into, and that there is no substitute for appropriate internal controls.

    Two-thirds of dealers responding to the Survey involve senior management in authorizing traders to commit the firm.

    Accounting and Disclosure

    Recommendation 19: Accounting Practices

    International harmonization of accounting standards for derivatives is desirable. Pending the adoption of harmonized standards, the following accounting practices are recommended:

    • Dealers should account for derivatives transactions by marking them to market, taking changes in value to income in each period.

    • End-users should account for derivatives used to manage risks so as to achieve a consistency of income recognition treatment between those instruments and the risks being managed. Thus, if the risk being managed is accounted for at cost (or, in the case of an anticipatory hedge, not yet recognized), changes in the value of a qualifying risk management instrument should be deferred until a gain or loss is recognized on the risk being managed. Or, if the risk being managed is marked to market with changes in value being taken to income, a qualifying risk management instrument should be treated in a comparable fashion.

    • End-users should account for derivatives not qualifying for risk management treatment on a mark-to-market basis.

    • Amounts due to and from counterparties should only be offset when there is a legal right to set off or when enforceable netting arrangements are in place.

    Where local regulations prevent adoption of these practices, disclosure along these lines is nevertheless recommended.

    Accounting policies for derivatives vary widely around the world. In some countries there are local accounting standards that address accounting for derivatives; in other countries there are no specific standards and a variety of customs and practices has developed. In view of the global nature of derivatives, it is desirable to achieve some harmonization of accounting treatment to assist in clarifying the financial statements of dealers and end-users.

    The recommendation for dealers to account for changes in the value of their derivatives positions in income during each period has become standard in many, although not all, countries. It provides a better representation of the economic effects of such positions than other methods.

    The recommended accounting treatment for end-users using derivatives to manage risks, referred to as “risk management accounting,” is also a standard treatment. It has evolved in many countries, at least in a modified form, as a response to anomalies in the existing accounting framework. Traditionally in some countries, this accounting treatment has been applied solely to transactions undertaken to reduce risks, usually referred to as “hedges.”

    Policies must define when financial instruments are eligible for risk management accounting to ensure that the method is not abused.

    Among a majority of dealers who responded to the Survey, senior management thought inconsistency of accounting standards with the economics of the business were either of serious or some concern.

    Recommendation 20: Disclosures

    Financial statements of dealers and end-users should contain sufficient information about their use of derivatives to provide an understanding of the purposes for which transactions are undertaken, the extent of the transactions, the degree of risk involved, and how the transactions have been accounted for. Pending the adoption of harmonized accounting standards, the following disclosures are recommended:

    • Information about management’s attitude to financial risks, how instruments are used, and how risks are monitored and controlled.

    • Accounting policies.

    • Analysis of positions at the balance sheet date.

    • Analysis of the credit risk inherent in those positions.

    • For dealers only, additional information about the extent of their activities in financial instruments.

    The Survey shows that the quality of the financial statement disclosure about derivatives transactions varies even more widely than the accounting policies that are applied. Until local standards-setting bodies can adopt harmonized standards, there is a need to improve the quality of financial statement disclosure concerning transactions in both derivatives and cash market instruments.

    Its qualitative nature dictates that information about management’s attitude to financial risks, how instruments are used, and how risks are monitored and controlled, should appear in the management analysis section of the annual report. The remaining information should appear in the footnotes to financial statements and be commented on as appropriate in the management analysis.

    This recommendation is not apparently precluded by accounting regulations in any country and its early adoption is encouraged.

    Inadequate public disclosure of exposures of counterparties is of some concern, or of serious concern, to about three-fifths of senior management among dealers responding to the Survey.

    Recommendations for Legislators, Regulators, and Supervisors

    Recommendation 21: Recognizing Netting

    Regulators and supervisors should recognize the benefits of netting arrangements where and to the full extent that they are enforceable, and encourage their use by reflecting these arrangements in capital adequacy standards. Specifically, they should promptly implement the recognition of the effectiveness of bilateral close-out netting in bank capital regulations.

    The bilateral or multilateral netting of contractual payments due on settlement dates, and of unrealized losses against unrealized gains in the event of a counterparty’s default, is the most important means of mitigating credit risk. By reducing settlement risk as well as credit exposures, netting contributes to the reduction of systemic risk.

    Significant efforts have been made to develop standard master agreements that effect netting across the full range of derivatives products. Nonetheless, the enforceability of such netting provisions remains among the highest concerns of senior management of derivatives dealers, according to the Survey.

    Regulators and supervisors should officially recognize netting where and to the full extent it is enforceable, and reflect these arrangements in the capital standards. In this way, regulators and supervisors will stimulate efforts to resolve uncertainties where they exist and create tangible incentives for using this most important method of reducing counterparty risk.

    An important step in implementing this recommendation was taken in April of this year when the Basle Committee released a Consultative Paper that included a proposal for recognizing the effectiveness of close-out netting. This is an amendment to the agreed framework of measuring bank capital adequacy (the “Basle Accord”) published by the Basle Committee in July 1988. When the consultation period for this proposal has ended, the national supervisory authorities represented on the Basle Committee should recognize and implement bilateral close-out nettings for capital purposes.

    Recommendation 22: Legal and Regulatory Uncertainties

    Legislators, regulators, and supervisors, including central banks, should work in concert with dealers and end-users to identify and remove any remaining legal and regulatory uncertainties with respect to:

    • The form of documentation required to create legally enforceable agreements (statute of frauds).

    • The capacity of parties, such as governmental entities, insurance companies, pension funds, and building societies, to enter into transactions (ultra vires).

    • The enforceability of bilateral close-out netting and collateral arrangements in bankruptcy.

    • The enforceability of multibranch netting arrangements in bankruptcy.

    • The legality/enforceability of derivatives transactions.

    These five main enforceability risks are analyzed for nine major jurisdictions in Appendix II (bound separately). Regulators and legislators in these jurisdictions should remove the remaining uncertainties that have been identified. In other countries, market participants, regulators, and legislators should work to identify and resolve any similar legal risks. These efforts should be conducted on a continuing basis, to account for new types of derivatives transactions and new technologies. It is important to approach these issues aggressively so that the largest risks faced by dealers and end-users are not legal risks from legal systems that have not kept pace with financial developments.

    Further work on the enforceability in bankruptcy or insolvency of bilateral netting and collateral arrangements is particularly important if the credit risk reduction techniques for derivatives are to evolve. These techniques are essential building blocks for enforceable multilateral netting arrangements, if that is a direction participants choose to take.

    Recommendation 23: Tax Treatment

    Legislators and tax authorities are encouraged to review and, where appropriate, amend tax laws and regulations that disadvantage the use of derivatives in risk management strategies. Tax impediments include the inconsistent or uncertain tax treatment of gains and losses on the derivatives, in comparison with the gains and losses that arise from the risks being managed.

    In most, if not all jurisdictions, the tax treatment being applied to derivatives transactions dates back to before they came into general use. This can lead to considerable uncertainty in determining how gains and losses associated with these instruments should be taxed depending upon their use.

    These uncertainties and inconsistencies present real difficulties to organizations that seek to use derivatives to manage risks in their businesses. Confusion can discourage them from pursuing commercially sensible risk management strategies.

    Recommendation 24: Accounting Standards

    Accounting standards-setting bodies in each country should, as a matter of priority, provide comprehensive guidance on accounting and reporting of transactions in financial instruments, including derivatives, and should work towards international harmonization of standards on this subject. Also, the International Accounting Standards Committee should finalize its accounting standard on Financial Instruments.

    At present no country has accounting and reporting standards that comprehensively address all financial instruments, including derivatives. Even in those countries where development of accounting standards is considered far advanced, there are gaps or inconsistencies between different standards. This is an area where action needs to be taken as a matter of priority.

    In a number of countries, accounting standards-setters have recognized the need to improve accounting standards in this area and some have commenced work. Furthermore, the International Accounting Standards Committee (IASC) has issued an exposure draft on Financial Instruments (E40) and presently intends to finalize an accounting standard by the end of 1993.

    In addressing the accounting and disclosure requirements for financial instruments, the IASC and national accounting standards-setters are encouraged to address the problems of accounting for risk management activities. Most existing accounting regulations were formulated before recent advances in risk management strategies. This poses considerable practical problems, both to end-users and dealers. Developments in accounting regulations have not kept pace with changes in the way risk is managed.

    In some countries, the accounting standards that govern the eligibility for hedge accounting treatment of hedges of anticipated transactions may be too restrictive: some relaxation should be permitted, subject to safeguards to prevent abuse.

    Similarly, accounting standards should deal with risk management in a broad sense and not deal just with risk reduction (hedging) which is only one aspect of risk management. Risk management strategies are increasingly being used by both financial and nonfinancial institutions to achieve an acceptable risk profile, but not necessarily a reduced level of risk. Concern over current accounting regulations is deterring some organizations from pursuing commercially sensible risk management strategies. While standards are necessary to ensure that risk management accounting is not abused, it is essential that accounting standards respond to modern risk management techniques.

    Appendix II 5 Joint Report on the Framework for Supervisory Information About the Derivatives Activities of Banks and Securities Firms

    [Excerpt]

    II. Catalogue of information for supervisory purposes*

    16. In monitoring the activities of a financial institution involved in derivatives, supervisors need to be satisfied that the firm has the ability to measure, analyze and manage these risks. In order to achieve these objectives, supervisors should seek to ensure that the firm has both quantitative and qualitative information on its derivatives activities.

    17. Quantitative information. Quantitative information about derivatives activities should address the following broad areas:

    • - credit risk

    • - liquidity risk

    • - market risk

    • - earnings

    Recognizing that exchange-traded and OTC derivatives generally differ in their credit risk, liquidity risk and the potential for complexity, the overall reporting framework distinguishes between exchange-traded and OTC derivatives in identifying information needed for supervisory assessment. Each of the four broad areas is discussed in greater detail in sections 1 to 4 below.

    18. Qualitative information. In order to effectively evaluate banks’ and securities firms’ derivatives activities and related risks, supervisors should assess qualitative information about institutions’ systems, policies and practices for measuring and managing the risk of derivatives. This includes, for example, information on the risk limits that banks and securities firms use to manage their exposures and any changes in these limits. The risk management guidelines for derivatives, which were issued by the two Committees in July 1994 and which highlight key attributes of the risk management systems of banks and securities firms, may be used as a guide in requesting information on institutions’ systems, policies and practices.4

    19. The following sections describe in greater detail the different elements of the framework for supervisory information about derivatives activities. The narrative discussion is summarized in tabular form in Annex 1. In Annex 1, two columns are provided for each of the major risk categories. The first column identifies a supervisory concern or use, and the second column describes the information that could be applicable to that use. Explanations follow that summarize how each data item might be used or why it is important from a supervisory perspective. In general, the data and related explanations reflect widely accepted concepts and techniques for measurement of risk exposure that are based on new developments in practice. Some information elements address multiple supervisory uses listed in the first column of Annex 1. To summarize such overlaps, Annex 2 cross-references the information elements with the supervisory uses that have been identified.**

    1. Credit risk

    20. Credit risk is the risk that a counterparty may fail to fully perform on its financial obligations. With respect to derivatives, it is appropriate to differentiate between the credit risk of exchange-traded and OTC instruments. Owing to the reduction in credit risk achieved by organized exchanges and clearing houses, supervisors may need to evaluate less information on exchange-traded derivatives for credit risk purposes than on OTC instruments. Accordingly, the following discussion on credit risk pertains primarily to OTC contracts.5

    21. The Committees recognize that the notional amount of OTC derivative contracts does not reflect the actual counterparty risk. Credit risk for an OTC contract is best broken into two components, current credit exposure to the counterparty and the potential credit exposure that may result from changes in the market value underlying the derivative contract. To the extent possible, credit risk from derivatives should be considered as part of an institution’s overall credit risk exposure. This should include exposure from other off-balance-sheet credit instruments such as standby letters of credit as well as the credit risk from on-balance-sheet positions.

    (a) Current credit exposure

    22. Current credit exposure is measured as the cost of replacing the cash flow of contracts with positive mark-to-market value (replacement cost) if the counterparty defaults. Legally enforceable bilateral netting agreements can significantly reduce the amount of an institution’s credit risk to each of its counterparties. These netting agreements can extend across different product types such as foreign exchange, interest rate, equity-linked and commodity contracts. Therefore, an institution’s current credit exposure from derivative contracts is best measured as the positive mark-to-market replacement cost of all derivative products on a counterparty by counterparty basis, taking account of any legally enforceable bilateral netting agreements.

    23. For individual institutions, breaking out the gross positive and negative market values of contracts may have supervisory value by providing an indication of the extent to which legally enforceable bilateral netting agreements reduce an institution’s credit exposure.

    (b) Potential credit exposure

    24. In light of the potential volatility of replacement costs over time, prudential analysis should not only focus on replacement cost at a given point in time but also on its potential to change. Potential credit exposure can be defined as the exposure of the contract that may be realized over its remaining life due to movements in the rates or prices underlying the contract. For banks, under the requirements of the 1988 Basle Capital Accord, potential exposure is captured through a so-called “add-on,” which is calculated by multiplying the contract’s gross or effective6 notional principal by a conversion factor that is based on the price volatility of the underlying contract. Bank supervisors should therefore evaluate information on the add-ons that banks must already compile for their risk-based capital calculations. Such information could include notional amounts by product category (i.e. interest rate, foreign exchange, equities, precious metals and other commodities) and by remaining maturity (i.e. one year or less, over one year to five years and more than five years). The Basle Accord defines remaining maturity as the maturity of the derivative contract. However, supervisors could also take into account information on the instrument underlying the derivative contract.

    25. Some banks and securities firms have developed sophisticated simulation models that may produce more precise estimates of their potential credit exposures than under the add-ons approach, and supervisors may wish to take account of the results of these models. These models are generally based on probability analysis and techniques modelling the volatility of the underlying variables (exchange rates, interest rates, equity prices, etc.) and the expected effect of movements of these variables on the contract value over time. Estimates of potential credit exposure by simulations are heavily influenced by the parameters used (a discussion of the major parameters that can influence simulation results is included in the market risk section below). Supervisors and firms should discuss the parameters and other aspects of the models to ensure an appropriate level of understanding and confidence in the use of such models.

    (c) Credit enhancements

    26. Information on credit enhancements used in connection with OTC derivative transactions is important to an effective supervisory assessment of the credit risk inherent in an institution’s derivatives positions. Collateral can be required by an institution to reduce both its current and potential credit risk exposure. Collateral held against the current exposure of derivative contracts with a counterparty effectively reduces credit risk and, therefore, merits supervisory attention. However, supervisors need to consider the legal enforceability of netting agreements and the quality and marketability of collateral.7 For supervisory analysis purposes, collateral held by an institution in excess of its netted credit exposure to a counterparty would not reduce current credit exposure below zero but could reduce potential credit exposure. Supervisors could obtain a better understanding of how collateral reduces credit risk by collecting information separately on collateral with a market value less than or equal to the netted current exposure to the counterparty and collateral with market values in excess of the netted current exposure and of the nature of that collateral.

    27. OTC contract provisions that require a counterparty to post initial collateral (or additional collateral as netted current exposure increases) may be used to reduce potential credit exposure. An OTC contract that is subject to a collateral or margin agreement may have lower potential exposure, since collateral would be required in the future to offset any increase in credit exposure. Accordingly, information about the notional amount and market value of OTC contracts subject to collateral agreements could enhance supervisory understanding of an institution’s potential credit risk.

    (d) Concentration of credit risk

    28. As with loans, an identification of significant counterparty OTC credit exposures relative to an institution’s capital is important for an evaluation of credit risk. This information should be evaluated together with qualitative information on an institution’s credit risk controls. To identify significant exposures and limit reporting burden, supervisors could focus on those counterparties presenting netted current and potential credit exposure above a certain threshold. As a minimum, supervisors could identify the 10 largest counterparties to which an institution is exposed, subject to the minimum threshold used.

    29. Since counterparty exposure may stem from different instruments, overall risk concentrations with single counterparties or groups of counterparties cannot be measured accurately if the analysis is limited to single instruments (e.g. swaps) or classes of instruments (e.g. OTC derivatives). For this reason, institutions should aim to monitor counterparty exposures on an integrated basis, taking into consideration both cash instruments and off-balance-sheet relationships. Supervisors could also consider information on exposure to counterparties in specific business sectors or to counterparties within a certain country or region.

    30. Supervisors could also analyze information on aggregate exposures to various exchanges, both on- and off-balance-sheet, and on exposures to certain types of collateral supporting derivative instruments. Overexposure to specific issues or markets can lead to additional credit concerns, particularly in the case of banks and securities firms with significant activity in securities markets. Some securities supervisors address this concentration risk by deducting from capital all positions above a certain level of market turnover or by applying some other suitable benchmarks. Supervisors without such provisions should ensure that they are at least informed about these concentrations, whether in the form of holdings of the underlying security itself or in the form of OTC derivatives positions which require the firm to deliver or receive such concentrated positions.

    (e) Counterparty credit quality

    31. Credit risk is jointly dependent upon credit exposure to the counterparty and the probability of the counterparty’s default. Information on the current and potential credit exposure to counterparties of various credit quality would increase supervisory insights into the probability of credit loss. Information indicative of counterparty credit quality includes total current and potential credit exposure—taking into account legally enforceable bilateral netting agreements—to counterparties with various characteristics, e.g. Basle Capital Accord risk weights (for banks), credit ratings assigned by rating agencies, or the institution’s internal credit rating system. Information on guarantees, standby letters of credit, or other credit enhancements may also enhance supervisory understanding of credit quality. Aggregate information on past-due status and past-due information by major counterparties, together with information on actual credit losses, may be of particular interest for identifying pending counterparty credit quality problems in the OTC derivatives markets.

    2. Liquidity risk

    32. As with cash instruments, there are two basic types of liquidity risk that can be associated with derivative instruments: market liquidity risk and funding risk.

    (a) Market liquidity risk

    33. Market liquidity risk is the risk that a position cannot be eliminated quickly by either liquidating the instrument or by establishing an offsetting position. Information that breaks out exchange-traded and OTC derivatives could further supervisory understanding of an institution’s market liquidity risk. Although exchange-traded and OTC markets both contain liquid and illiquid contracts, the basic differences between the two markets give an indication of the comparative difficulty of offsetting exposures using other instruments.8 Among both OTC and exchange-traded products, information on broad risk categories (i.e. interest rate, foreign exchange, equities and commodities) and types of instrument would be useful in judging the market liquidity of an institution’s positions. Accordingly, notional amounts and market values of exchange-traded and OTC instruments by type (and perhaps by maturity and by product) could enhance a supervisor’s understanding of an institution’s market liquidity risk. In addition, supervisors could gain important insights into an institution’s market liquidity by taking into account the availability of alternative hedging strategies and closely substitutable instruments.

    34. To understand the market liquidity risk arising from an institution’s derivatives activities, supervisors would benefit greatly from a picture of the aggregate size of the market in which the institution is active. This is particularly important for OTC derivatives, which are generally tailored to the specific needs of customers and for which marking to market is more difficult than for standardized products with liquid markets. As a result, it may be difficult to unwind a position in an appropriate time frame because of its size, the availability of suitable counterparties, or the narrowness of the market. Currently available information on notional values of derivative instruments provides, at best, an incomplete indication of the aggregate size of the market for a particular derivative instrument or of an institution’s participation in that market. An alternative, yet still imperfect, measure of market size would be the gross positive and gross negative market values of contracts by risk category or product. Such data would provide an indication of the economic or market value of the derivative instruments held by banks and securities firms in a particular market at a point in time and an institution’s concentration in that market.

    (b) Funding risk

    35. Funding risk is the risk of derivatives activities placing adverse funding and cash flow pressures on an institution. Funding risk stemming from derivatives alone provides only a partial picture of an institution’s liquidity position. In general, funding risk is best analyzed on an institution-wide basis across all financial instruments. However, it is also important for supervisors to understand the impact of derivatives on an institution’s overall liquidity position.

    36. Separate analysis of notional contract amounts of exchange-traded and OTC instruments (as described earlier) should augment supervisory awareness of funding risks, particularly given the requirements for margin and daily cash settlement of exchange-traded instruments and the resulting demands for liquidity that large positions in these instruments may entail. For example, significant positions in OTC contracts hedged with exchange-traded instruments could result in liquidity pressures arising from the daily margin and cash requirements of the exchange-traded products. Data on OTC contracts with collateral or other “margin-like” requirements may also be necessary for assessing liquidity risk. In addition, information about the notional amounts and expected cash flows of derivatives according to specified time intervals would be helpful in assessing funding risk.

    37. Information on OTC contracts subject to “triggering agreements” provides further information about funding risk. Triggering agreements generally entail contractual provisions requiring the liquidation of the contract or the posting of collateral if certain events, such as a downgrade in credit rating, occur. Substantial positions in contracts with triggering agreements could increase funding risk by requiring the liquidation of contracts or the pledging of collateral when the institution is experiencing financial stress. Accordingly, information on the total notional amount and replacement cost of OTC contracts (aggregated across products) with triggering provisions provides supervisors with important information about liquidity risk.

    38. Supervisors should also consider evaluating information based on institutions’ sensitivity analyses of the effect of adverse market developments on their funding requirements. This information would shed light on the potential for additional margin or collateral calls associated with exchange-traded and OTC derivatives positions due to changes in market variables such as interest rates and exchange rates.

    3. Market risk

    39. Market risk is the risk that the value of on- or off-balance-sheet positions will decline before the positions can be liquidated or offset with other positions. Supervisors should assess information on market risk by major categories of risk, such as interest rates, foreign exchange rates, equity prices and commodities. The market risk of derivatives is best assessed for the entire institution and should combine cash and derivatives positions. The assessment should cover all types of activities generating market risks. Supervisors may also consider breakdowns of positions at the level of individual portfolios, including, in the case of banks, trading and non-trading activities.

    40. Supervisors will be interested in some or all of the following: position data that would allow independent supervisory assessment of market risk through the use of some supervisory model or monitoring criteria and data derived from an institution’s own internal estimates of market risk.

    41. For certain institutions, particularly those that are not major dealers, it may be appropriate to obtain position data (e.g. equities, debt securities, foreign exchange and commodities), which could be drawn from the framework of the Basle Committee’s standardized approach for market risk, once adopted, or from other approaches adopted by national banking and securities supervisors. The collection of position data could be carried out at various levels of detail, depending on the nature and scope of the institution’s trading and derivatives activities. The detail can range from a broad measure of exposure at the portfolio level to a finer disaggregation by instrument and maturity.

    42. As an alternative or supplement to assessing position data, supervisors could evaluate available information on an institution’s internal estimates of market risk. For some institutions, this information could be derived from their internal value-at-risk methodology, which involves the assessment of potential losses due to adverse movements in market prices of a specified probability over a defined period of time. As an alternative to value-at-risk, supervisors may find it useful on a case-by-case basis to assess internally generated information on earnings-at-risk,9 duration or gap analysis, scenario analyses, or any other approach that sheds light on an institution’s market risk. Whatever the approach taken, supervisors should consider the measure of market risk exposure in the context of the institution’s limit policies.

    43. If a firm uses value-at-risk models for measuring market risk, the supervisor should evaluate in detail the methodology used, including its main parameters. Key parameters for evaluating value-at-risk estimates include: (1) the volatility and correlation assumptions of the model (either implied or historical volatilities), (2) the holding period over which the change in portfolio value is measured (e.g., two weeks), (3) the confidence interval used to estimate exposure (e.g., 99% of all outcomes) and (4) the historical sample period (e.g., one year or two years) over which risk factor prices are observed.

    44. Value-at-risk measured solely at a point in time may not provide appropriate insights about market risk due to the speed with which positions in derivatives and other instruments can be altered. Such difficulties may be addressed by the use of summary statistics for the period over which the institution is reporting. For example, supervisors could require institutions to communicate information on the highest value-at-risk number measured during the reporting period, together with monthly or quarterly averages of value-at-risk exposures. By comparing end-of-period value-at-risk with these other measures, supervisors can better understand the volatility which has occurred in these measures during the period. Supervisors could also encourage or require institutions to convey comparisons of daily value-at-risk estimates with daily changes in actual portfolio value over a given period.10 Internal models should be validated by comparing past estimates of risk with actual results and by assessing the models’ major assumptions.

    45. Institutions with significant trading books should subject their portfolios on a regular basis to stress tests using various assumptions and scenarios. These analyses of the portfolio under “worst case” scenarios should preferably be performed on an institution-wide basis and should include an identification of the major assumptions used. Quantitative information on the results of stress scenarios, which could be specified by supervisors or institutions themselves, coupled with qualitative analyses of the actions that management might take under particular scenarios, would be very useful for supervisory purposes. Examples of scenarios for interest rate risk include a parallel yield curve shift of a determined amount, a steepening or flattening of the yield curve, or a change of correlation assumptions.

    46. To minimize burden, supervisory assessment of market risks should draw as much as possible on the information that institutions must collect for supervisory capital purposes. In the case of the banking sector, the Basle Committee’s market risk capital requirements, once finalized and implemented, should serve as a basis for supervisory information on banks’ market risks. In addition, bank supervisors should consider adopting some of the definitions of the market risk capital standards for reporting purposes, such as the definition of the trading book.

    4. Earnings

    47. As with cash market instruments, the profitability of derivatives activities and related on-balance-sheet positions are of interest to supervisors. The separate effects on income of trading activities and activities other than trading would also be of interest.

    48. Accounting standards and valuation techniques differ from country to country and many member supervisors have little or no legal authority in this area. The Committees therefore recognize that earnings information identified under this framework may not be fully comparable across member countries.

    (a) Trading purposes

    49. Many sophisticated market participants view cash and derivative instruments as ready substitutes; their use of derivatives is complementary to cash instruments and positions in financial instruments are often managed as a whole. For supervisors to consider information that concentrates solely on derivatives and to omit similar data on cash instruments could be misleading. In this context, the decomposition of trading revenues (from cash and derivative instruments) according to broad risk classes—interest rate risk, foreign exchange risk, commodities and equities exposures, or other risks to the firm—without regard to the type of instrument that produced the trading income, may better describe the outcome of overall risk taking by the organization.

    50. The systems of some banks or securities firms may not decompose trading revenues by broad categories of risk. Under these circumstances, simplifying assumptions can be used to approximate this categorization of income. For example, if a particular department of an institution typically handles domestic bonds and related derivatives, it may be appropriate to consider trading gains and losses on these instruments as interest related income. Further, the income from complex instruments that are exposed to both foreign exchange and interest rate risk could be classified according to the primary attribute of the instrument (e.g. either as a foreign currency or an interest rate instrument).

    51. Finer disaggregation of trading revenue within risk categories, for example, by origination revenue, credit spread revenue and other trading revenue could be useful in evaluating an organization’s performance relative to its risk profile.11 However, even those dealers with sophisticated information systems may not now be able to differentiate income beyond broad risk categories. As the analytical abilities and systems of market participants evolve, it may be desirable to consider supervisory information that differentiates between revenue earned from meeting customer needs and that earned from other sources. Furthermore, as market participants’ systems evolve, it may be desirable for supervisors to evaluate information that differentiates between trading revenue earned from cash and derivatives positions in each broad risk category. As with cash instruments, a rapid build-up of material trading losses on derivative instruments may indicate deficiency in an institution’s risk management systems and other internal controls that it should promptly evaluate and correct.

    (b) Purposes other than trading

    52. Information about derivatives held for purposes other than trading (end-user derivatives holdings) can also be useful to supervisors. For example, quantitative information that includes the effect on reported earnings of off-balance-sheet positions held by the organization to manage interest rate and other risks would be useful. When combined with information on other factors affecting net interest margins and interest rate sensitivity, this could provide insight into whether derivatives were being used to reduce interest rate risk or to take positions inconsistent with this objective.

    (c) Identifying unrealised or deferred losses

    53. As with cash instruments, any material build-up of unrealised losses or losses that have been realised but deferred by the institution may be an area of supervisory interest, particularly for banking supervisors. At a minimum, the detection of such losses, and particularly, an accumulation of such losses, should prompt supervisory inquiry. Derivative contracts with unrealised losses or deferred losses may reduce future earnings and capital positions when these losses are reflected in profits and losses for accounting purposes. Therefore, when unrealised losses or deferred amounts are material, it is important for supervisors to consider an institution’s plans for reflecting these losses in their reported profits and losses for accounting purposes. Moreover, a rapid build-up of material unrealised or deferred losses may indicate a deficiency in an institution’s internal controls and accounting systems that it should promptly evaluate or correct.

    (d) Derivatives valuation reserves and actual credit losses

    54. Supervisors should assess information on the valuation reserves that an institution has established for its derivatives activities and on any credit losses on derivative instrument that the institution has experienced during the period. In assessing these valuation reserves and any credit losses, it is important to understand the institution’s risk management policies and valuation practices regarding derivatives. In addition, supervisors should determine how the institution reflected valuation reserves and credit losses in its balance sheet and income statement. Information on valuation reserves and the treatment of credit losses is useful in understanding how adverse changes in derivatives risks can affect an institution’s financial condition and earnings.

    Appendix II 6 Basle Committee Report on Risk Management Guidelines for Derivatives

    [Excerpt]

    I. Introduction and basic principles1

    1. Derivatives instruments have become increasingly important to the overall risk profile and profitability of banking organizations throughout the world. Broadly defined, a derivatives instrument is a financial contract whose value depends on the values of one or more underlying assets or indexes. Derivatives transactions include a wide assortment of financial contracts, including forwards, futures, swaps and options. In addition, other traded instruments incorporate derivatives characteristics, such as those with imbedded options. While some derivatives instruments may have very complex structures, all of them can be divided into the basic building blocks of options, forward contracts or some combination thereof. The use of these basic building blocks in structuring derivatives instruments allows the transfer of various financial risks to parties who are more willing, or better suited, to take or manage them.

    2. Derivatives contracts are entered into throughout the world on organized exchanges and through over-the-counter (OTC) arrangements. Exchange-traded contracts are typically standardized as to maturity, contract size and delivery terms. OTC contracts are custom-tailored to an institution’s needs and often specify commodities, instruments and/or maturities that are not offered on any exchange. This document addresses banks’ activities in both OTC and exchange-traded instruments.

    3. Derivatives are used by banking organizations both as risk management tools and as a source of revenue. From a risk management perspective, they allow financial institutions and other participants to identify, isolate and manage separately the market risks in financial instruments and commodities. When used prudently, derivatives can offer managers efficient and effective methods for reducing certain risks through hedging. Derivatives may also be used to reduce financing costs and to increase the yield of certain assets. For a growing number of banking organizations, derivatives activities are becoming a direct source of revenue through “market-making” functions, position taking and risk arbitrage:

    • “market-making” functions involve entering into derivatives transactions with customers and with other market-makers while maintaining a generally balanced portfolio with the expectation of earning fees generated by a bid/offer spread;

    • position-taking, on the other hand, represents efforts to profit by accepting the risk that stems from taking outright positions in anticipation of price movements;

    • arbitrageurs also attempt to take advantage of price movements, but focus their efforts on trying to profit from small discrepancies in price among similar instruments in different markets.

    4. Participants in the derivatives markets are generally grouped into two categories based primarily on their motivations for entering into derivatives contracts. End-users typically enter into derivatives transactions to achieve specified objectives related to hedging, financing or position taking on the normal course of their business operations. A wide variety of business enterprises are end-users. They include, but are not limited to, a broad range of financial institutions such as banks, securities firms and insurance companies; institutional investors such as pension funds, mutual funds and specialized investment partnerships; and corporations, local and state governments, government agencies and international agencies.

    5. Intermediaries, which are sometimes referred to as “dealers,” cater to the needs of end-users by “making markets” in OTC derivatives instruments. In doing so, they expect to generate income from transaction fees, bid/offer spreads and their own trading positions. Important intermediaries, or derivative dealers, include major banks and securities firms around the world. As intermediaries, banks have traditionally offered foreign exchange and interest rate risk management products to their customers and generally view derivatives products as a financial risk management service.

    6. The basic risks associated with derivatives transactions are not new to banking organizations. In general, these risks are credit risk, market risk, liquidity risk, operations risk and legal risk. Because they facilitate the specific identification and management of these risks, derivatives have the potential to enhance the safety and soundness of financial institutions and to produce a more efficient allocation of financial risks. However, since derivatives also repackage these basic risks in combinations that can be quite complex, they can also threaten the safety and soundness of institutions if they are not clearly understood and properly managed.

    7. Recognizing the importance of sound risk management to the effective use of derivatives instruments, the following guidance is intended to highlight the key elements and basic principles of sound management practice for both dealers and end-users of derivatives instruments. These basic principles include:

    • Appropriate oversight by boards of directors and senior management;

    • Adequate risk management process that integrates prudent risk limits, sound measurement procedures and information systems, continuous risk monitoring and frequent management reporting; and,

    • Comprehensive internal controls and audit procedures.

    II. Oversight of the risk management process

    1. As is standard practice for most banking activities, an institution should maintain written policies and procedures that clearly outline its risk management guidance for derivatives activities. At a minimum these policies should identify the risk tolerances of the board of directors and should clearly delineate lines of authority and responsibility for managing the risk of these activities. Individuals involved in derivatives activities should be fully aware of all policies and procedures that relate to their specific duties.

    Board of directors

    2. The board of directors should approve all significant policies relating to the management of risks throughout the institution. These policies, which should include those related to derivatives activities, should be consistent with the organization’s broader business strategies, capital strength, management expertise and overall willingness to take risk. Accordingly, the board should be informed regularly of the risk exposure of the institution and should regularly re-evaluate significant risk management policies and procedures with special emphasis placed on those defining the institution’s risk tolerance regarding these activities. The board of directors should also conduct and encourage discussions between its members and senior management, as well as between senior management and others in the institution, regarding the institution’s risk management process and risk exposure.

    Senior management

    3. Senior management should be responsible for ensuring that there are adequate policies and procedures for conducting derivatives operations on both a long-range and day-to-day basis. This responsibility includes ensuring that there are clear delineations of lines of responsibility for managing risk, adequate systems for measuring risk, appropriately structured limits on risk taking, effective internal controls and a comprehensive risk-reporting process.

    4. Before engaging in derivatives activities, management should ensure that all appropriate approvals are obtained and that adequate operational procedures and risk control systems are in place. Proposals to undertake derivatives activities should include, as applicable:

    • a description of the relevant financial products, markets and business strategies;

    • the resources required to establish sound and effective risk management systems and to attract and retain professionals with specific expertise in derivatives transactions;

    • an analysis of the reasonableness of the proposed activities in relation to the institution’s overall financial condition and capital levels;

    • an analysis of the risks that may arise from the activities;

    • the procedures the bank will use to measure, monitor and control risks;

    • the relevant accounting guidelines;

    • the relevant tax treatment; and

    • an analysis of any legal restrictions and whether the activities are permissible.

    5. After the institution’s initial entry into derivatives activities has been properly approved, any significant changes in such activities or any new derivatives activities should be approved by the board of directors or by an appropriate level of senior management, as designated by the board of directors.

    6. Senior management should regularly evaluate the procedures in place to manage risk to ensure that those procedures are appropriate and sound. Senior management should also foster and participate in active discussions with the board, with staff of risk management functions and with traders regarding procedures for measuring and managing risk. Management must also ensure that derivatives activities are allocated sufficient resources and staff to manage and control risks.

    7. As a matter of general policy, compensation policies—especially in the risk management, control and senior management functions—should be structured in a way that is sufficiently independent of the performance of trading activities, thereby avoiding the potential incentives for excessive risk taking that can occur if, for example, salaries are tied too closely to the profitability of derivatives.

    Independent risk management functions

    8. To the extent warranted by the bank’s activities, the process of measuring, monitoring and controlling risk consistent with the established policies and procedures should be managed independently of individuals conducting derivatives activities, up through senior levels of the institution. An independent system for reporting exposures to both senior-level management and to the board of directors is an important element of this process.

    9. The personnel staffing independent risk management functions should have a complete understanding of the risks associated with all of the bank’s derivatives activities. Accordingly, compensation policies for these individuals should be adequate to attract and retain personnel qualified to assess these risks.

    III. The risk management process

    1. The primary components of a sound risk management process are the following: a comprehensive risk measurement approach; a detailed structure of limits, guidelines and other parameters used to govern risk taking; and a strong management information system for controlling, monitoring and reporting risks. These components are fundamental to both derivatives and non-derivatives activities alike. Moreover, the underlying risks associated with these activities, such as credit, market, liquidity, operations and legal risk, are not new to banking, although their measurement and management can be more complex. Accordingly, the process of risk management for derivatives activities should be integrated into the institution’s overall risk management system to the fullest extent possible using a conceptual framework common to the institution’s other activities. Such a common framework enables the institution to manage its risk exposure more effectively, especially since the various individual risks involved in derivatives activities can, at times, be interconnected and can often transcend specific markets.

    2. As is the case with all risk-bearing activities, the risk exposures an institution assumes in its derivatives activities should be fully supported by an adequate capital position. The institution should ensure that its capital position is sufficiently strong to support all derivatives risks on a fully consolidated basis and that adequate capital is maintained in all group entities engaged in these activities.

    Risk measurement

    3. An institution’s system for measuring the various risks of derivatives activities should be both comprehensive and accurate. Risk should be measured and aggregated across trading and non-trading activities on an institution-wide basis to the fullest extent possible.

    4. While the use of a single prescribed risk measurement approach for management purposes may not be essential, the institution’s procedures should enable management to assess exposures on a consolidated basis. Risk measures and the risk measurement process should be sufficiently robust to reflect accurately the multiple types of risks facing the institution. Risk measurement standards should be understood by relevant personnel at all levels of the institution—from individual traders to the board of directors—and should provide a common framework for limiting and monitoring risk taking activities.

    5. With regard to dealer operations, the process of marking derivatives positions to market is fundamental to measuring and reporting exposures accurately and on a timely basis. An institution active in dealing foreign exchange, derivatives and other traded instruments should have the ability to monitor credit exposures, trading positions and market movements at least daily. Some institutions should also have the capacity, or at least the goal, of monitoring their more actively traded products on a real-time basis.

    6. Analyzing stress situations, including combinations of market events that could affect the banking organization, is also an important aspect of risk measurement. Sound risk measurement practices include identifying possible events or changes in market behavior that could have unfavorable effects on the institution and assessing the ability of the institution to withstand them. These analyses should consider not only the likelihood of adverse events, reflecting their probability, but also “worst case” scenarios. Ideally, such worst case analysis should be conducted on an institution-wide basis by taking into account the effect of unusual changes in prices or volatilities, market illiquidity or the default of a large counterparty across both the derivatives and cash trading portfolios and the loan and funding portfolios.

    7. Such stress tests should not be limited to quantitative exercises that compute potential losses or gains. They should also include more qualitative analyses of the actions management might take under particular scenarios. Contingency plans outlining operating procedures and lines of communication, both formal and informal, are important products of such qualitative analyses.

    Limiting risks

    8. A sound system of integrated institution-wide limits and risk taking guidelines is an essential component of the risk management process. Such a system should set boundaries for organizational risk taking and should also ensure that positions that exceed certain predetermined levels receive prompt management attention. The limit system should be consistent with the effectiveness of the organization’s overall risk management process and with the adequacy of its capital position. An appropriate limit system should permit management to control exposures, to initiate discussion about opportunities and risks and to monitor actual risk taking against predetermined tolerances, as determined by the board of directors and senior management.

    9. Global limits should be set for each major type of risk involved in an institution’s derivatives activities. These limits should be consistent with the institution’s overall risk measurement approach and should be integrated to the fullest extent possible with institution-wide limits on those risks as they arise in all other activities of the institution. Where appropriate, the limit system should provide the capability to allocate limits down to individual business units.

    10. If limits are exceeded, such occurrences should be made known to senior management and approved only by authorized personnel. These positions should also prompt discussions about the consolidated risk taking activities of the institution or the unit conducting the derivatives activities. The seriousness of limit exceptions depends in large part upon management’s approach toward setting limits and on the actual size of individual and organizational limits relative to the institution’s capacity to take risk. An institution with relatively conservative limits may encounter more exceptions to those limits than an institution with less restrictive limits.

    Reporting

    11. An accurate, informative and timely management information system is essential to the prudent operation of derivatives activities. Accordingly, the quality of the management information system is an important factor in the overall effectiveness of the risk management process. The risk management function should monitor and report its measures of risks to appropriate levels of senior management and to the board of directors. In dealer operations, exposures and profit and loss statements should be reported at least daily to managers who supervise but do not, themselves, conduct those activities. More frequent reports should be made as market conditions dictate. Reports to other levels of senior management and the board may occur less frequently, but the frequency of reporting should provide these individuals with adequate information to judge the changing nature of the institution’s risk profile.

    12. Management information systems should translate the measured risk for derivatives activities from a technical and quantitative format to one that can be easily read and understood by senior managers and directors, who may not have specialized and technical knowledge of derivatives products. Risk exposures arising from various derivatives products should be reported to senior managers and directors using a common conceptual framework for measuring and limiting risks.

    Management evaluation and review

    13. Management should ensure that the various components of the institution’s risk management process are regularly reviewed and evaluated. This review should take into account changes in the activities of the institution and in the market environment, since the changes may have created exposures that require additional attention. Any material changes to the risk management system should also be reviewed.

    14. The risk management functions should regularly assess the methodologies, models and assumptions used to measure risk and to limit exposures. Proper documentation of these elements of the risk measurement system is essential for conducting meaningful reviews. The review of limit structures should compare limits to actual exposures and should also consider whether existing measures of exposure and limits are appropriate in view of the institution’s past performance and current capital position.

    15. The frequency and extent to which an institution should re-evaluate its risk measurement methodologies and models depends, in part, on the specific risk exposures created by their derivatives activities, on the pace and nature of market changes and on the pace of innovation with respect to measuring and managing risks. At a minimum, an institution with significant derivatives activities should review the underlying methodologies of its models at least annually—and more often as market conditions dictate—to ensure they are appropriate and consistent. Such internal evaluations may, in many cases, be supplemented by reviews by external auditors or other qualified outside parties, such as consultants who have expertise with highly technical models and risk management techniques. Assumptions should be evaluated on a continual basis.

    16. The institution should also have an effective process to evaluate and review the risks involved in products that are either new to it, or new to the marketplace and of potential interest to the institution. It should also introduce new products in a manner that adequately limits potential losses and permits the testing of internal systems. An institution should not become involved in a product at significant levels until senior management and all relevant personnel (including those in risk management, internal control, legal, accounting and auditing) understand the product and are able to integrate the product into the institution’s risk measurement and control systems.

    Appendix II 7 OCC Banking Circular No. 277: Risk Management of Financial Derivatives

    Risk Management of Financial Derivatives1

    [Excerpt]

    GUIDANCE

    A. Senior Management and Board Oversight

    National banks that engage in derivatives activities should have effective senior management supervision and oversight by the Board of Directors to ensure that such activities are conducted in a safe and sound manner and are consistent with the Board of Director’s overall risk management philosophy and the bank’s business strategies.

    1. Written Policies and Procedures

    A bank should have comprehensive written policies and procedures to govern its use of derivatives. Senior management should review the adequacy of these policies and procedures, in light of the bank’s activities and market conditions, at least annually. Appropriate governance by the Board of Directors should include an initial endorsement of significant policies (and changes, as applicable) and periodic approval thereafter, as appropriate, considering the scope, size, and complexity of the bank’s derivatives activities.

    2. General Risk Monitoring and Control

    Senior management of each national bank engaging in derivatives transactions should establish an independent unit or individual responsible for measuring and reporting risk exposures. That responsibility should include monitoring compliance with policies and risk exposure limits.

    3. Risk Management Systems

    National banks engaged in financial derivatives transactions should have comprehensive risk management systems that are commensurate with the scope, size, and complexity of their activities and the risks they assume. Such systems must ensure that market factors affecting risk exposures are adequately measured, monitored, and controlled. These factors include changes in interest and currency exchange rates, commodity and equity prices and their associated volatilities, changes in the credit quality of counterparties, changes in market liquidity, and the potential for major market disruptions. Risk management procedures also should adequately control potential losses arising from system deficiencies.

    4. Audit Coverage

    National banks should have audit coverage of their financial derivatives activities adequate to ensure timely identification of internal control weaknesses and/or system deficiencies. Such audit coverage should be provided by competent professionals who are knowledgeable of the risks inherent in the financial derivatives transactions.

    B. Market Risk Management

    1. Dealers and Active Position-Takers

    National banks whose financial derivatives activities involve dealing or active position-taking should have risk measurement systems that can quantify risk exposures arising from changes in market factors. Those systems should be structured to enable management to initiate prompt remedial action. The systems also should facilitate stress testing and enable management to assess the potential impact of various changes in market factors on earnings and capital.

    2. Limited End-Users

    A bank whose derivatives activities are limited in volume and confined to risk management activities may need less sophisticated risk measurement systems than those required by a dealer or active position-taker. Senior management at such a bank should ensure that all significant risks arising from their transactions can be quantified, monitored, and controlled. At a minimum, risk management systems should evaluate the possible impact on the bank’s earnings and capital which may result from adverse changes in interest rates and other market conditions that are relevant to the bank’s risk exposure and the effectiveness of financial derivatives transactions in the bank’s overall risk management.

    C. Credit Risk Management

    Credit risk management should parallel the prudent controls expected in traditional lending activities. Policies and procedures should be formalized to address concerns such as significant counterparty exposures, concentrations, credit exceptions, risk ratings, nonperforming contracts, and allowance allocations. Timely, meaningful reports should be generated and distributed consistent with policy and procedure requirements.

    1. Credit Approval Function

    To ensure safe and sound management of derivatives credit risk exposures, bank management should make sure that credit authorizations are provided by personnel independent of the trading unit. Credit officers should be qualified to identify and assess the level of credit risk inherent in a proposed derivatives transaction. Approving officers also should be able to identify if a proposed derivatives transaction is consistent with a counterparty’s policies and procedures with respect to derivatives activities, as they are known to the bank.

    2. Pre-Settlement Risk

    The system a bank uses to quantify pre-settlement credit risk exposure should take into account current exposure (“mark-to-market”) as well as potential credit risk due to possible future changes in applicable market rates or prices (“add-on”). That system should use a reliable source for determining the credit risk factor used to calculate the credit risk add-on.

    3. Settlement Risk

    A bank’s system for managing counterparty credit risk should address settlement risk.

    4. Credit Risk Monitoring

    Credit risk monitoring should be independent of the units that create financial derivatives exposures. This risk monitoring unit should be responsible for producing and distributing timely, accurate information about credit exposures such as line usage, concentrations, credit quality, limit exceptions, and significant counterparty exposures. Credit exposure reports should provide aggregate information about the bank’s credit risk to a given counterparty (including products such as loans, securities underwritings, and other traded products). The risk monitoring unit should ensure that appropriate levels of senior management and the Board of Directors receive relevant information about credit exposure arising from derivatives activities on a periodic and timely basis.

    D. Liquidity Risk Management

    Bank management should establish effective controls over the liquidity exposure arising from financial derivatives activities. Key principles in the governance and management of this risk are diversification and communication.

    1. Market/Product Liquidity Risk

    Exposure to market/product liquidity risk should be formally addressed within market risk limits. Diversification policies specifically addressing known or potential liquidity problems also should be implemented. Limits should be designed to trigger management action and control loss. Quality and timely communication also should be an integral part of a bank’s risk management culture.

    2. Cash Flow/Funding Liquidity Risk

    A bank should have liquidity policies to formally govern its exposure to cash flow gaps (from intermediate payments or settlements) arising from financial derivatives activities.

    3. Early Termination Arrangements and Credit Enhancements

    Policies should control the bank’s exposure arising from early termination arrangements, as well as collateralization or other credit enhancements.

    4. Monitoring

    Banks should have management information systems that permit daily monitoring of liquidity positions relative to limits. These reports should be prepared by an area or employee(s) independent of the trading unit.

    E. Operations and Systems Risk Management

    The Board of Directors and senior management should ensure the proper dedication of resources (financial and personnel) to support operations and systems development and maintenance. The operations unit for financial derivatives activities, consistent with other trading and investment activities, should report to an independent unit, and should be managed independently of the business unit. The sophistication of the systems support and operational capacity should be commensurate with the size and complexity of the derivatives business activity.

    1. Quality of Personnel

    Senior management should recognize the need for, and devote appropriate resources to, employing knowledgeable and experienced personnel in the operations area.

    2. Systems

    Systems design and needs may vary according to the size and complexity of a bank’s financial derivatives business. However, each system should provide for accurate and timely processing and allow for proper risk exposure monitoring.

    3. Segregation of Duties

    Segregation of operational duties, exposure reporting, and risk monitoring from the business unit is critical to proper internal control.

    4. Valuation Issues

    Banks that engage in financial derivatives activities should ensure that the methods they use to value their derivatives positions are appropriate and that the assumptions underlying those methods are reasonable.

    5. Documentation

    Bank management should ensure a mechanism exists whereby financial derivatives contract documentation is confirmed, maintained, and safeguarded. Documentation exceptions should be properly monitored and resolved.

    F. Legal Issues

    Prior to engaging in derivatives transactions, a national bank should reasonably satisfy itself that its counterparties have the legal, and any necessary regulatory, authority to engage in those transactions. In addition to determining the authority of a counterparty to enter into a derivatives transaction, a national bank also should reasonably satisfy itself that the terms of any contract governing its derivatives with a counterparty are legally sound.

    1. Bilateral Netting

    In order to reduce counterparty credit exposure, a national bank should use master close-out netting agreements with its counterparties to the broadest extent legally enforceable, including in any possible insolvency proceedings of such counterparties. However, the reliance upon such agreements where the enforceability of such agreements against a particular counterparty has not been legally established should be considered carefully and will be scrutinized closely by the OCC.

    2. Multilateral Netting

    A national bank should determine credit and liquidity exposure and account for financial derivatives transactions on a multilaterally netted basis only if cleared through a clearinghouse, organization, or facility that meets the conditions set forth in the Report of the Committee on Interbank Netting Schemes of the Central Banks of the Group of 10 Countries, Bank for International Settlements, Nov. 1990 (“Lamfalussy Report”).

    3. Physical Commodity Transactions

    National banks may engage in physical commodity transactions in order to manage the risks arising out of physical commodity financial derivatives transactions if they meet the following conditions:

    • Any physical transactions supplement the bank’s existing risk management activities, constitute a nominal percentage of a bank’s risk management activities, are used only to manage risk arising from otherwise permissible (customer-driven) banking activities, and are not entered into for speculative purposes; and

    • Before entering into any such physical transactions, the bank has submitted a detailed plan for the activity to the OCC and the plan has been approved.

    G. Capital Adequacy

    The Board of Directors should ensure that the bank maintains sufficient capital to support the risk exposures (e.g., market risk, credit risk, liquidity risk, operation and systems risk, etc.) that may arise from its derivatives activities. Significant changes in the size or scope of a bank’s activities should prompt an analysis of the adequacy of the amount of capital supporting those various activities by senior management and/or the Board of Directors. This analysis should be approved by the Board of Directors and be available for bank examiner review. In addition to internal reviews of capital adequacy, senior management should ensure that the bank meets all regulatory capital standards for financial derivatives activities.

    Appendix II 8 Principles and Practices for Wholesale Financial Market Transactions

    Introduction1

    These Principles and Practices for Wholesale Financial Market Transactions are the result of a joint effort by several groups that represent participants in the over-the-counter financial markets. These Principles were prepared in order to confirm the relationship between Participants and to articulate a set of best practices with respect to over-the-counter financial markets transactions between Participants.

    Representatives of the Emerging Markets Traders Association, the Foreign Exchange Committee of the Federal Reserve Bank of New York, the International Swaps and Derivatives Association, the New York Clearing House Association, the Public Securities Association and the Securities Industry Association participated in the preparation of the Principles. The preparation of the Principles was coordinated by the Federal Reserve Bank of New York.

    1. PURPOSE OF PRINCIPLES AND PRACTICES

    1.1 Applicability

    These Principles and Practices for Wholesale Financial Market Transactions (the “Principles”) are intended to provide guidance for the conduct of wholesale transactions in the over-the-counter financial markets between Participants (“Transactions”).

    “Participant” means any corporation, partnership, trust, government or other entity that engages regularly in one or more types of Transactions. The term “counterparty” as used in the Principles means a Participant that is the other party to a Transaction with a Participant.

    The Principles reflect principles and practices in the United States of America and may not reflect principles and practices in other countries.

    1.2 Nature of Principles

    The Principles confirm the arm’s-length nature of Transactions and describe the assumptions that Participants may make about each other. The Principles also articulate a set of best practices that Participants should aspire to achieve in connection with their Transactions. It is intended that the Principles (especially those contained in Section 3) will continue to evolve over time as business practices change. The Principles do not create any legally enforceable obligations, duties, rights or liabilities.

    Adherence to the Principles is strictly voluntary. A Participant may implement the Principles as it deems appropriate. Any policies or procedures implemented or other actions taken by a Participant based on the Principles should be appropriate for the size, nature and complexity of the Participant and its Transactions as well as its business activities generally.

    It should not be assumed that an entity that is within the definition of Participant necessarily adheres to the Principles. Nevertheless, because the Principles confirm the nature of the relationship between Participants, an entity that is within the definition of Participant should be aware that Participants will make certain assumptions when entering into Transactions with that entity.

    1.3 Supplementary Nature of Principles

    The Principles are intended to supplement, and are not intended to replace or modify, applicable statutes, governmental regulations, exchange, board of trade or self-regulatory organization rules and industry practices (including those embodied in applicable codes of conduct).

    2. PARTICIPANTS—FINANCIAL RESOURCES

    2.1 Financial Resources

    A Participant should maintain adequate financial resources, including capital, liquidity or other sources of support, to manage the material risks associated with its Transactions and meet its Transaction commitments.

    3. PARTICIPANTS—POLICIES AND PROCEDURES

    3.1 Policies and Procedures

    With respect to policies and procedures of the types identified in the Principles, a Participant should have policies approved by its board of directors, a committee thereof or an appropriate level of senior management. An appropriate level of senior management should approve controls and procedures to implement these policies. All policies, controls and procedures should be appropriate to the size, nature and complexity of the Participant and its Transactions, and should be reviewed as business and market circumstances change.

    3.2 Supervision and Training of Employees

    A Participant should maintain internal policies and procedures for supervising and training appropriate officers, employees and representatives of the Participant with respect to conduct related to Transactions.

    3.3 Control and Compliance

    A Participant should maintain and enforce internal control and compliance procedures designed so that its Transactions are conducted in accordance with applicable legal and regulatory requirements, internal policies and any specific requirements contained in any agreements applicable to its Transactions.

    3.4 Risk Management

    A Participant should maintain (i) policies and procedures that clearly delineate lines of responsibility for managing market, credit and other risks, (ii) adequate systems for measuring risks, including, where appropriate, systems for developing stress scenarios to measure the impact of market conditions that might reduce liquidity or cause extraordinary changes in price or volatility, (iii) appropriately structured limits on risk taking, (iv) policies and procedures designed for comprehensive and timely risk reporting, and (v) policies and procedures for reviewing the adequacy of internal measures of credit risk, market risk and valuation.

    3.5 Independent Risk Monitoring

    A Participant should have knowledgeable individuals responsible for risk monitoring and control who are independent of the individuals that conduct the Transactions that create the risk exposure.

    3.6 Valuation

    3.6.1 Valuation of Transactions

    A Participant should maintain policies and procedures for the valuation of Transactions at intervals appropriate for the type of Transaction in question, regardless of the accounting methodology employed by the Participant. These policies and procedures should address the specific methodology used for valuation, including as appropriate the use of market or model based valuations with reserves and adjustments.

    3.6.2 Obtaining External Valuations

    If a Participant does not have the internal capability to value a Transaction and a price or market valuation of a Transaction is not publicly available or otherwise readily ascertainable, then the Participant should (i) ascertain the availability of external valuations (which may include valuations from its counterparty) prior to entering into the Transaction and (ii) obtain an external valuation of the Transaction at intervals appropriate for the type of Transaction in question.

    When a Participant requests an external valuation for a Transaction, the Participant should clearly state the desired characteristics of the requested valuation (e.g., mid-market, indicative or firm price).

    3.6.3 Evaluating External Valuations

    In assessing any external valuation received, it is essential that the Participant consider the circumstances in which the valuation was provided, including criteria such as whether the party providing the valuation is a counterparty to the Transaction, the time frame within which the valuation was provided and whether the party supplying the valuation was compensated for its services. Participants should understand that a valuation of a particular Transaction may include adjustments for, among other factors, credit spreads, cost of carry and use of capital and profit, and may not be representative of either (i) the valuation used by a counterparty for internal purposes or (ii) other market or model based valuations.

    3.6.4 Providing Valuations to Other Participants

    Entering into a Transaction does not obligate a Participant to provide valuations of that Transaction to its counterparty. However, if a Participant does provide valuations of Transactions, it should maintain policies and procedures concerning the provision of valuations. Such policies and procedures should require the Participant to clearly state the characteristics of any valuation provided (e.g., mid-market, indicative or firm price). In those markets with specific conventions regarding valuations, Participants should supply valuations using those conventions, unless otherwise agreed.

    3.7 Credit Risk

    Before entering into a Transaction involving credit exposure to a counterparty, a Participant should assess its counterparty’s ability to meet its payment obligations.

    As credit relationships depend upon the existence of a legal relationship between parties, Participants should recognize situations where special steps may be necessary to assure that Transactions are enforceable against the party on whose credit the Participant is relying, particularly when dealing through third parties such as agents, brokers or investment advisors acting for undisclosed principals.

    3.8 Legal Capacity and Authority to Transact

    Before entering into a Transaction, a Participant should take measures reasonable under the circumstances to satisfy itself that its counterparty has the legal capacity and authority to enter into the Transaction. A Participant should recognize that Transactions with governmental units and regulated counterparties (such as depository institutions, mutual funds, pension plans, trusts and insurance companies) may require additional scrutiny to establish the scope of the counterparty’s legal capacity and authority. Special scrutiny also should be given to the scope of a third party agent’s authority to act for its principal.

    4. RELATIONSHIPS BETWEEN PARTICIPANTS

    4.1 Fair Dealing and Professional Standards

    A Participant should act honestly and in good faith when marketing, entering into, executing and administering Transactions. A Participant should act in a manner designed to promote public confidence in the wholesale financial markets. In addition, a Participant should show its counterparties professional courtesy and consideration.

    4.2 Relationships with Counterparties

    4.2.1 Decision-Making Capability

    A Participant should satisfy itself that it has the capability (internally or through independent professional advice) to understand and make independent decisions about its Transactions. That capability includes the experience, knowledge and ability to analyze the tax and accounting treatment as well as the legal, credit, market and liquidity risks of each Transaction. Absent a written agreement to the contrary, a Participant should expect that its counterparty will assume that the Participant has the capability to understand and make independent decisions about its Transactions and will act accordingly.

    4.2.2 Reliance on Investment Advice

    The character and level of risk that is desirable for a particular Participant is a business judgment that is appropriately made by the Participant’s governing body or management, in accordance with any applicable statutory or regulatory constraints, based on an evaluation of the totality of its particular circumstances and objectives.

    A Participant may communicate to its counterparty economic or market information relating to Transactions and trade or hedging ideas or suggestions. All such communications (whether written or oral) should be accurate and not intentionally misleading. Absent a written agreement or an applicable law, rule or regulation that expressly imposes affirmative obligations to the contrary, a counterparty receiving such communications should assume that the Participant is acting at arm’s length for its own account and that such communications are not recommendations or investment advice on which the counterparty may rely.

    In any case where a Participant does not wish to make independent investment decisions regarding a Transaction and instead wishes to rely on a counterparty’s communications as recommendations or investment advice, the Participant should, prior to entering into a Transaction with that counterparty involving such reliance, (i) put its counterparty on notice in writing that it is relying on the counterparty, (ii) obtain the counterparty’s agreement in writing to do business on that basis, and (iii) provide the counterparty with accurate information regarding its financial objectives and the size, nature and condition of its business sufficient to provide such recommendations or investment advice. The extent of the counterparty’s obligations to provide recommendations and investment advice then will be determined by that written agreement and any applicable law, rule or regulation that imposes affirmative obligations on the counterparty. Certain laws, rules or regulations expressly provide that, in some situations, an oral agreement or the facts and circumstances of a relationship alone may give rise to an advisory or fiduciary relationship, in some cases even in the presence of a written agreement purporting to negate such a relationship. Nonetheless, to avoid misunderstandings and disputes, the steps outlined above should be followed.

    4.2.3 Transaction Information

    A Participant should ensure that it identifies and reaches agreement on all material terms and conditions of each Transaction it enters into. In some cases it may be useful for the parties to exchange a written outline of the principal terms and conditions of a Transaction prior to its execution. A Participant should either ask questions and request additional information or seek independent professional advice when it does not have a full understanding of either the risks involved in a Transaction or the fit between a Transaction and its desired risk profile. A counterparty should answer such questions and respond to such requests for additional information in good faith, and the information provided should be accurate and not intentionally misleading. A Participant should expect that, if it does not expressly ask questions or request additional information with respect to a Transaction, its counterparty will assume that the Participant understands the Transaction and has all the information it needs for its decision-making process.

    4.2.4 Other Activities of Counterparties

    A Participant should be aware that in the over-the-counter financial markets it may be customary for a counterparty to (i) take positions in instruments that are identical or economically related to a Transaction that has been or will be entered into with the Participant, or (ii) have commercial relationships with the issuer of an instrument underlying a Transaction that has been or will be entered into with the Participant.

    4.2.5 Role as Agent or Broker

    A Participant that represents itself as generally acting as a “broker” in Transactions should act only as agent for both parties or (in those markets where it is customary to do so) as riskless principal, unless it discloses clearly to all parties before executing a Transaction that it is acting in another capacity.

    A Participant that represents itself as generally acting as a principal may on occasion agree to act as an agent for a counterparty, to assist the counterparty to execute a Transaction with other Participants on a “best execution” basis or at a specified level, or to effect a Transaction directly if and when the Participant is prepared to do so at a specified level. A Participant acting as an agent should avoid misusing its knowledge of the terms on which the counterparty is prepared to execute a Transaction to take unfair advantage of the counterparty.

    A Participant should be aware that its agent may be engaging in other activities as described above in Section 4.2.4.

    4.3 Confidentiality

    A Participant expects that its involvement in a Transaction will be handled in confidence by its counterparty. Accordingly, a Participant should not, except with express permission, disclose or discuss, or request that others disclose or discuss, information relating to its counterparty’s involvement in a Transaction except to the extent required by law or required or requested by a regulatory authority.

    5. CONSIDERATIONS RELATING TO RELATIONSHIPS BETWEEN PARTICIPANTS

    5.1 Introduction

    A Participant (particularly one that is holding itself out as a dealer in a particular wholesale financial instrument) should maintain policies and procedures that identify and address circumstances that can lead to uncertainties, misunderstandings or disputes with the potential for relationship, reputational or litigation risk. A Participant should consider including in such policies and procedures provisions designed to address the particular circumstances described in this Section 5. Maintaining and complying with such policies and procedures should be regarded as steps taken by the Participant for its own protection. Accordingly, neither the maintenance nor compliance with such policies and procedures should be construed as giving rise to duties to others.

    5.2 Counterparty Decision-Making Capability

    A Participant may wish to evaluate (based upon information in its possession) its counterparty’s capability (internally or through independent professional advice) to understand and make independent decisions about the terms and conditions of its Transactions. A Participant may, without limitation, consider the following factors in evaluating a counterparty’s capability: the nature of the counterparty’s business; the financial size and condition of the counterparty; the counterparty’s prior dealings or experience in Transactions; and the nature, complexity and risks of a proposed Transaction. A Participant should be aware that if it holds itself out as a dealer for a certain type of Transaction, other Participants will assume that it has the capability to understand and make independent decisions regarding that type of Transaction.

    A Participant may wish to maintain policies and procedures for identifying (based on information in the possession of the representative of the Participant executing the Transaction on the Participant’s behalf) and addressing exceptional situations (which may pose relationship, reputational or litigation risks to the Participant) where its counterparty either (i) does not have the capability (internally or through independent professional advice) to understand and make independent decisions regarding a particular Transaction or a type of Transaction being proposed by the Participant or (ii) has the capability to understand and make independent decisions regarding a Transaction, but where (a) the amount of risk to the counterparty involved in the Transaction appears to be clearly disproportionate in relation to the size, nature and condition of the counterparty’s business or (b) the counterparty appears to assume incorrectly that it may rely on the Participant for recommendations or investment advice.

    A Participant may wish to consider taking such steps, if any, as it may deem appropriate in the circumstances to address these types of exceptional situations, including, without limitation, (i) providing or obtaining additional information to or from the counterparty, (ii) involving additional qualified personnel internally, (iii) involving additional qualified personnel of the counterparty, (iv) entering into a written agreement specifying the nature of the relationship or (v) not entering into the particular Transaction or type of Transaction with that counterparty. This list of steps to consider for exceptional situations is neither exhaustive nor mandatory because any appropriate response will be based upon the facts and circumstances of a specific situation.

    5.3 Notifying Counterparties of Nature of Relationship

    A Participant may wish to inform some or all of its own counterparties of the nature of the relationships between Participants. Such information may, without limitation, take the form of (i) communications to a counterparty that are designed to put the counterparty on notice about the Participant’s assumptions regarding the counterparty’s capability to understand and make independent decisions and non-reliance concerning Transactions with the Participant (which communications may include sending a copy of the Principles to the counterparty), or (ii) representations or disclosures to be acknowledged by a counterparty that are designed to confirm that the Participant’s assumptions regarding the counterparty’s capability to understand and make independent decisions and non-reliance concerning Transactions with the Participant are correct.

    5.4 Providing Additional Information to Counterparties

    For a Transaction in which the payment formula is particularly complex or which includes a significant leverage component, a Participant may wish to assist a counterparty in its decision-making process by providing more information (such as loss scenarios) to a counterparty than is typically provided for other types of Transactions. Where loss scenarios are part of the information voluntarily provided to a counterparty, or where loss scenarios are prepared at a counterparty’s request and the counterparty does not stipulate some or all of the assumptions to be used in making the calculations, the Participant should attempt in good faith to use assumptions that provide information that is reasonable under the circumstances.

    6. MECHANICS OF TRANSACTIONS

    6.1 When Transactions are Binding

    A Transaction should be considered final and binding when entered into in accordance with applicable market practice, whether by oral, written or electronic means.

    6.2 Confirmations

    Transactions should be confirmed as soon as possible and in accordance with applicable market practice. For most types of Transactions, a confirmation (whether sent by mail, telex, facsimile, electronic or other means) provides a necessary final safeguard against errors. All confirmations should be dispatched promptly by one or both parties and reviewed carefully by the receiving party, even when oral checks of the Transactions have been undertaken. The dispatch and checking of confirmations also should be carried out or reviewed independently from those who conduct the Transactions.

    6.3 Payment and Settlement Instructions

    A Participant should provide its counterparty with standing payment and settlement instructions, and any modifications to those standing instructions should be communicated as quickly as possible to facilitate prompt settlement of Transactions.

    6.4 Documentation

    A Participant should use, to the greatest extent practicable, standardized or master agreements or comparable arrangements that apply to multiple Transactions, in order to provide standardized terms governing Transactions and to provide for the netting or offset of credit exposures and payment obligations. A Participant should review and where appropriate modify the documentation it uses in connection with Transactions periodically in light of changes in market practice or law.

    6.5 Complaints and Settlement of Differences

    A Participant should notify its counterparty promptly of any dispute or complaint involving a Transaction in order to mitigate any damages to itself or its counterparty. A Participant should attempt to resolve promptly and fairly any such dispute or complaint. A Participant should ensure that all complaints involving Transactions are promptly and fairly investigated, wherever practicable, by employees or representatives of the Participant who were not directly involved with the disputed Transaction. Such investigations should be construed as an act of prudence to reduce the risk of loss resulting from the dispute, and not as an admission of liability by the Participant.

    In addition, upon receiving information that a complaint or dispute involving a Transaction may create market exposure, the Participant should consider all available methods to reduce potential losses from that exposure. Any such steps taken should be construed as an act of prudence and not an admission of liability by the Participant.

    7. STANDARDS FOR TRANSACTIONS

    7.1 Misuse of Market Terminology and Conventions

    Traders, brokers, and other employees or representatives of a Participant should use clear and unambiguous language when negotiating Transactions. Recognizing that each type of Transaction may have its own unique terminology, definitions and calculations, a Participant should, prior to engaging in a Transaction, familiarize itself with that type of Transaction’s terminology and conventions, and, where necessary, inform its personnel of differences in terminology, conventions and specific terms that may be particularly susceptible to misinterpretation. In addition, no Participant should abuse deliberately market procedures or conventions to obtain an unfair advantage over, or to unfairly prejudice, its counterparties.

    7.2 Manipulative Practices

    A Participant should not engage in any trading practices that constitute fraudulent, deceptive or manipulative acts or practices under applicable laws and regulations.

    7.3 Bribes and Outside Fees and Commissions

    No employee or representative of a Participant should offer or solicit explicit inducements to or from employees or representatives of other institutions in exchange for conducting business. It is recognized, however, that entertainment and gifts in reasonable amounts are offered and accepted in the ordinary course of business, and do not necessarily constitute inducements. A Participant should maintain policies and procedures that provide guidance on the provision and receipt of entertainment and gifts by staff.

    7.4 Rumors and False Information

    A Participant should not spread any rumors or misinformation that the Participant knows or believes to be false or misleading. In addition, a Participant should not disseminate any information that falsely states or implies governmental approval of any institution or Transaction.

    7.5 Money Laundering and Other Criminal Activities

    A Participant should take measures designed to satisfy itself that its Transactions are not being used to facilitate money laundering or other criminal activities.

    Appendix II 9 Report of the Committee on Interbank Netting Schemes of the Central Banks of the Group of Ten Countries

    [Excerpt]1

    Minimum standards for the design and operation of cross-border and multi-currency netting and settlement schemes

    • Netting schemes should have a well-founded legal basis under all relevant jurisdictions.

    • Netting scheme participants should have a clear understanding of the impact of the particular scheme on each of the financial risks affected by the netting process.

    • Multilateral netting systems should have clearly defined procedures for the management of credit risks and liquidity risks which specify the respective responsibilities of the netting provider and the participants. These procedures should also ensure that all parties have both the incentives and the capabilities to manage and contain each of the risks they bear and that limits are placed on the maximum level of credit exposure that can be produced by each participant.

    • Multilateral netting systems should, at a minimum, be capable of ensuring the timely completion of daily settlements in the event of an inability to settle by the participant with the largest single net-debit position.

    • Multilateral netting systems should have objective and publicly disclosed criteria for admission which permit fair and open access.

    • All netting schemes should ensure the operational reliability of technical systems and the availability of back-up facilities capable of completing daily processing requirements.

    Appendix II 10 Report on Netting Schemes Prepared by the Group of Experts on Payment Systems of the Central Banks of the Group of Ten Countries

    [Excerpt]1

    … the Payments Group believes that certain general conclusions can be drawn with respect to the allocation of credit and liquidity risks that are produced by different institutional forms of netting. Thus, assuming the legal enforceability of netting agreements, the Payments Group believes that arrangements which net outstanding financial or payment obligations can be ranked as follows, in comparison with the benchmark case, where no netting takes place:

    • (i) bilateral position netting reduces liquidity risks to counterparties, and perhaps others such as correspondent banks, relative to the case of no netting; but it leaves counterparty credit risk unchanged, or may induce increases in risk if net exposures are treated as if they were true exposures;

    • (ii) bilateral netting by novation reduces both liquidity and credit risks to counterparties, and possibly to the financial system (other things being equal), relative to the cases of no netting and bilateral position netting;

    • (iii) multilateral position netting may reduce liquidity risks relative to the cases of no netting and bilateral netting, under certain circumstances; if significant defaults occur, liquidity risks may be higher; credit risks are the same as, or may be larger than, in the case of no netting; credit risks are greater than in the case of bilateral netting by novation;

    • (iv) multilateral netting by novation and substitution has the potential to reduce liquidity risks more than any other institutional form, but this depends critically on the financial condition of any central counterparty to the netting; if the liquidity of a central counterparty is weak, the liquidity risks of this institutional form may be greater than in the case of bilateral netting by novation; the credit risks of this institutional form are generally less than in other forms that have been considered, subject again to the identity and condition of any central counterparty.

    Appendix II 11 Basle Committee Amendment of the 1988 Capital Accord

    Basle Capital Accord: Treatment of Potential Exposure for Off-Balance-Sheet Items*

    Text amending the Capital Accord

    The following text is to substitute for the section beginning on p. 27 of Annex 3 of the 1988 Capital Accord.** It recognizes the effects of netting in the calculation of the additions, expands the matrix of add-on factors, and also incorporates the language of the July 1994 amendment recognizing bilateral netting in the calculation of current exposure. Footnotes are as they would appear in the amended 1988 Capital Accord.

    Forwards, swaps, purchased options and similar derivative contracts

    The treatment of forwards, swaps, purchased options and similar derivative contracts needs special attention because banks are not exposed to credit risk for the full face value of their contracts, but only to the potential cost of replacing the cash flow (on contracts showing positive value) if the counterparty defaults. The credit equivalent amounts will depend inter alia on the maturity of the contract and on the volatility of the rates and prices underlying that type of instrument. Instruments traded on exchanges may be excluded where they are subject to daily receipt and payment of cash variation margin. Options purchased over the counter are included with the same conversion factors as other instruments.

    Despite the wide range of different instruments in the market, the theoretical basis for assessing the credit risk on all of them has been the same. It has consisted of an analysis of the behavior of matched pairs of swaps under different volatility assumptions. Interest rate contracts are defined to include single-currency interest rate swaps, basis swaps, forward rate agreements, interest rate futures, interest rate options purchased and similar instruments. Exchange rate contracts with an original maturity of 14 calendar days or less may be excluded. Gold contracts are treated the same as exchange rate contracts for the purpose of calculating credit risk except that contracts with original maturity of 14 calendar days or less are included. Precious metals other than gold receive a separate treatment and include forwards, swaps, purchased options and similar derivative contracts that are based on precious metals (e.g. silver, platinum, and palladium). Other commodities are also treated separately and include forwards, swaps, purchased options and similar derivative contracts based on energy contracts, agricultural contracts, base metals (e.g. aluminum, copper, and zinc), and any other non-precious metal commodity contracts. Equity contracts include forwards, swaps, purchased options and similar derivative contracts based on individual equities or on equity indices.

    The current exposure method

    The G-10 supervisory authorities are of the view that the best way to assess the credit risk on these items is to ask banks to calculate the current replacement cost by marking contracts to market, thus capturing the current exposure without any need for estimation, and then adding a factor (the “add-on”) to reflect the potential future exposure over the remaining life of the contract. It has been agreed that, in order to calculate the credit equivalent amount of these instruments under this current exposure method, a bank would sum:

    • the total replacement cost (obtained by “marking to market”) of all its contracts with positive value and

    • an amount for potential future credit exposure calculated on the basis of the total notional principal amount of its book, split by residual maturity as follows:

    Residual
    Maturity
    Interest
    Rate
    Exchange
    Rate and
    Gold
    EquityPrecious
    Metals
    Except Gold
    Other
    Commodities
    One year or less0.0%1.0%6.0%7.0%10.0%
    Over one year to five years0.5%5.0%8.0%7.0%12.0%
    Over five years1.5%7.5%10.0%8.0%15.0%

    Notes:

    • For contracts with multiple exchanges of principal, the factors are to be multiplied by the number of remaining payments in the contract.

    • For contracts that are structured to settle outstanding exposure following specified payment dates and where the terms are reset such that the market value of the contract is zero on these specified dates, the residual maturity would be set equal to the time until the next reset date. In the case of interest rate contracts with remaining maturities of more than one year that meet the above criteria, the add-on factor is subject to a floor of 0.5%.

    • Forwards, swaps, purchased options and similar derivative contracts not covered by any of the columns of this matrix are to be treated as “other commodities.”

    • No potential future credit exposure would be calculated for single currency floating/floating interest rate swaps; the credit exposure on these contracts would be evaluated solely on the basis of their mark-to-market value.

    Supervisors will take care to ensure that the add-ons are based on effective rather than apparent notional amounts. In the event that the stated notional amount is leveraged or enhanced by the structure of the transaction, banks must use the effective notional amount when determining potential future exposure.

    The original exposure method

    At national supervisory discretion,3 banks may also use a simpler alternative method for interest rate and foreign exchange-related contracts, whereby the potential credit exposure is estimated against each type of contract and a notional capital weight allotted, no matter what the market value of the contract might be at a particular reporting date. The original exposure method may be used until market risk-related capital requirements are implemented, at which time the original exposure method will cease to be available for banks supervised according to this Accord.4 Banks that engage in forwards, swaps, purchased options or similar derivative contracts based on equities, precious metals except gold, or other commodities are required to apply the current exposure method.

    In order to arrive at the credit equivalent amount using this original exposure method, a bank would simply apply one of the following two sets of conversion factors to the notional principal amounts of each instrument according to the nature of the instrument and its maturity:

    Maturity5Interest Rate
    Contracts
    Exchange Rate
    Contracts and Gold
    One year or less0.5%2.0%
    Over one year to two years1.0%5.0%
    (i.e. 2% + 3%)
    For each additional year1.0%3.0%

    Bilateral netting

    Careful consideration has been given to the issue of bilateral netting, i.e., weighting the net rather than the gross claims with the same counterparties arising out of the full range of forwards, swaps, options and similar derivative contracts.6 The Committee is concerned that if a liquidator of a failed counterparty has (or may have) the right to unbundle netted contracts, demanding performance on those contracts favorable to the failed counterparty and defaulting on unfavorable contracts, there is no reduction in counterparty risk.

    Accordingly, it has been agreed for capital adequacy purposes that:

    • (a) Banks may net transactions subject to novation under which any obligation between a bank and its counterparty to deliver a given currency on a given value date is automatically amalgamated with all other obligations for the same currency and value date, legally substituting one single amount for the previous gross obligations.

    • (b) Banks may also net transactions subject to any legally valid form of bilateral netting not covered in (a), including other forms of novation.

    • (c) In both cases (a) and (b), a bank will need to satisfy its national supervisor that it has:7

      • (1) a netting contract or agreement with the counterparty which creates a single legal obligation, covering all included transactions, such that the bank would have either a claim to receive or obligation to pay only the net sum of the positive and negative mark-to-market values of included individual transactions in the event a counterparty fails to perform due to any of the following: default, bankruptcy, liquidation or similar circumstances;

      • (2) written and reasoned legal opinions that, in the event of a legal challenge, the relevant courts and administrative authorities would find the bank’s exposure to be such a net amount under:

        • the law of the jurisdiction in which the counterparty is chartered and, if the foreign branch of a counterparty is involved, then also under the law of the jurisdiction in which the branch is located;

        • the law that governs the individual transactions; and

        • the law that governs any contract or agreement necessary to effect the netting.

        The national supervisor, after consultation when necessary with other relevant supervisors, must be satisfied that the netting is enforceable under the laws of each of the relevant jurisdictions;8

      • (3) procedures in place to ensure that the legal characteristics of netting arrangements are kept under review in the light of possible changes in relevant law.

    Contracts containing walkaway clauses will not be eligible for netting for the purpose of calculating capital requirements pursuant to this Accord. A walkaway clause is a provision which permits a non-defaulting counterparty to make only limited payments, or no payment at all, to the estate of a defaulter, even if the defaulter is a net creditor.

    For banks using the current exposure method, credit exposure on bilaterally netted forward transactions will be calculated as the sum of the net mark-to-market replacement cost, if positive, plus an add-on based on the notional underlying principal. The add-on for netted transactions (ANet) will equal the weighted average of the gross add-on (AGross)9 and the gross add-on adjusted by the ratio of net current replacement cost to gross current replacement cost (NGR). This is expressed through the following formula:

    where

    NGR=level of net replacement cost/level of gross replacement cost for transactions subject to legally enforceable netting agreements.10

    The scale of the gross add-ons to apply in this formula will be the same as those for non-netted transactions as set out in this Annex. The Committee will continue to review the scale of add-ons to make sure they are appropriate. For purposes of calculating potential future credit exposure to a netting counterparty for forward foreign exchange contracts and other similar contracts in which notional principal is equivalent to cash flows, notional principal is defined as the net receipts falling due on each value date in each currency. The reason for this is that offsetting contracts in the same currency maturing on the same date will have lower potential future exposure as well as lower current exposure.

    The original exposure method may also be used for transactions subject to netting agreements which meet the above legal requirements until market risk-related capital requirements are implemented. The conversion factors to be used during the transitional period when calculating the credit exposure of bilaterally netted transactions will be as follows:

    MaturityInterest Rate
    Contracts
    Exchange Rate
    Contracts
    One year or less0.35%1.5%
    Over one year to two years0.75%3.75%
    (i.e. 1.5%+ 2.25%)
    For each additional year0.75%2.25%

    These factors represent a reduction of approximately 25% from those on page 29 of the Accord.*** For purposes of calculating the credit exposure to a netting counterparty during the transitional period for forward foreign exchange contracts and other similar contracts in which notional principal is equivalent to cash flows, the credit conversion factors on page 29 of the Accord**** could be applied to the notional principal, which would be defined as the net receipts falling due on each value date in each currency. In no case could the reduced factors above be applied to net notional amounts.

    Risk weighting

    Once the bank has calculated the credit equivalent amounts, whether according to the current or the original exposure method, they are to be weighted according to the category of counterparty in the same way as in the main framework, including concessionary weighting in respect of exposures backed by eligible guarantees and collateral. In addition, since most counterparties in these markets, particularly for long-term contracts, tend to be first-class names, it has been agreed that a 50 per cent weight will be applied in respect of counterparties which would otherwise attract a 100 per cent weight.11 However, the Committee will keep a close eye on the credit quality of participants in these markets and reserves the right to raise the weights if average credit quality deteriorates or if loss experience increases.

    Appendix II 12 Basle Committee Report on Asset Transfers and Securitisation

    ASSET TRANSFERS AND SECURITISATION1

    This report reviews some aspects of asset transfers and securitisation by focusing largely on the transferor or issuer of asset-backed securities rather than on the purchaser or investor. It describes the mechanics of the securitisation process, the incentives for securitisation and the risks associated with it, and considers some of the factors that influence supervisors’ response.

    1. Introduction

    In recent years banks have been increasingly active in the process of transferring loans or other assets, whether in part or in whole and, more recently, in issuing securities backed by these assets. Transfers of loans or participation in loans are now more common in most G-10 countries. Securitisation is more complex, is therefore less common, and in some countries is not permitted by existing legal arrangements.

    Asset securitisation has become most popular in the United States, particularly with regard to mortgage loans where about 40% of the outstanding residential mortgage debt has been securitised. This process has undoubtedly been encouraged by the support of federal government agencies which provide credit enhancement to investors. However, the process is now being used for other types of loans, such as credit card receivables and other consumer loans, and substantial increases in market volume have been recorded. Outside the United States significant amounts of mortgage-backed securities have been issued in Canada and the United Kingdom and interest is growing by banks and financial institutions in other countries who wish to participate in the securitisation business (see annex).2

    Asset securitisation in its basic form consists of the pooling of a group of homogeneous loans, the sale of these assets to a special purpose company or trust, and the issue by that entity of marketable securities against the pooled assets. The payment of interest and principal on the securities is directly dependent on the cash-flows arising from the underlying pooled assets. Asset-backed securities are attractive to investors as their returns tend to be high relative to the credit risk; credit enhancement is normally provided for a portion or the whole amount of the issue. Moreover, denominations and cash-flows can be structured to meet the cash flow and other needs of particular types of investor.

    However, asset securitisation schemes are not static. Many securitisation techniques have been invented relatively recently and the pace of innovation appears to be accelerating. Some of the new models involve not only complex and sophisticated structures but also seek to enlarge the type and composition of loans suitable for pooling and securitisation. Although credit losses have been negligible so far, some of the newer techniques have not yet been fully tested in times of stress or disruption in the securities markets.

    For banks the process provides a number of benefits in respect of prudential requirements, asset and liability management, and profitability, and these provide the incentive to participate in the securitisation process. In addition non-bank financial institutions increasingly participate, as the process separates the exercise of functions normally carried out by a lending bank, thus enabling these institutions to enter the business of financial intermediation more easily.

    A number of concerns have been raised in connection with asset securitisation. The main ones are that credit risk could remain with the bank if a clean sale does not take place and the securitisation could damage the asset quality of a bank if it is a bank’s best assets that are securitised. Moreover, certain structures can lead to credit flowing directly from end-investors to end-borrowers changing and perhaps lessening the role of banks in the intermediary process.

    The impact of asset securitisation on the overall risk profile of a bank therefore demands close attention by bank supervisors in order to ensure that banks conduct this business in a prudent manner. There are also implications for banks in the similar activities of non-bank participants who can take the same risk but who may not be as adequately supervised.

    2. Mechanics of the Asset Securitisation Process

    (a) Packaging, Sale and Administration

    To initiate the securitisation process a pool of homogeneous assets such as mortgages, credit card receivables or automobile loans is created. Homogeneity is necessary to enable a cost-efficient analysis of the credit risk of the pooled assets and to achieve a common payment pattern. The originator of a securitisation scheme can be a bank or another financial institution. If a bank is the originator it may take the assets from its own loan portfolio, but the securitisation of assets that are purchased from a third party or that are non-bank assets (e.g. receivables of commercial companies) is becoming more prevalent.

    In the second step the pool is sold to a special purpose vehicle (SPV) which finances the purchase by issuing securities backed by the pool of assets and which are the sole assets of the SPV. At that stage further parties, together with a rating agency, are often involved to give advice to the originator, analyze the credit quality of the portfolio, and structure the transaction. If an underwriter participates in the scheme the securities may pass through his books before being sold to investors.

    To facilitate the securitisation process a servicer and a trustee are normally involved. The servicer—who in many instances is the originator—is responsible for the collection of interest and principal repayments deriving for the pooled assets and the remittance of these funds to the trustee. The servicer is entitled to receive a fee for these services and in addition may benefit from the temporary investment of the funds collected pending periodic onward transmission. Its servicing capacity and expertise will be reviewed by the rating agencies. The rating of the originator/servicer, along with the rating agency assessment of the quality of the underlying assets and the structure of the scheme, will affect the extent of the credit enhancement that may need to be provided or arranged, especially if the rating of the assets is lower than that desired by potential investors.

    The trustee acts on behalf of the investors. In that capacity he must have a priority interest in the assets supporting the security issue, an ability to oversee the performance of the other parties involved in the transaction including the servicer, review periodic information on the status of the pool, superintend the distribution of the cash flows to the investors and, if necessary, declare the issue in default and take the legal actions that are necessary to protect the investors’ interests.

    (b) Credit and Liquidity Enhancement

    As investors are not normally prepared to take on all the credit risks associated with a pool of loans, asset-backed securities are usually provided with credit enhancement by a third party bank or insurance company and sometimes by the originator. Often different forms of enhancement may be combined. The simplest form of enhancement would be a recourse arrangement providing the buyer of the assets with the right to receive payment from the enhancer if the obligator fails to pay when due. However, such an arrangement would be regarded as shifting the credit risk fully to the provider of the recourse and is not therefore often used.

    To determine the appropriate enhancement the estimated credit risk in the pooled assets is assessed together with its historic loss profile. Usually this results in an enhancement that covers, by a multiple of several times, the historic default rates of the underlying assets. The most common forms of such credit enhancements are: irrevocable letters of credit, third-party insurance, spread accounts, cash collateral accounts, over-collateralisation and senior-subordinated structures.

    An irrevocable letter of credit may be issued by a third party bank to cover a portion of the assets normally equal to the estimated loss profile and is often subordinated to the other enhancements.

    Non-bank insurance companies have also been active in the United Kingdom by providing a third party insurance against the first portion of the default risk.

    A spread account is a deposit typically built up from the spread between the interest paid on the pooled assets and the lower interest paid on the securities issued. The servicer, instead of passing the spread back to the originator, passes on all funds collected to the trustee where the spread is accumulated up to the level required for the credit enhancement. After having reached this level all future spread earning can be passed back to the originator. To provide for early losses the originator normally has to deposit funds in the spread account in advance. The account is used to cover any losses occurring on the pooled assets, and any balance left over in the spread account when the securities are redeemed reverts to the originator.

    A cash collateral account is a deposit equal to the necessary credit enhancement which is held for the benefit of the holders of the securities. The account will be drawn down if and when losses occur. Cash advances are made to this cash account by the originator or a third party lender.

    Over-collateralisation means that the value of the underlying assets in the pool exceeds the amount of the securities issued. In such schemes the excess collateral must be maintained at a level sufficient to provide the agreed amount of credit enhancement. If the value declines below that level the enhancer must fill the gap with new collateral.

    Where credit enhancement is provided by a senior-subordinated structure at least two classes of securities are issued. The senior tranche has a prior claim on the cash flows from the underlying assets so that all losses will accrue first to the junior securities up to the amount of this particular class. If for example an issue consists of 90% senior and 10% junior securities the holders of the junior securities will carry all of the losses up to 10% of the total assets in the scheme.

    At first glance all these forms of credit enhancement appear to support only a portion of the total portfolio but in reality they consist of highly condensed credit risk. Normally, the credit enhancements, which as noted above are often used in combination with one another, will effectively cover several multiples of expected losses in the total portfolio and the provider is therefore in the same position as if he had owned all the assets. Where there are several enhancements the losses will be shared among them in a predetermined order. These factors need to be taken into account when applying capital requirements to the credit enhancers themselves (see section 5(c)).

    Another enhancement technique that may be used for the issue of asset-backed securities is liquidity support. It is particularly common for asset-backed commercial paper programmes. These issues include in the pool of underlying assets different types of receivables. However, the maturity of the receivables usually does not match that of the commercial paper, which therefore has to be rolled over or replaced by new issues.

    To cover the risk that the issuer cannot renew the paper as it falls due the liquidity enhancer agrees to provide the funds required. Although formally the liquidity enhancer is not guaranteeing the securities but is providing a short-term loan facility to the issuer, he effectively takes on the residual risk beyond that taken by the credit enhancement of the underlying receivables, which are the sole assets of the issuing special purpose vehicle. Therefore, whether the liquidity support can be regarded solely as a pure liquidity line depends on any enhancement being subordinated to the liquidity line in the event of liquidation.

    3. Incentives for Asset Securitisation

    The main benefit from asset securitisation is that it enables banks to pass the risks of lending on to other parties, thus freeing capital resources to back new lending which would otherwise be beyond their capacity. The funding and liquidity benefits of the securitisation process derive from the conversion of illiquid assets into liquid funds available for additional lending. Because of the credit enhancements, the rating of asset-backed securities is often higher than that of the originator who is therefore able to tap funding sources not normally accessible to him.

    Asset securitisation also helps banks in their asset and liability management. Interest rate risk can be reduced by passing it on to the investors. A bank wishing to extend its lending but not having funds of adequate maturity can avoid a security mismatch by securitising the new loans. Securitisation offers a bank which is heavily exposed to a particular region or economic sector an ability to transfer part of its loan portfolio and also to purchase with the proceeds other types of ABS thus achieving a more diversified loan portfolio.

    Banks engaging in one or more of the securitisation roles, such as lender, servicer, trustee, or enhancer, can increase and diversify their sources of fee and interest income. By transferring assets banks can continue their existing types of lending or invest the proceeds in other lines of business and avoid concentration in a single type of credit risk.

    Asset securitisation can also have important benefits for borrowers. Since such securitisation generally helps to improve the liquidity of credit markets, it can increase the availability of credit to borrowers and can allow borrowers to obtain funds at a lower cost.

    4. Implications of Asset Securitisation

    (a) Risks for Banking Organisations

    The securitisation process, if not carried out prudentially, can leave risks with the originating bank without allocating capital to back them. While all banking activity entails operational and legal risks, these may be greater the more complex the activity. But the main risk a bank may face in a securitisation scheme arises if a true sale has not been achieved and the selling bank is forced to recognise some or all of the losses if the assets subsequently cease to perform. Funding risks and constraints on liquidity may also arise if assets designed to be securitised have been originated, but because of disturbances in the market the securities cannot be placed. There is also at least a potential conflict of interest if a bank originates, sells, services, and underwrites the same issue of securities.

    A bank that has originated and transferred assets effectively may nonetheless be exposed to moral pressure to repurchase the securities if the assets cease to perform. The complexity of securitisation schemes could contribute to such pressure. After having completed the securitisation transaction the seller does not in general disappear but exercises other functions in the process. These functions and the fact that the investors are well aware of the identity of the provider of the assets backing the securities may give rise to links between seller and investor that could, at least morally, cause the seller to be under pressure to protect its reputation and to support the securitisation scheme.

    The risks for banks acting as a servicer are principally operational and are comparable to those of an agent bank for a syndicated loan. However, the number of loans in the portfolio and the different parties involved in a securitisation scheme means that there are higher risks of malfunction for which the servicer might also become liable. Thus, servicers need to engage sophisticated personnel, equipment and technology to process these transactions in order to minimise operational risk.

    It is sometimes contended that banks in seeking a good market reception for their securitised assets may tend to sell their best quality assets and thereby increase the average risk in their remaining portfolio. Investor and rating agency demand for high quality assets could encourage the sale of an institution’s better quality assets. Moreover, an ongoing securitisation program needs a growing loan portfolio and this could force a bank to lower its credit standards to generate the necessary volume of loans. In the end a capital requirement that assumes a well diversified loan portfolio of a given quality might prove to be too low if the average asset quality has deteriorated. Such arguments are not easy to support with empirical evidence. Banks that have securitised large amounts of assets do not exhibit signs of lower asset quality. It should also be noted that banks which constantly securitise assets are necessarily interested in maintaining the quality of their loan portfolio. Any asset quality deterioration would affect their reputation and their rating and indeed the capital adequacy requirement imposed by their supervisors.

    The securitisation of revolving credits such as credit-card receivables is a particularly complicated example which involves the issue of securities of a fixed amount and term against assets of a fluctuating amount and indefinite maturity. A portfolio of credit-card receivables fluctuates daily as the individual accounts increase and decrease, and because of the different repayment patterns by credit-card users (e.g. by fast and slow payers). It is also likely that as a scheme matures the security holders will be repaid out of a fixed share of gross flow on the accounts in the pool, so deriving repayment principally from fast payers who resolve their debt quickly. Such schemes need a structure adequate to ensure control of the amortisation process and to ensure appropriate risk-sharing during amortisation by the security-holders.

    (b) Implications for Financial Systems

    The possible effects of securitisation on financial systems may well differ between countries because of differences in the structure of financial systems or because of differences in the way in which monetary policy is executed. In addition, the effects will vary depending upon the stage of development of securitisation in a particular country. The net effect maybe potentially beneficial or harmful, but a number of concerns are highlighted below that may in certain circumstances more than offset the benefits. Several of these concerns are not principally supervisory in nature, but they are referred to here because they may influence monetary authorities’ policy on the development of securitisation markets.

    While asset transfers and securitisations can improve the efficiency of the financial system and increase credit availability by offering borrowers direct access to end-investors, the process may on the other hand lead to some diminution of the importance of banks in the financial intermediation process. In the sense that securitisation could reduce the proportion of financial assets and liabilities held by banks, this could render more difficult the execution of monetary policy in countries where central banks operate through variable minimum reserve requirements. A decline in the importance of banks could also weaken the relationship between lenders and borrowers, particularly in countries where banks are predominant in the economy.

    One of the benefits of securitisation, namely the transformation of illiquid loans into liquid securities, may lead to an increase in the volatility of asset values, although credit enhancements could lessen this effect. Moreover, the volatility could be enhanced by events extraneous to variations in the credit standing of the borrower. A preponderance of assets with readily ascertainable market values could even, in certain circumstances, promote liquidation as opposed to going-concern concept for valuing banks.

    Moreover, the securitisation process might lead to some pressure on the profitability of banks if non-bank financial institutions exempt from capital requirements were to gain a competitive advantage in investment in securitised assets.

    Although securitisation can have the advantage of enabling lending to take place beyond the constraints of the capital base of the banking system, the process could lead to a decline in the total capital employed in the banking system, thereby increasing the financial fragility of the financial system as a whole, both nationally and internationally. With a substantial capital base, credit losses can be absorbed by the banking system. But the smaller that capital base is, the more the losses must be shared by others. This concern applies, not necessarily in all countries, but especially in those countries where banks have traditionally been the dominant financial intermediaries.

    5. Supervisory Conditions

    Supervisors of individual institutions need to assess carefully whether the risk associated with a particular securitisation scheme has been effectively transferred to the investor or the credit enhancer, in full or in part, and satisfy themselves that the scheme is managed in a prudent manner so that the operational risks are kept to an acceptable level.

    (a) The Concept of a True Sale

    As a first step, supervisors need to assess whether or not a true sale of the assets, covering both the legal and, to the extent practical, the moral aspects, has been achieved. Where a true sale has not been achieved, capital support clearly continues to be required.

    A bank selling its assets to an originator of a securitisation scheme or originating a scheme by pooling its own assets or assets purchased from a third party could be presumed not to have executed a true sale if there is, inter alia, any obligation:

    • to repurchase or exchange any of the assets;

    • for any kinds of legal recourse through which any risk of loss from the assets sold could be retained or put back to the selling bank;

    • to any party for the payment of principal or interest on the assets sold (other than those arising as services).

    In any of these three cases the assets normally should remain as a claim on the capital of the bank.

    There would also be doubts whether a true sale of own or third party assets has been accomplished if the selling bank has ownership or exercises any equity or management control for the benefit of the bank over the special purpose vehicle that owns the pooled assets and issues the securities, or is required to consolidate the SPV as a subsidiary in its financial statements. A further indication that there may be strong links between the selling bank and the scheme is the inclusion of the name of the selling bank in the name of the vehicle.

    Furthermore, any credit enhancement (and possibly some liquidity enhancements) provided by the selling bank may be indicators that the bank has accepted a liability on recourse and therefore no true sale has been achieved. This would also include the retention of any subordinated class of securitised assets.

    There might be some exceptions. In some countries a spread account could be regarded as not being provided by the originator but by the scheme itself. Alternatively, initial payment into such an account by the originating bank could be reasonable, if the initial payment was deducted from capital. Liquidity support provided by the seller together with a significant credit enhancement by a third party, subordinated to the seller, could be regarded as a credit line. In these cases the enhancements could be regarded as not obstructing a true sale. No capital support for credit risk would therefore be needed, but capital support would continue to be required in those cases where risk remains with the bank.

    (b) Administration of Securitisation Schemes

    A bank which is involved in the administration of a securitisation scheme merely as a servicer or trustee may nonetheless be exposed to some form of moral obligation to offer recourse. The element of moral hazard may be greater if the servicer is also the originator. Therefore, in order to avoid a capital charge as a result of its administrative responsibilities, the bank generally needs to ensure that any offering circular contains a highly visible, unequivocal statement that it does not stand behind the issue or the vehicle and will not make good on any losses in the portfolio. For servicing the scheme the bank may of course receive a benefit from the transaction but this ought clearly to be seen as a fee for services provided and not as a reward for incurring risk of ownership.

    A bank may be closely connected to the pool and become exposed to credit risks by virtue of its administrative duties. Indications of the existence of such a commitment are, as already mentioned, a requirement to consolidate the special purpose vehicle or the inclusion of its name in the name of the vehicle.

    Other indications of possible credit support are:

    • an obligation to provide support to the vehicle or the scheme, for example, by covering losses of the issue;

    • an obligation to remit funds to the buyer before they are received from the obligor, or to cover cash shortfalls arising from delayed payments or non-performance of assets being administered unless these are solely tools to facilitate the timing of cash flows.

    In all these cases there must be a strong presumption that the bank is exposed to credit risk in some form and such risk deserves to be supported by the holding of appropriate capital.

    (c) Credit Enhancement or Liquidity Support by a Third Party Bank

    Credit enhancement for a securitisation scheme provided by a third party bank is comparable to an off-balance-sheet exposure and is generally treated as a direct credit substitute. One supervisory response might be for the whole amount of the pooled assets to be taken into account and risk weighted, particularly if the bank’s enhancement is supporting the first losses that arise or if the amount of loss covered is significant by reference to historical loss experience. An alternative approach would be for the enhancement to be deducted from the providing bank’s capital.

    Liquidity support given in cases where there is no significant third party credit enhancement, and the liquidity support is in fact providing credit enhancement to the scheme, ought to be regarded as effectively a guarantee of the securities and be treated in a way similar to a credit enhancement given by a third party bank. Pure liquidity support given in cases where there are separate arrangements for significant credit enhancement can generally be treated solely as a liquidity facility and as a commitment for capital adequacy purposes.

    Appendix II 13 The London Code of Conduct for Principals and Broking Firms in the Wholesale Markets

    I. INTRODUCTION1

    Aims

    1. The London financial markets have a long-established reputation for their high degree of professionalism and the maintenance of the highest standards of business conduct. All those operating in these markets share a common interest in their health and in maintaining the established exacting standards.

    2. The Code is applicable to most wholesale market dealings which are not regulated by the rules of a recognized investment exchange. These typically form part of ‘treasury’ operations and are undertaken in large amounts. A full list of the products covered and the appropriate size criteria are shown in the box opposite.2

    3. The Bank of England (the Bank) wishes to sustain the efficient functioning of the London wholesale markets in which these products are traded and to avoid over-burdensome regulation; and believes that this Code is consistent with these objectives.

    4. The Code has been developed in close consultation with market practitioners and will continue to be kept under regular review. A fuller description of the Bank’s regulatory arrangements covering the wholesale markets, of which this Code is an integral part, is set out in the ‘Grey Paper’ (The regulation of the wholesale markets in sterling, foreign exchange and bullion) available from the Wholesale Markets Supervision Division of the Bank of England.

    5. The Code sets out the general standards and controls which the management and individuals at broking firms (including electronic broking firms) are ‘core principals’ (banks, building societies plus financial institutions authorised under the Financial Services Act 1986) should adopt when transacting business in the relevant financial products. Furthermore, the Chartered Institute of Public Finance and Accountancy and the Association of Corporate Treasurers commend the Code to their members, which also deal as principal in these markets, as best practice, to which they, too, should adhere.

    PRODUCTS COVERED BY THE BANK’S WHOLESALE MARKETS ARRANGEMENTS

    • A: Cash Market Products

      • Sterling wholesale deposits.

      • Foreign currency wholesale deposits.

      • Gold and silver bullion wholesale deposits.

      • Spot and forward foreign exchange.

      • Spot and forward gold and silver bullion.

    • B: Instruments which are defined as investments in the Financial Services Act but which are outside the scope of the Investment Services Directive:

      • 6. Over the counter (OTC) options (including warrants) or futures contracts on gold or silver.

    • C: Instruments which are defined as investments in the Financial Services Act and are within the scope of the Investment Services Directive:

      • 7. Certificates of deposit (CDs), or other debt instruments, issued by institutions authorised under the Banking Act 1987, European authorised institutions, and by UK building societies, with an original maturity of not more than 5 years. (This class of instrument is included in the Financial Services Act under the generic term ‘debenture’).

      • 8. Bank Bills (or bankers’ acceptances).*

      • 9. Other debentures with an original maturity of not more than 1 year (including non-London CDs and commercial paper).

      • 10. Medium-term notes issued under the Banking Act 1987 (Exempt Transactions) (Amendment) Regulations.

      • 11. UK local authority debt (bills, bonds, loan stock or other instruments) with an original maturity of not more than 5 years.

      • 12. Other public sector debt with an original maturity of not more than 1 year (e.g. Treasury bills but not gilt-edged securities).

      • 13. Any certificate (or other instrument) representing the securities covered in items 7-12; or rights to and interests in, these instruments.

      • 14. OTC options (including warrants) or futures contracts on any currency (including sterling); interest rate; or items 7–13 above.

      • 15. Interest rate and currency swaps, regardless of their original maturity; forward rate agreements, or any other ‘contracts for differences’ involving arrangements to profit (or avoid loss) by reference to movements in the value of any of the instruments in 7–13 above; or the value of any currency; or in the interest on loans in any currency.

      • 16. Sale and repurchase agreements (‘repos’), sale and buybacks and stock borrowing and lending involving debentures, loan stock or other debt instruments, including gilts, of whatever original maturity where the repurchase or repayment will take place within twelve months.

    Note 1.Instruments subject to the rules of a recognised investment exchange are not covered.
    Note 2.Instruments denominated in foreign currencies, as well as in sterling are covered.
    Note 3.Transactions by listed institutions may come within the Bank’s supervisory framework even if one of the other parties to the transaction is operating abroad.
    Note 4.The regulation of the deposit-taking under the Banking Act 1987 is not affected in any way.
    Note 5.The Government made clear in January 1988 that ordinary forward foreign exchange (and bullion) transactions fall outside the Financial Services Act; these nevertheless fall within the scope of the Bank’s arrangements.
    Note 6.Wholesale transactions between core principals in items 1 and 8 are not usually less than £100,000. For items 2 and 4, the usual minimum is £500,000 (or currency equivalent). For bullion (items 3 and 5), the relevant amounts are 2,000 ounces for gold and 50,000 ounces for silver.
    Note 7.For items 7, 9–13, and 16, the minimum size of wholesale transactions is £100,000 (or the equivalent in foreign currency). For swaps, options, futures, forward rate agreements (FRAs) and other ‘contracts for differences’ (items 6, 14 and 15) the minimum underlying value is £500,000 (or the equivalent in foreign currency).

    With effect from 1 January 1996, following amendment to the Financial Services Act.

    Distribution

    6. It is the responsibility of broking firms/core principals to seek to establish whether their UK based clients/counterparties have a copy of the Code. If they do not, they should send them one or advise them to contact the Bank direct. Where relevant, local authorities plus other institutions and companies in the UK are encouraged to adopt a similar approach.

    7. The Bank will seek to make as many as possible overseas based firms aware that their wholesale market deals in the London market are undertaken in accordance with the London Code. If broking firms or core principals receive any questions from overseas based firms about their wholesale market deals they should, where appropriate, make them aware of the Code’s existence; and that copies can be obtained from the Bank. Non-core principals are encouraged to adopt a similar approach.

    Compliance and Complaints

    8. Compliance with the Code is necessary to ensure that the highest standards of integrity and fair dealing continue to be observed throughout these markets. Breaches by those institutions which they supervise will be viewed most seriously by the Bank and by the Building Societies Commission; any such breaches may be reflected in their assessment of the fitness and propriety of these institutions. In addition, the Securities and Investments Board and the UK Self-Regulating Organisations expect those core principals which they supervise to abide by the code when dealing in the wholesale markets.

    9. If any principal (core or non-core) or broking firm believes that an institution supervised by the Bank has breached either the letter or the spirit of the Code in respect of any wholesale market transaction in which it is involved, it is encouraged—whether or not it is itself supervised by the Bank—to seek to settle this matter amicably with the other party. If this is not possible, the institution which is subject to the complaint should make the complainant aware that it can bring the matter to the attention of the Head of Wholesale Markets Supervision Division of the Bank of England. All such complaints will be investigated by the Bank. As a general rule the Bank will seek evidence from all parties named in the complaint and will wish to discuss this in detail with management of the institution subject to the complaint.

    10. Where a breach of the Code by a bank or other firm listed by the Bank under Section 43 of the Financial Services Act (FSA)—a ‘listed institution’—is established, and depending on how serious it is, the Bank may publicly reprimand individuals and/or the firms involved. It may also restrict a listed institution’s activities or, if the breach is sufficiently serious to cast doubt on the competence of the firm or on its integrity, suspend or remove the offending firm from the list. The Bank will seek to promulgate its decision as widely as it considers appropriate; in so doing the Bank will wish to consider the possible implications of making its findings known to others.

    11. Since the compensation fund arrangements established under the FSA do not apply to any exempt business undertaken by listed institutions, if any breaches of the Code are found to have occurred, the offending institution will be expected to consider making appropriate redress to any damaged party or parties, bearing in mind any legal implications of so doing.

    Arbitration

    12. In order to help resolve differences the Bank is willing, if asked, to arbitrate in disputes between firms it supervises. These arrangements are set out in more detail in paragraph 120.

    II. GENERAL STANDARDS

    Core principals and broking firms—and their employees—should at all times abide by the spirit as well as the letter of the Code when undertaking, arranging or advising on transactions in the wholesale markets.

    Managers of core principals and broking firms must ensure that the obligations imposed on them and their staff by the general law are observed. Management and staff should also be mindful of any relevant rules and codes of practice of other regulatory bodies.

    Responsibilities

    • Of the principal/broker

    13. All firms (core principals and brokers) should ensure that they and, to the best of their ability, all other parties act in a manner consistent with the Code so as to maintain the highest reputation for the wholesale markets in London.

    14. Core principals which conduct non-investment business (see the box on page 3)1 with private individuals should have internal procedures which set out whether these individuals will be treated as retail customers or as wholesale market participants under the arrangements set out in this Code. The procedures set out in Part IV of this Code may not be relevant, directly, to such business.

    15. It is essential that all relevant staff are made familiar with the Code and conduct themselves at all times in a thoroughly professional manner. In particular they must conduct transactions in a way that is consistent with the procedures set out in Part IV of this Code.

    16. All firms will be held responsible for the actions of their staff. They must:

    • — ensure that any individual who commits the firm to a transaction has the necessary authority to do so.

    • — ensure that employees are adequately trained in the practices of the markets in which they deal/broke; and are aware of their own, and their firm’s, responsibilities. Inexperienced dealers should not rely on a broker, for instance, to fill gaps in their training or experience; to do so is clearly not the broker’s responsibility.

    • — ensure staff are made aware of and comply with any other relevant guidance that may from time to time be issued by the Bank.

    • — ensure that employees comply with any other regulatory requirements that may be applicable or relevant to a firm’s activities in the wholesale markets.

    17. When establishing a relationship with a new counterparty or client, firms must take steps to make them aware of the precise nature of firms’ liability for business to be conducted, including any limitations on that liability and the capacity in which they act. In particular, broking firms should explain to a new client the limited role of brokers (see paragraphs 29 and 30 below).

    18. All firms should identify any potential or actual conflicts of interest that might arise when undertaking wholesale market transactions and take measures either to eliminate these conflicts or control them such as to ensure the fair treatment of counterparties.

    19. All firms should know their counterparty. For principals this is essential where the nature of the business undertaken requires the assessment of creditworthiness. Before dealing with another principal for the first time in any product covered by this Code, core principals should ensure that appropriate steps (see Part III of this Code) are taken.

    20. As part of the ‘know your counterparty’ process firms must take all necessary steps to prevent their transactions in the wholesale markets being used to facilitate money laundering. To this end firms should be familiar with the Guidance Notes published in 1995.1 These make clear the very limited responsibilities name passing brokers have in this area; in particular banks (and others that use brokers) should not seek to rely on brokers to undertake anything other than identity and location checks on their behalf.

    21. As a general rule core principals will assume that their counterparties have the capability to make independent decisions and to act accordingly; it is for each counterparty to decide if it needs to seek independent advice. If a non-core principal wishes to retain a core principal as its financial adviser it is strongly encouraged to do so in writing, setting forth the exact nature and extent of the reliance it will place upon the core principal. All principals should accept responsibility for entering into wholesale market transactions and any subsequent losses they might incur. They should assess for themselves the merits and risks of dealing in these markets. Non-core principals must recognize that it is possible for core principals to take proprietary positions which might be similar or opposite to their own.

    22. It is good practice for principals, subject to their own legal advice, to alert counterparties to any legal or tax uncertainties which they know are relevant to a proposed relationship or transaction, in order that the counterparty may seek its own advice if it so wishes.

    23. Management of broking firms should advise their employees of the need to ensure that their behavior could not at any time be construed as having misled counterparties about the limited role of brokers (see paragraphs 29 and 30 below); failure to be vigilant in this area will adversely affect the reputation of the broking firm itself.

    Of the employee

    24. When entering into or arranging individual deals, dealers and brokers must ensure that at all times great care is taken not to misrepresent in any way the nature of any transaction. Dealers and brokers must ensure that:

    • — the identity of the firm for which they are acting and its role is clear to their counterparties/clients to avoid any risk of confusion. This is particularly important, for instance, where an individual dealer acts for more than one company, or in more than one capacity. If so, he must make absolutely clear, at the outset of any deal, on behalf of which company or in which capacity he is acting.

    • — it is clearly understood in which products they are proposing to deal.

    • — any claims or acknowledgements about, or relevant to, a particular transaction being considered should, as far as the individual dealer or broker is aware, be fair and not misleading.

    • — facts believed to be material to completing a specific transaction are disclosed before the deal is done, except where such disclosure would reveal confidential information about the activities of another firm. Unless specifically asked for more information, or clarification, a dealer at a core principal will assume his counterparty has all the necessary information for this decision making process when entering into a wholesale market transaction.

    25. When a deal is being arranged through a broker, the broker should act in a way which does not unfairly favour one client, amongst those involved, over another, irrespective of what brokerage arrangements exist between them and the broking firm.

    Clarity of role

    • Role of principals

    26. The role of firms acting as principal is to deal for their own account. All principals have the responsibility for assessing the creditworthiness of their counterparties or potential counterparties whether dealing direct or through a broking firm. It is for each principal to decide whether or not to seek independent professional advice to assist in this process.

    27. It is also for the principal to decide what credence, if any, is given to any information or comment provided by a broker to a dealer. Where such information or comment might be interpreted as being relevant to a particular counterparty or potential counterparty, this does not alter the fact that the responsibility for assessing the creditworthiness of a counterparty, whether or not it is supervised, rests with the principal alone.

    28. Some firms may act as agent for connected or other companies as well as, or instead of, dealing for their own account. If so, such agents should:

    • — always make absolutely clear to all concerned the capacity in which they are acting (e.g. if they also act as principal or broker).

    • — declare at an early stage of negotiations the party for whom they are acting. It may be considered desirable to set out this relationship formally in writing for future reference.

    • — ensure that all confirmations make clear when a deal is done on an agency basis.

    • — when acting as agent for an unregulated principal, make clear at an early stage this qualification to potential counterparties; and include this on confirmations.

    • Role of brokers

    29. Typically the role of the specialist wholesale market broking firms in London supervised as such by the Bank is to act as arrangers of deals.1

    They:

    • — bring together counterparties on mutually acceptable terms and pass names to facilitate the conclusion of a transaction.

    • — receive payment for this service in the form of brokerage (except where a prior explicit agreement between the management of all parties to a deal provides otherwise).

    • — are not permitted, even fleetingly, to act as principal in a deal (even on a ‘matched principal’ basis), or to act in any discretionary fund management capacity.1

    30. It is accepted that, in providing the service specified in the previous paragraph, individual brokers may be called upon to give advice or express opinions, usually in response to requests from individual dealers. While brokers should be mindful of the need not to reveal confidential information about the market activities of individual clients, there is no restriction on brokers passing, or commenting, on general information which is in the public domain. Equally, there is no responsibility upon a broker to volunteer general information of this type. Where information is sought or volunteered individual brokers should exercise particular care. For instance, brokers do not have sufficient information to be qualified to advise principals on the creditworthiness of specific counterparties and to do so is not their role.

    III. CONTROLS

    It is essential that Management have in place, and review regularly, appropriate control procedures which their dealing and other relevant staff must follow.

    Know your counterparty

    It is necessary for a variety of reasons, including firms’ own risk control and the need to meet their legal obligations (e.g. on money laundering) for firms to undertake basic ‘know their counterparty’ checks before dealing in any products covered by this Code.

    Before agreeing to establish a dealing relationship in any of these wholesale market products, core principals should be mindful of any reputational risks which might arise as a result, and whether these risks might be greater when undertaking such transactions with non-core principals. In the absence of firm evidence to the contrary, non-core principals should be regarded as end-users (i.e. ‘customers’) of the wholesale markets.

    31. In order to minimize the risks which they face it is desirable for core principals to have in place a clearly articulated approval process for their dealers and salespersons to follow before dealing for the first time in any wholesale market product with counterparties. This process, which should be appropriately monitored by management, should apply both when granting an initial dealing line for a product, and subsequently if changing or extending it to other wholesale products. Such a process might include the following considerations, which will need to be tailored to the type of transaction being considered.

    • With all counterparties

    • — What information is available to the core principal on the legal capacity of the counterparty to undertake such transactions? Is this information sufficient to make an informed decision on the legal risks it might face if it undertakes such business with the counterparty?

    • With customers

    • — Who initiated the request for the product relationship? Might this decision have been influenced by any product advice given by the core principal?

    • — If advice is given was this subject to a written agreement between the parties; if not, should it be? Are both parties clear what reliance the customer is placing upon that advice?

    • — What, if any, are the legal responsibilities the core principal might owe to the customer to whom advice is given in subsequently undertaking transactions in that product? For instance, management might ask itself if it is being asked to advise on the customer’s whole portfolio—which might put it in a different legal position than if it were advising on only part of the portfolio.

    • — Are there potential conflicts between the firm’s interests and those of the potential customer? If there are how should they be managed; and does the customer need to be alerted?

    • — Have appropriate legal agreements between the core principal and the customer been enacted? Do they make clear the respective responsibilities of both parties for any losses? Do they make clear which party is responsible for decisions to close-out trades undertaken?

    32. Procedures should be in place to ensure that the information available to banks and other core principals, upon which they will base their judgement on whether or not to open/extend a dealing relationship with a particular customer, is carefully assessed on a broad product by product basis.

    33. Once a customer dealing relationship has been established in one, or more, wholesale market product(s) it is strongly recommended that management at both parties periodically review it, against the above criteria. It is also in their own interest for core principals to review periodically the totality of their business relationship with each customer against the same criteria.

    • Additional arrangements for small investors

    The Bank believes that it is in the interest of banks and other listed institutions for management to consider most carefully whether to grant or extend dealing facilities in OTC wholesale market products to ‘small investors’ (i.e. individuals or small business investors as defined under SFA rules).

    34. The expectation at the time the FSA was introduced was that individuals (or other small investors) would not normally be dealing in the wholesale OTC markets, which are primarily for core principals and other professionals such as large corporates, that regularly use the markets and which should have professionally trained staff able to undertake such transactions on their behalf.

    35. It is more likely, therefore, that small investors will ask for advice on the particular product being considered (for instance in terms of its risk profile, how this might differ from exchange traded instruments with which they might be more familiar, or how to value its worth over time, etc). It is the Bank’s view (shared by the SIB) that where this is so they should not automatically be granted a new or extended dealing line for this product. If the product being considered is a derivative and/or leveraged, the Bank believes that it is in the interest of banks and other listed institutions to have in place a written agreement, which makes clear which products are concerned and the extent to which any reliance can be placed by the small investor on the advice given.

    36. Where an FSA exempt product is involved (items 6–16 in the box on page 3)1 small investors should also be advised that by seeking to conduct such business with a s43 listed institution they would not have the protection of the FSA. The provisions set out in paragraph 21 above would apply.

    37. The Bank believes it prudent for core principals to maintain, as accurately as they can, records of conversations—both internal or with the investor—material to their relationship. Where these are in written form, records must be kept in line with statutory requirements. Where tapes are the only record of specific transactions, management should consider very carefully whether some or all of these should be retained for a similar length of time to written records.

    Dealing mandates

    38. There has been growing interest in the use of dealing mandates as a means of clarifying the extent of a relationship between core principals and their customers, and their respective responsibilities. That in turn could help reduce the scope for errors. In the Bank’s view it is appropriate for core principals to consider the merits of establishing dealing mandates to govern their relationship with non-core principals, but it is unlikely that mandates would be necessary between core principals. When deciding whether to initiate a mandate it is important that proper consideration is given by both parties to the manner in which the mandate is to be structured and subsequently administered.

    39. It is good practice for both parries to agree what the mandate should and should not cover. To aid this process associations like the ACT and BBA may be able to guide their members on common practice. Where a mandate has been initiated, both parties should review it periodically; as a general rule, the onus is on the counterparty to notify the core principal promptly of any change necessary to an existing mandate.

    40. While they can have a useful role in improving internal controls dealing mandates should not be used as a vehicle to pass all responsibility to another counterparty. They should not, therefore, weaken the standard set out in paragraph 16—that all firms will be held responsible for the actions of their staff. Firms must, in particular, ensure that any individual who commits the firm to a transaction has the necessary authority to do so, and is aware of the term of any mandate that has been agreed.

    Confidentiality

    41. Confidentiality is essential for the preservation of a reputable and efficient market place. Principals and brokers share equal responsibility for maintaining confidentiality. Principals or brokers should not, without explicit permission, disclose or discuss, or apply pressure on others to disclose or discuss, any information relating to specific deals which have been transacted, or are in the process of being arranged, except to or with the parties directly involved (and, if necessary, their advisers) or where this is required by law or to comply with the requirements of a supervisory body.

    42. Where confidential or market sensitive information is routinely shared by a London based firm with other branches/subsidiaries within its group it is for management to review periodically if this is appropriate. Where it is, the Bank believes that London management should be responsible and accountable for how such information is subsequently controlled—in particular they should make clear that such information should at all times continue to be treated as being subject to the confidentiality provisions of the Code. It is a responsibility of management to ensure that all relevant personnel are aware of, and observe, this fundamental principle.

    43. Care should be taken over the use of open loudspeakers in both brokers’ offices and principals’ dealing rooms to ensure that they do not lead to breaches of confidentiality.

    44. Situations arise where sales/marketing staff from core principals visit the offices of their customers; during such visits the customer may wish to arrange a transaction via the sales/marketing representative. Subject to proper controls this is perfectly acceptable. However, individual dealers or brokers should not visit each others’ dealing rooms except with the express permission of the management of both parties. In particular a principal’s dealer should not deal from within the offices of a broker or another principal. Brokers should never conduct business from outside their own offices. The only exception to these general rules might be when it is necessary for two unconnected institutions to share the same facilities as part of their agreed contingency arrangements. In such circumstances management should ensure appropriate arrangements are in place to protect counterparty confidentiality.

    45. A principal should not place an order with a broker with the intention of ascertaining the name of a counterparty in order to make direct contact to conclude the deal; neither should direct contact be made to increase the amount of a completed trade arranged through a broker.

    Location of back office functions

    46. There is a growing trend towards locating front and back office functions in physically separate locations; indeed a number of the branches of international banks in London have relocated and consolidated their back office functions in their home country. Others have back offices outside London. The Bank’s view is that there should be no objection to banks consolidating back offices in a single location, even if that were overseas—provided that there are individuals in London with whom any deal or settlement queries can be resolved quickly.

    47. At the same time the banking supervisors have reviewed whether it is still necessary in all cases, on control grounds, to maintain a physical segregation of back and front office staff within banks. They have concluded that whilst in most cases physical segregation is preferable, a lack of such segregation may be acceptable provided that it can be demonstrated that appropriate management controls are in place. For instance lack of segregation may be acceptable where computer logical access controls are in place. Even so, it is essential that a strict segregation of duties between staff in the front and back office is maintained, and especially that confirmations are sent direct to back office staff (see also paragraph 98 below).

    Taping

    48. Experience has shown that recourse to tapes proves invaluable to the speedy resolution of differences and disputes. The use of recording equipment in the offices of voice brokers and principals has become common; other means for monitoring ‘conversations’ are embodied within electronic broking systems now used in the markets. The Bank strongly recommends taping by principals and brokers of all conversations by dealers and brokers together with backoffice telephone lines used by those responsible for confirming deals or passing payment and other instructions. The Bank expects firms which it supervises to use tapes. Any which do not tape all their front plus relevant back office conversations should review this management policy periodically and be prepared to persuade the Bank that there are particular reasons for them to continue with such an approach. This review should be repeated annually. Failure to tape will normally count against a firm if it seeks to use the arbitration process described in paragraph 120 to settle a difference, or is the subject of a complaint.

    49. When initially installing tape equipment, or taking on new clients or counterparties, firms should take the necessary steps to inform them that conversations will be recorded. Tapes should be kept for at least two months, and preferably longer. Experience suggests that, with the growing involvement of the private banking divisions within core principals in selling wholesale products to small investors, taping of all conversations by salesmen/account officers in these areas is in the interests of core principals. The longer tapes are retained the greater the chances are that any subsequent disputes over transactions or where advice has been given, can be resolved satisfactorily. Tapes which cover any transaction about which there is a dispute should be retained until the problem has been resolved. Management should ensure that access to taping equipment and tapes, whether in use or in store, is strictly controlled so that they cannot be tampered with.

    Deals at non-current rates

    There is now widespread recognition thaty as a general rule, deals at non-market rates should not be undertaken.

    50. Banks and other listed firms are strongly discouraged from undertaking deals involving rolling-over an existing contract at the original rate. These should only be undertaken, if at all, on rare occasions and then after most careful consideration by both parties and approval, on a deal by deal basis, by their senior management. Senior management must ensure that proper procedures are in place to identify and bring to their attention all such deals when they are proposed so that they can be made fully aware of the details before reaching a decision on whether a particular trade should go ahead on this basis. Before reaching such a decision, senior management should seek written confirmation from the counterparty, also at senior management level, of the reasons for the transaction. This is essential not only because of the potential credit risk implications of rolling-over deals at original rates but also because failure to use current rates could result in the principal unknowingly participating in the concealment of a profit or loss, or in perpetration of a fraud. In order to provide a clear audit trail, there should be an immediate exchange of letters between the senior managements of both parties to any such deals to demonstrate that the above procedures have been followed.

    51. However, if management accept that the application of non-market rates can be necessary to create deal structures which satisfy the legitimate requirements of counterparties, they should ensure proper controls are in place to prevent such arrangements from concealing fraud, creating unacceptable conflicts of interest, or involving other illegal activity. It is particularly important to ensure that there is no ambiguity in such transactions over the amounts which each counterparty is to pay and receive. It should, for instance, be possible to demonstrate from the documentation available to both parties that the combination of cashflows, coupons, and foreign exchange rates etc., used in such transactions produces a result that is consistent with the current market price for a straightforward transaction of similar maturity. It is therefore essential that appropriate documentation is in place before any such deals are undertaken and that this is reviewed, by senior management, regularly so that they can satisfy themselves whether it remains appropriate to undertake further transactions on this basis.

    52. A specific area where there is sometimes pressure to conduct deals at non-current rates is in the foreign exchange market. In particular pressure can be placed on dealers undertaking a foreign exchange swap to avoid the immediate fixing of the spot price underlying the trade. This practice is judged by practitioners in the London market to be unethical and is not appropriate practice for UK based institutions. Spot rates should be determined immediately after completion of the foreign exchange swap transaction.

    Dealing with unidentified principals

    53. There has been a growing trend towards discretionary management companies dealing in wholesale market products on behalf of their clients. For its own commercial reasons a fund manager may not wish to divulge the name of its client(s) when concluding such deals. Since this practice raises important considerations, particularly in terms of banks’ ability to assess their credit risk to particular counterparties and to meet supervisory requirements on large exposures, the Bank is in discussions with the relevant market associations about it; and may in due course seek views from other supervisors in Basle on this practice. In the interim, before any institution transacts business on this basis its senior management should decide, as a matter of policy, whether they judge it appropriate to do so. In doing so, they should consider all the risks involved. They should fully document the decision which they reach.

    After-hours dealing

    54. Extended trading after normal local hours has become accepted in some markets, most notably foreign exchange. Dealing after-hours into other centres forms an integral part of the operations of many firms both in London and elsewhere. Such dealing can involve additional hazards—whether undertaken direct or via a broker. For example, when dealing continues during the evening from premises other than the principals’ dealing rooms, one of the principals involved might subsequently forget, or deny, having done a deal. Management should therefore issue clear guidelines to their staff, both on the kinds of deal which may be undertaken in those circumstances and on the permitted limits of any such dealing. All deals should be confirmed promptly—preferably by telex or similar electronic message direct to the counterparty’s offices—and carefully controlled when arranged off-premises. Management should consider installing answerphone facilities in the dealing area which dealers should use to record full details of all off-premises trades. These should be processed promptly on the next working day.

    Stop-loss orders

    55. Principals may receive requests from branches, customers and correspondents to execute transactions—for instance to buy or sell a currency—if prices or rates should reach a specified level. These orders, which include stop-loss and limit orders from counterparties desiring around-the-clock protection for their own positions, may be intended for execution during the day, overnight, or until executed or cancelled. Management should ensure that the terms of such orders are explicitly identified and agreed, and that there is a clear understanding with the counterparty about the obligation it has assumed in accepting such orders. Moreover, management needs to establish clear policies and procedures for its traders who accept and execute stop-loss and limit orders. Management should also ensure that any dealer handling such an instruction has adequate lines of communication with the counterparty so that the dealer can reach authorized personnel in case of an unusual situation or extreme price/rate movement.

    Conflicts of interest

    • Dealing for personal account

    56. Management should consider carefully whether their employees should be allowed to deal at all for own account in any of the products covered by this Code. Where allowed by management, it is their responsibility to ensure that adequate safeguards are established to prevent abuse. These safeguards should reflect the need to maintain confidentiality with respect to non-public price-sensitive information and to ensure that no action is taken by employees which might adversely affect the interest of the firm’s clients or counterparties.

    • Deals using a connected broker

    57. Brokers have a legal obligation to disclose the nature and extent of any material conflict between their own interests and their responsibilities to clients. To safeguard the independence of brokers they should give all their clients formal written notification of any principal(s) where a material connection exists (unless a client explicitly waives its rights to this information in writing); and notify any subsequent changes to this list of principals as they occur. For the purposes of this Code, a material connection would include situations where the relationship between the parties could have a bearing on the transaction or its terms, as a result for example of common management responsibilities or material shareholding links, whether direct or indirect. The Bank regards a shareholding of 10% or more in a broker as material; but, depending on the circumstances, a smaller holding may also represent a material connection.

    58. Any deals arranged by a broker involving a connected principal must be at arm’s length (i.e. at mutually agreed rates which are the same as those prevailing for transactions between unconnected counterparties).

    Marketing and incentives

    59. When listed institutions are operating within the boundaries of the Section 43 arrangements, they will not be subject to advertising or cold-calling rules since these would be inappropriate in such professional markets. Nevertheless listed institutions should take care to ensure that any advertisements for their services within the exempt area are directed so far as possible towards professionals.

    60. In recent years a number of foreign exchange electronic broking services have begun operating in London. Understandably such firms have considered a range of marketing arrangements, in the form of incentives, to generate liquidity in their systems. After consulting through the Joint Standing Committee it was concluded that the principle that brokers should not make payments to banks for using their services should be strictly maintained. As with conventional voice brokers, the provision of discount arrangements is a legitimate marketing technique, even if these involve cross-product subsidisation between different parts of the same group.

    Entertainment, gifts and gambling

    61. Management or employees must neither offer inducements to conduct business, nor solicit them from the personnel of other institutions. However it is recognized that entertainment and gifts are offered in the normal course of business and do not necessarily constitute inducements. Nevertheless, this is an area where the Bank receives a surprisingly high number of complaints about the potentially excessive nature of entertainment being offered. In response the Bank consulted practitioners during 1994 on how best to help facilitate a consistent approach across the London market. This reconfirmed that management should have a clearly articulated policy towards the giving/receipt of entertainment (and gifts), and ensure it is properly observed. It should include procedures for dealing with gifts judged to be excessive but which cannot be declined without causing offence. The policy should be reviewed periodically. In developing and implementing its policy, management should have regard to the potential adverse impact on the reputation of the firm, and the London market generally, of any adverse comment/publicity generated by any entertainment (or gifts) given or received.

    62. The following general pointers have been identified which management ought to consider including as part of their policy:

    • — Firms should have in place arrangements to monitor the type, frequency and cost of entertainment and gifts. Periodic control reports should be made available to management.

    • — Authorisation and control procedures should be ciear and unambiguous in order to ensure proper accountability.

    • — Policies should contain specific reference to the appropriate treatment for gifts (given and received). This policy should specifically preclude the giving (or receiving) of cash or cash convertible gifts.

    • — In determining whether the offer of a particular gift or form of entertainment might be construed as excessive, management should bear in mind whether it could be regarded as an improper inducement, either by the employer of the recipient or the supervisory authorities. Any grey areas should be cleared in advance with management at the recipient firm(s).

    • — Firms should not normally offer entertainment if a representative of the host company will not be present at the event.

    63. These procedures should be drawn up bearing in mind that the activities of dealers of some of the principals active in the markets may be governed by statute. For instance, offering hospitality or gifts to officers and members of local authorities and other public bodies is subject to the provisions of legislation that carries sanctions under criminal law. One of the most onerous requirements of this legislation is that any offer or receipt of hospitality is, prima facie, deemed to be a criminal offence, unless the contrary is proved.

    64. Similar guidelines should also be established on gambling with other market participants. All these activities carry obvious dangers and, where allowed at all, it is strongly recommended that they are tightly restricted.

    Abused substances (including drugs and alcohol)

    65. Management should take all reasonable steps to educate themselves and their staff about possible signs and effects of the use of drugs and other abused substances. The judgement of any member of staff using such substances is likely to be impaired; dependence upon drugs etc makes them more likely to be vulnerable to outside inducement to conduct business not necessarily in the best interests of the firm or the market generally and could seriously diminish their ability to function satisfactorily.

    IV. DEALING PRINCIPLES AND PROCEDURES: A STATEMENT OF BEST PRACTICE

    Scope

    Deals in the London wholesale markets (defined by the products covered in the box on page 3)1 should be conducted on the basis of this Code of Conduct.

    66. Whilst this Code is designed for the London markets, its provisions may extend beyond UK shores, for example where a listed UK broker arranges a deal involving an overseas counterparty. Where deals involving overseas counterparties are to be made on a different basis in any respect, for example because of distinct local rules or requirements, this should be clearly identified at the outset to avoid any possible confusion.

    Overseas market conventions

    The trading of currency assets in London should follow recognised trading conventions that have been established internationally or in specific overseas markets, provided they do not conflict with the principles of this Code.

    67. Where foreign currency-denominated short-term securities issued overseas are traded in London, there may be important differences in dealing practice compared with the trading of London instruments, partly reflecting the way the instruments are traded in their domestic markets. The London Code is intended to be complementary to any generally accepted local standards and practices for such instruments traded in London. The Bank would expect firms trading these instruments in London to abide by any such local conventions.

    Procedures

    • Preliminary negotiation of terms

    Firms should clearly state at the outset, prior to a transaction being executed, any qualifying conditions to which it will be subject.

    68. Typical examples of qualifications include where a price is quoted subject to the necessary credit approval; finding a counterparty for matching deals; or the ability to execute an associated transaction. For instance principals may quote a rate which is ‘firm subject to the execution of a hedge transaction’. For good order’s sake it is important that firms complete deals as quickly as possible; the onus is on both sides to keep each other informed of progress or possible delays. If a principal’s ability to conclude a transaction is constrained by other factors, for example opening hours in other centres, this should be made known to brokers and potential counterparties at an early stage and before names are exchanged.

    69. In the Euronote and commercial paper markets, principals should notify investors, at the time of sale, of their willingness or otherwise to repurchase paper. Investors should also be notified, before the sale, of any significant variation from the standard terms or conditions of an issue.

    • Undertaking derivative transactions with end-users (i.e. ‘customers’ of the market)

    It is important, before derivative transactions are undertaken with a customer, that dealers are satisfied that appropriate ‘know your counterparty’ procedures (see section III above) have been implemented for the product under consideration.

    70. When a core principal is dealing with any customer of the market in leveraged or derivative products it is good practice for its dealers to assist their opposite number by using clear concise terminology. It is however the responsibility of each party involved to seek clarification, before concluding a deal, on any points about which they are not clear. Each party should also consider whether it would be helpful for the core principal to send by electronic means (telex or fax) a pre-deal message setting out the terms upon which the deal will be priced and agreed by both parties. While this may not be judged appropriate for some customers (e.g. an experienced large corporate), it is likely to be helpful to send predeal messages to small investors (as defined earlier). Such a message may also be particularly useful, for instance, where the product involved is relatively new to the customer; or where the individual dealer acting on behalf of the customer is not the regular contact point for undertaking such trades with that customer. The sending or receipt of such a message is not a substitute for the confirmation procedures described below.

    71. The existence, or not, of such a message should not however be taken as undermining in any way the principle that each party must accept responsibility for entering into such trades and any losses that they might incur as a result of doing so. There are, of course, circumstances in which this principle might be brought into question; for instance if the dealer at the core principal had deliberately misled the customer by knowingly providing false and/or inaccurate information at die time the deal was being negotiated. It is therefore very important that great care is taken not to mislead or misinform.

    72. To help minimise the scope for error and misunderstanding the Bank strongly recommends that management require their dealers to use standard pre-deal check lists of the key terms that they need to agree when entering into leveraged and/or derivative transactions.

    • Firmness of quotation

    All firms, whether acting as principal, agent or broker, have a duty to make absolutely clear whether the prices they are quoting are firm or merely indicative. Prices quoted by brokers should be taken to be firm in marketable amounts unless otherwise qualified.

    73. A principal quoting a firm price (or rate) either through a broker or directly to a potential counterparty is committed to deal at that price (or rate) in a marketable amount provided the counterparty name is acceptable. In order to minimise the scope for confusion where there is no clear market convention, dealers quoting a firm price (rate) should indicate the length of time for which their quote is firm.

    74. It is generally accepted that when dealing in fast moving markets (like spot forex or currency options) a principal has to assume that a price given to a broker is good only for a short length of time—typically a matter of seconds. However, this practice would be open to misunderstandings about how quickly a price is deemed to lapse if it were adopted when dealing in generally less hectic markets, for example the forward foreign exchange or deposit markets, or when market conditions are relatively quiet. Since dealers have prime responsibility for prices put to a broker, the onus in such circumstances is on dealers to satisfy themselves that their prices have been taken off, unless a time limit is placed by the principal on its interest at the outset (e.g. ‘firm for one minute only’). Otherwise, the principal should feel bound to deal with an acceptable name at the quoted rate in a marketable amount.

    75. For their part brokers should make every effort to assist dealers by checking from time to time with them whether their interest at particular prices (rates) is still current. They should also do so when a specific name and amount have been quoted.

    76. What constitutes a marketable amount varies from market to market but will generally be familiar to practitioners. A broker, if quoting on the basis of small amounts or particular names, should qualify the quotation accordingly. Where principals are proposing to deal in unfamiliar markets through a broker, it is recommended that they first ask brokers what amounts are sufficient to validate normal market quotations. If their interest is in a smaller amount, this should be specified by the principal when initially requesting a price from or offering a price to the broker.

    77. In the swap market, considerable use is made of ‘indicative interest’ quotations. When arranging a swap an unconditional firm rate will only be given where a principal deals directly with a client, or when such a principal has received the name of a client from a broker. A principal who quotes a rate or spread as ‘firm subject to credit’ is bound to deal at the quoted rate or spread if the name is consistent with a category of counterparty previously identified for this purpose (see also paragraph 82 below). The only exception is where the particular name cannot be accepted, for example if the principal has reached its credit limit for that name, in which case the principal will correctly reject the transaction. It is not an acceptable practice for a principal to revise a rate which was ‘firm subject to credit’ once the name of the counterparty has been disclosed. Brokers and principals should work together to establish a range of institutions for whom the principal’s rate is firm subject to credit.

    • Concluding a deal

    Principals should regard themselves as bound to a deal once the price and any other key commercial terms have been agreed. Oral agreements are considered binding. However, holding brokers unreasonably to a price is viewed as unprofessional and should be discouraged by management.

    78. Where quoted prices are qualified as being indicative or subject to negotiation of commercial terms, principals should normally treat themselves as bound to a deal at the point where the terms have been agreed without qualification. Oral agreements are considered binding; the sub-sequent confirmation is evidence of the deal but should not override terms agreed orally. The practice of making a transaction subject to documentation is not good practice (see also paragraphs 107–109). In order to minimize the likelihood of disputes arising once documentation is prepared, firms should make every effort to agree all material points quickly during the oral negotiation of terms, and should include these on the confirmation. Any remaining details should be agreed as soon as possible thereafter.

    79. Where brokers are involved, it is their responsibility to ensure that the principal providing die price (rate) is made aware immediately it has been dealt upon. As a general rule a deal should only be regarded as having been ‘done’ where the broker’s contact is positively acknowledged by the dealer. A broker should never assume that a deal is done without some form of oral acknowledgement from the dealer. Where a broker puts a specific proposition to a dealer for a price (e.g. specifying an amount and a name for which a quote is required), the dealer can reasonably expect to be told almost immediately by the broker whether the price has been hit or not.

    • Passing of names by brokers

    Brokers should not divulge the names of principals prematurelyy and certainly not until satisfied that both sides display a serious intention to transact. Principals and brokers should at all times treat the details of transactions as absolutely confidential to the parties involved (see paragraph 41 above).

    80. To save time and minimise frustration, principals should wherever practicable give brokers prior indication of counterparties with whom, for whatever reason, they would be unwilling to do business (referring as necessary to particular markets or instruments). At the same time brokers should take full account of the best interests and any precise instructions of the client.

    81. To save subsequent awkwardness, principals (including agents) have a particular obligation to give guidance to brokers on any particular features (maturities etc) or types of counterparty (such as non-financial institutions) which might cause difficulties. In some instruments, principals may also wish to give brokers guidance on the extent of their price differentiation across broad categories of counterparties. Where a broker is acting for an unlisted (or unsupervised) name he should disclose this fact as soon as possible; the degree of disclosure required in such a case will usually be greater. For instance, credit considerations may require that such names be disclosed to a listed principal first (as in the swap market), in order that the listed principal may quote a rate at which it is committed to deal. Equally, disclosure of difficult names may be necessary since this may influence the documentation.

    82. In all their wholesale market business, brokers should aim to achieve a mutual and immediate exchange of names. However, this will not always be possible. There will be times when one principal’s name proves unacceptable to another and the broker will quite properly decline to divulge by whom it was refused. This may sometimes result in the principal whose name has been rejected feeling that the broker may in fact have quoted a price (rate) which it could not in fact substantiate. In such cases, the Bank will be prepared to establish with the reluctant principal that it did have business to do at the quoted price and the reasons why the name was turned down, so that the aggrieved party can be assured the original quote was valid without, of course, revealing the reluctant party’s name.

    83. In the sterling and currency deposit markets, it is accepted that principals dealing through a broker have the right to turn down a name wishing to take deposits; this could therefore require predisclosure of the name before closing the deal. Once a lender has asked the key question ‘who pays’, it is considered committed to do business at the price quoted with that name, or an alternative acceptable name if offered immediately. The name of a lender shall be disclosed only after the borrower’s name has been accepted by the lender. Conversely, where a borrower is taking secured money there may be occasions when it will wish to decline to take funds, through a broker, when the lender’s name is passed.

    84. In the case of instruments like CDs, where the seller may not be the same entity as the issuer, the broker shall first disclose the issuer’s name to die potential buyer. Once a buyer has asked ‘whose paper is it’, the buyer is considered committed to deal at the price quoted. Once the buyer asks ‘who sells’ it is considered committed to deal with the particular seller in question (or an alternative acceptable name, so long as this name is immediately shown to the buyer by the broker). The name of the buyer shall be disclosed only after the seller’s name has been accepted by the buyer. The seller has the right to refuse the particular buyer, so long as it is prepared at that time to sell the same amount at the same price to an alternative acceptable name immediately shown to it by the broker.

    85. In the CD markets a price quoted is generally accepted as good for any name ‘on the run’.

    • Use of intermediaries

    Brokers must not interpose an intermediary in any deal which could take place without its introduction.

    86. An intermediary should only be introduced by a broker where it is strictly necessary for the completion of a deal, most obviously where a name switch is required because one counterparty is full of another’s name but is prepared to deal with a third party. Any fees involved in transactions involving intermediaries must be explicitly identified by the broker and shown on the relevant confirmation(s).

    87. Where a broker needs to switch a name this should be undertaken as promptly as possible, bearing in mind that this may take longer at certain times of the day; or if the name is a particularly difficult one; or if the deal is larger than normal. In no circumstances should a deal be left overnight without acceptable names having been passed.

    • Confirmation procedures

    Prompt passings recording and careful checking of confirmations is vital to minimise the possibility of errors and misunderstanding whether dealing direct or through brokers. Details should be passed as soon as practicable after deals have been done and checked upon receipt. The passing of details in batches is not recommended. For markets where standard terms are applicable e.g. under standard documentation, it is recommended that confirmations conform to the formats specified for the market or instrument concerned.

    (a) Oral deal checks

    An increasing number of practitioners find it helpful to undertake oral deal checks at least once a day, especially when using a broker.

    88. Particularly when dealing in faster moving markets like foreign exchange, but also when dealing in other instruments which have very short settlement periods, many principals now request regular oral deal checks—whether dealing through brokers or direct—prior to the exchange and checking of a written or electronically dispatched confirmation. Their use can be an important means of helping to reduce the number and size of differences particularly when dealing through brokers or for deals involving non-London counterparties. It is for each firm to agree with its broker(s) whether or not it wishes to be provided with this service; and if so, how many such checks a day it requires. When arbitrating in disputes, the Bank will take into account the extent to which principals have sought to safeguard their interests by undertaking oral checks.

    89. If a single check is thought to be sufficient, the Bank sees merit in this being undertaken towards the end of the trading day as a useful complement, particularly where late deals are concerned, to the process of sending out and checking confirmations.

    90. As a matter of common sense, the broker should always obtain acknowledgement from a dealer on completion of the check that all the deals have been agreed or, if not, that any identified discrepancies are resolved as a matter of urgency. Lack of response should not be construed as acknowledgement.

    (b) Written/electronic confirmations

    In all markets, the confirmation provides a necessary final safeguard against dealing errors. Confirmations should be dispatched and checked carefully and promptly, even when oral deal checks have been undertaken. The issue and checking of confirmations is a back-office responsibility which should be carried out independently from those who initiate deals.

    91. A confirmation of each deal must be sent out without delay. This is particularly essential if dealing for same day settlement. As a general rule the Bank believes all participants in the wholesale markets should have, or be aiming to have, in place the capability to dispatch confirmations so that they are received and can be checked within a few hours of when the deal was struck. Where the products involved are more complex, and so require more details to be included on the confirmation, this may not be possible; nevertheless it is in the interest of all concerned that such deals are confirmed as quickly as is practicable. The Bank recommends that principals should enquire about any confirmations which have not been received within the expected timescale.

    92. It is not uncommon in the derivatives markets, and perfectly acceptable if the two principals involved agree, for only one party (rather than both) to the deal to send out a confirmation. But where this is so, it is imperative not only that the recipient checks it promptly, but that it also in good time responds to the issuer of the confirmation agreeing/querying the terms. For good order’s sake it would also be imperative that the issuer of the confirmation has in place procedures for chasing a response if one is not forthcoming within a few hours of the confirmation being sent.

    93. All confirmations should include the trade date, the name of the other counterparty and all other details of the deal, including where appropriate the commission charged by the broker. Some principals include their own terms and conditions of trading on their written confirmations. To avoid misunderstandings, any subsequent changes should be brought specifically to the attention of their counterparties.

    94. In many markets, it is accepted practice for principals to confirm directly all the details of transactions arranged through a broker; the broker should nevertheless also send a confirmation to each counterparty.

    95. All principals are reminded that the prompt sending and checking of confirmations is also regarded as best practice in deals not arranged through a broker, including those with corporates and other customers.

    96. Wherever practicable the Bank wishes to discourage the practice in some markets of sending two confirmations (e.g. an initial one by telex, fax or other acceptable electronic means) followed by a written confirmation, which if posted could easily not arrive until after the settlement date and could cause confusion and uncertainty. For this reason, the Bank believes that wherever practicable a single confirmation should be sent promptly by each party, if possible by one of the generally accepted electronic means now available (notably the ACS system, SWIFT, fax or telex). Where this is not practicable, for instance in more complex derivative transactions, firms should indicate (e.g. on the preliminary confirmation) that a more detailed written version is to follow. The Bank does not believe that it is good practice to rely solely on an oral check.

    97. It is vital that principals check confirmations carefully and immediately upon receipt so that discrepancies can be quickly revealed and corrected. Firms that check within a few hours of receipt would be complying with best practice.

    98. As a general rule, confirmations should not be issued by or sent to and checked by dealers. This is a back-office function. Where dealers do get involved in these procedures they should be closely controlled. The most common instance where it may sometimes be thought helpful to mark a copy of the confirmation for the attention of the person who has arranged the deal, in addition to the back office, is in markets requiring detailed negotiation of terms (notably those involving contracts for differences). Certain automated dealing systems produce confirmations automatically; provided these are received in the back office no additional confirmation need be sent.

    99. Particular attention needs to be paid by all parties when confirming deals in which at least one of the counterparties is based outside London, and to any consequential differences in confirmation procedure.

    • Payment/settlement instructions

    Instructions should be passed as quickly as possible to facilitate prompt settlement. The Bank strongly recommends the use of standard settlement instructions; their use can make a significant contribution to reducing both the incidence and size of differences arising from the mistaken settlement of funds.

    100. The use of standard settlement instructions (SSIs) continues to increase in London. International acceptance of the benefits of many SSIs is an important next step. In order to facilitate still greater usage of SSIs the BBA now maintains a directory of London based institutions that use them. The Bank wishes to encourage firms that it supervises, that do not already do so, to draw up plans to move towards using SSIs as soon as possible. A major advantage of using SSIs is that they remove the need to confirm payment details by phone.

    101. The guidelines set out in Schedule 2, which have been drawn up in consultation with practitioners, set out a framework which it is hoped principals will aim to adopt when using SSIs for wholesale market transactions. The guidance notes emphasise that SSIs should only be established via confirmed letter or authenticated SWIFT message, and not by SWIFT broadcast. While many firms comply with this guidance, difficulties have been encountered where some insist on using SWIFT broadcasts. Having raised the matter with SWIFT it is clear that broadcast messages remain unsuitable for the purpose of changing SSIs and are non-binding on recipients. SWIFT is currently looking at developing a new message for this purpose. In the interim, however, the majority view is that banks which receive notice from a counterparty of the amendment of an SSI by a SWIFT broadcast should be free to act upon such notice if they so wish. They should seek authentication of the message by way of sending confirmation of the arrangement, making clear when and for what deals the new instructions will be implemented. Until that process is complete the original instructions will be deemed still to be operative.

    102. It has been the practice in the domestic sterling market that brokers pass payment instructions. In view of the increasing use of SSIs, the domestic sterling market should be moving away from requiring this service from brokers. Brokers should therefore only be expected to pass payment instructions in very unusual circumstances or in certain deposit markets where the counterparty is a non-core principal (such as a local authority).

    103. Similarly brokers do not pass payment instructions in the foreign exchange and currency deposits market where the counterparties are both in the UK. It is for banks to agree with brokers the basis on which they will be able to pass such instruction for deals using a non-UK counterparty; all such instructions should be passed with minimum delay. It is intended that, with the hoped for increasing use of SSIs internationally, brokers will cease providing payment instructions involving overseas counterparties in due course.

    104. Where SSIs are not being used, principals should ensure that any alterations to original payment instructions, including the paying agent where this has been specifically requested, should be immediately notified direct to the counterparty. This notification should be supported by written, telex, or similar confirmation of the new instructions.

    105. While it is important that payment instructions are passed quickly, it is equally important that principals have in place appropriate procedures for controlling the timing of their instructions to correspondent banks to release funds when settling wholesale market transactions. A recent survey by G-10 central banks suggested that there is a wide gap between the best and worst controls practised in the markets; failure to maintain effective controls over payment flows can significantly increase the risks that institutions face when dealing in the OTC wholesale markets.

    • Fraud

    106. There is a need for great vigilance by all staff against attempted fraud. This is particularly so where calls are received on an ordinary telephone line (usually in principal to principal transactions). As a precautionary measure, it is strongly recommended that details of all telephone deals which do not include pre-agreed standard settlement instructions should be confirmed by telex or similar means without delay by the recipient, seeking an answer-back to ensure the deal is genuine.

    • Terms and documentation

    It is now common for wholesale market deals to be subject to some form of legal documentation binding the two parties to certain standard conditions and undertakings. The Bank endorses the use, wherever possible, of such documentation (which typically will take the form either of signed Master Agreements exchanged between the two parties or can take the form of standard Terms), Core principals should have procedures in place to enable documentation to be completed and exchanged as soon as possible.

    107. It is in the interest of all principals to make every effort to progress the finalisation of documentation as quickly as possible. In some markets, such as repo, or in other circumstances such as those described in paragraphs 31 and 51, documentation should be in place before any deals are undertaken. More generally, however, the Bank believes the aim should be for documentation to be in place within three months of the first deal being struck. Failure to agree documentation within this timescale should cause management to review the additional risks that this might imply for any future deals with the counterparty concerned. Factors which may influence managements’ views include whether they can take comfort on their legal position from the mutual confirmation of terms with a particular counterparty; or where the delay is in putting in place multiple master agreements for products that are, in the interim, subject to previously agreed documentation.

    108. Some documentation in common usage provides for various options and/or modifications to be agreed by mutual consent. These must be clearly stated before dealing. Firms should make clear at an early stage, when trading any of the above mentioned products, if they are not intending to use standard terms documentation. Where changes are proposed these should also be made clear. For other wholesale instruments, where standard terms do not yet exist (e.g. barrier options), particular care and attention should be paid to the negotiation of terms and documentation.

    109. Some outstanding transactions might still be subject to old documentation (e.g. the 1987 ISDA) that results in one-way payment provisions. The use of such provisions is not recommended. Banking supervisors worldwide have indicated that such transactions will not be eligible for netting for capital adequacy purposes and the Bank supports moves to amend such clauses where they are still in existence. Non-core principals are encouraged to co-operate in core principals in this objective.

    • Stock lending and repos

    Where sale and repurchase (or stock borrowing and tending) transactions are entered into, proper documentation and prior agreement of key terms and conditions are essential.

    110. The Bank expects core principals to abide by the relevant codes drawn up by market practitioners. When undertaking stock lending transactions the Stock Borrowing and Lending Committee Code of Guidance should apply. With the advent of a gilt repo market the Gilt Repo Code of Best Practice should be adhered to.

    111. The Gilt Repo Code will apply not only to gilt repo, but also to other transactions involving gilts which have similar effect and intent, including secured lending (of money and gilts) e.g. under the gilt-edged stock lending agreement; lending of gilts against collateral; and buy/sellbacks (whether or not under a Master Agreement). The Bank also believes that the general standards set down in the Gilt Repo Code will be relevant when undertaking other, non-gilt, repo activity covered by the London Code.

    • Assignments or transfers

    Assignments should not generally be undertaken without the consent of the parties concerned.

    112. Assignments have become increasingly common in the derivatives market. Principals who enter into any wholesale market transaction with the intention of shortly afterwards assigning or transferring the deal to a third party should make clear their intention to do so when initially negotiating the deal. It is recommended that the confirmation sent by the principal should specify any intent to assign and give details of the procedure that will be used. The subsequent documentation should also make provision for assignment.

    113. When a principal is intending to execute such a transfer it must obtain the consent of the transferee before releasing its name. If the principal proposes to use a broker to arrange the transfer, consent from the transferee for this to happen must also be obtained. The transferee has an obligation to give the principal intending to transfer sufficient information to enable the transaction to be conducted in accordance with the principles of best practice set out elsewhere in the Code. Where the transaction is conducted through a broker, this information should likewise be made available to him. In particular, the information from the transferee should include details of the type of credit the transferee is prepared to accept, and whether he is seeking any sort of reimbursement for the administrative costs that might be incurred. Principals and brokers arranging a transfer or assignment should also agree the basis of pricing the transfer at an early stage of the negotiations. When arranging assignments, it is important for participants to observe the general principle set out elsewhere in the Code that there should be mutual disclosure of names. Finally it should be noted that proper, clear documentation is as important for transfers as for the origination of deals.

    Settlement of differences

    If all the procedures outlined above are adhered to, the incidence and size of differences should be reduced; and those mistakes which do occur should be identified and corrected promptly. Failure to observe these principles could leave those responsible bearing the cost, without limit on size or duration, of any differences which arise. Except in the foreign exchange market, all differences must be settled in cash.

    114. In all the wholesale markets (including foreign exchange) if a broker misses a price he is required by the Bank to offer to close the deal at the next best price if held to the deal. The broker must then settle the difference arising by cheque (or, if both sides agree, points if it is a foreign exchange transaction); principals should always be prepared to accept this cash settlement since to do otherwise would put the broker in breach of the Code. It is unprofessional for a dealer to refuse to accept a difference cheque and insist the deal is honoured; individual brokers facing this situation should advise their senior management who, if necessary, should raise the matter with management of the client. The Bank is keen to be advised of any persistent offenders.

    115. Where brokers are used to arrange derivative products like barrier options, they should not be held liable for disputes between principals that arise where there is a disagreement over whether a certain spot level has or has not been reached in sufficient quantity to trigger the option. Nor should brokers be cited as independent referees in such transactions unless they have explicitly agreed to do so before the deal is struck.

    116. As noted above, the prompt despatch and checking of confirmations is of paramount importance. Non-standard settlement instructions should be particularly carefully checked, and any discrepancies identified promptly upon receipt, and notified direct to the counterparty, or to the broker (in circumstances described earlier).

    117. Where difference payments arise because of errors in the payment of funds, principals are reminded that it is the view of the Bank and the Joint Standing Committees that they should not benefit from undue enrichment by retaining the funds. Technological developments have resulted in faster and more efficient mechanisms for the delivery and checking of confirmations. This means that when brokers pass payment instructions that cannot be cross-checked against direct confirmation details, their liability in the event of an error should be limited to 24 hours from when the deal was struck. This limit on the broker’s liability is not intended to absolve brokers of responsibility for their own errors; rather it recognises that once payments do go astray the broker is limited in what action it can directly take to rectify the situation.

    118. In the foreign exchange and currency deposit markets arrangements have been drawn up to facilitate the payment of differences via the Secretary of the Foreign Exchange Joint Standing Committee.1 In the foreign exchange market only, and only with the explicit consent of principals, brokers may make use of ‘points’ to settle differences. Even then their use will only be permitted if arrangements for management control, recording and reporting of points consistent with the requirements laid down by the Bank (see Annex I)2 have been established.

    119. Listed broking firms must agree their own procedures with the Wholesale Markets Supervision Division of the Bank before using ‘points.’ The informal use of ‘points’ between individual dealers and brokers is not acceptable. Using ‘points’ in lieu of cash to settle differences is not permitted in any market other than foreign exchange. As a matter of prudent housekeeping, all differences should normally be settled within 30 days from the date the original deal was undertaken.

    Arbitration procedure

    120. The Bank is prepared to arbitrate in disputes between firms it supervises about the application of the Code, or current market practice, to specific transactions in wholesale market products. As a condition for doing so the Bank will expect the parties to have exhausted their own efforts to resolve the matter directly. All parties must then first agree to the Bank taking such a role and to accept its decision in full and final settlement of the dispute. In doing so, the Bank may draw on the advice and expertise of members of the Joint Standing Committees or other market practitioners as it feels appropriate. Requests for arbitration should be addressed to the Bank’s Wholesale Markets Supervision Division. The Bank will not normally arbitrate in any dispute which is subject to, or is likely to be subject to, legal proceedings. Paragraphs 48 and 49 of the Code, on taping, and paragraphs 88–90, on oral deal checks, are especially relevant to firms considering recourse to these arrangements.

    Commission/brokerage

    Brokers’ charges are freely negotiable, Principals should pay brokerage bills promptly,

    121. Where the services of a broker are used it is traditional practice for an appropriate brokerage package to be agreed by the directors or senior management on each side. Any variation on a particular transaction from those previously agreed brokerage arrangements should be expressly approved by both parties and clearly recorded on the subsequent documentation; this should be the exception rather than the rule. Under no circumstances should a broker pay cash to a principal as an incentive to use its service (see also early section on Marketing).

    122. Although brokers normally quote dealing prices excluding commission/brokerage charges, it is perfectly acceptable, and not uncommon, in some derivative markets for the parties to agree that the broker quotes rates gross of commission and separately identifies the brokerage charge. Equally there may be circumstances when the broker (or principal) and client may agree on an acceptable net rate; if so it is important that the broker (or principal) subsequently informs the client how that rate is divided between payments to counterparties and upfront commission. In such cases it is essential that all parties are quite clear that this division will be determined no later than the time at which the deal is struck; and that a record is kept.

    123. The Bank is aware that some principals fail to pay due brokerage bills promptly. This is not good practice and can significantly disadvantage brokers since overdue payments are treated by the Bank, for regulatory purposes, as a deduction from their capital base.

    Market conventions

    Management should ensure that individual brokers and dealers are aware of their responsibility to act professionally at all times and, as part of this, to use cleary unambiguous terminology. This is even more important when dealing with non-core principals, whose staff may be less experienced in dealing in these markets,

    124. The use of clear language is in the interests of all concerned. Management should establish internal procedures (including retraining if necessary) to alert individual dealers and brokers who act in different markets (or move from one market to another) both to any differences in terminology between markets and to the possibility that any particular term could be misinterpreted. The use of generally accepted concise terminology is undoubtedly helpful. In those markets where standard terms and conditions have been published individual dealers and brokers should familiarise themselves with the definitions they contain.

    125. Standard conventions for calculating the interest and proceeds on certain sterling and currency instruments, together with market conventions regarding brokerage, are set out in Schedule 1.

    Market disruption/bank holidays

    126. There have been instances of general disruption to the wholesale markets which have, in turn, resulted in interruptions to the sterling settlement systems and consequent delays in sterling payments. It has been agreed by the Joint Standing Committees that in such unexpected circumstances the Bank should determine and publish the interest rate(s) which parties to deals affected by such interruptions should use to calculate the appropriate interest adjustment (unless all the parties to the deal agree instead on some other arrangement—such as to continue to apply the existing rate of interest on the original transaction or as provided for in the relevant documentation). The Bank shall have absolute discretion in its determination of any interest rate(s), and shall not be required to explain its method of determining the same and shall not be liable to any person in respect of such determination.

    127. Occasionally unforseen events mean that market participants will have entered into contracts for a particular maturity date only to find, subsequently, that that day is declared a public holiday. It is normal market practice in London to extend contracts maturing on a non-business day to the next working day. But to minimise possible disputes market participants may need to agree settlement arrangements for such deals with their counterparties in advance.

    Schedule 1 MARKET CONVENTIONS

    1. Calculation of interest and brokerage in the sterling deposit market

    • Interest

    On CDs and deposits or loans this is calculated on a daily basis on a 365-day year.

    Interest on a deposit or loan is paid at maturity, or annually and at maturity, unless special arrangements are made at the time the deal is concluded.

    On secured loans the discount houses and Stock Exchange money brokers do not pay interest at intervals of less than 28 days. The current general practice is to calculate at the close of business on the penultimate working day interest outstanding on secured loans to the last working day of each calendar month and to pay the interest thereon on the last working day of the month.

    • Brokerage

    All brokerage is calculated on a daily basis on a 365-day year and brokerage statements are submitted monthly.

    2. Calculation of interest in a leap year

    The calculation of interest in a leap year depends upon whether interest falls to be calculated on a daily or an annual basis. The position may differ as between temporary and longer-term loans.

    • Temporary loans

    Because temporary loans may be repaid in less than one year (but may, of course, be continued for more than a year) interest on temporary money is almost invariably calculated on a daily basis. Thus any period which includes 29 February automatically incorporates that day in the calculation; in calculating the appropriate amount of interest, the number of days in the period since the last payment of interest is expressed as a fraction of a normal 365-day year, not the 366 days of a leap year, which ensures that full value is given for the ‘extra’ day.

    Examples:

    Assume last previous interest payment 1 February (up to and including 31 January) and date of repayment 1 April (in a leap year). Duration of loan for final interest calculation = 29 days (February) + 31 days (March) = 60 days.

    Calculation of interest would be

    Assume no intermediate interest payments. Loan placed 1 March and called for repayment 1 March the following year (leap year). Total period up to and including 29 February = 366 days. Calculation of interest would be

    This is in line with banking practice regarding interest on deposits which is calculated on a ‘daily’ basis and no conflict therefore arises.

    • Longer-term loans

    The following procedure for the calculation of interest on loans which cannot be repaid in less than one year (except under a TSB or building society stress clause) was agreed between the BBA and the Chartered Institute of Public Finance and Accountancy on 12 December 1978.

    (a) Fixed interest

    The total amount of interest to be paid on a longer-term loan at fixed interest should be calculated on the basis of the number of complete calendar years running from the first day of the loan, with each day of any remaining period bearing interest as for 1/365 of a year.

    Normal practice for the calculation of interest in leap years is to disregard 29 February if it falls within one of the complete calendar years. Only when it falls within the remaining period is it counted as an additional day with the divisor remaining at 365.

    Example: 3½ year loan, maturing on 30 June of a leap year.

    First 3 years’ interest:

    Final 6 months’ interest:

    Certain banks, however, require additional payment of interest for 29 February in all cases, and it was therefore agreed that:

    both the original offer or bid, and the agent’s confirmation, must state specifically if such payment is to be made; and

    the documentation must incorporate the appropriate phraseology.

    Interest on longer term loans should be paid half-yearly, on the half-yearly anniversary of the loan or on other prescribed dates and at maturity. To calculate half-yearly interest payments the accepted market formula is:

    where d = actual number of days.

    Although, with the agreement of both parties, the following is sometimes used:

    (b) Floating rate

    Interest on variable rate loans, or roll-overs, which are taken for a fixed number of years with the rate of interest adjusted on specific dates, should be calculated in the same manner as for temporary loans.

    3. Brokerage and other market conventions in the foreign exchange and currency deposit markets

    • Brokerage

    (a) General (foreign exchange and currency deposits)

    Brokerage arrangements are freely negotiable.

    These arrangements should be agreed by directors and senior management in advance of any particular transaction.

    (b) Currency deposits

    Calculation of brokerage on all currency deposits should be worked out on a 360-day year.

    Brokers’ confirmations and statements relating to currency deposits should express brokerage in the currency of the deal.

    In a simultaneous forward-forward deposit (for example one month against six months), the brokerage to be charged shall be on the actual intervening period (in the above example, five months).

    Other Market Conventions

    Currency deposits

    Length of the year

    For the purpose of calculating interest, one year is in general deemed to comprise 360 days; but practice is not uniform in all currencies or centres.

    Spreads and quotations

    Quotations will normally be made in fractions, except in short-dated foreign exchange dealings, where decimals are normally used.

    Call and notice money

    For US dollars (and sterling), notice in respect of call money must be given before noon in London. For other currencies, it should be given before such time as may be necessary to conform with local clearing practice in the country of the currency dealt in.

    4. Calculations in the foreign currency asset markets

    • Euro-commercial paper (and other such instruments)

    The net proceeds of short-term interest-bearing and discount Eurocommercial paper, on which interest is determined on a 360-day basis, are calculated in the same manner as those for short-term, interest-bearing and discount CDs.

    Formula for non-interest bearing Euronotes quoted on a ‘discount to yield’ basis:

    where

    N = Nominal amount or face value

    Y = Yield

    M = Number of days to maturity

    Example:

    A Euronote with a face value of US$5 million and with 90 days to run is sold to yield 7.23% per annum.

    • US Treasury bills (and other US discount securities such as bankers’ acceptances and commercial paper)

    The quoted trading rates for such assets are discount rates. The price of the asset is calculated on the basis of a 360-day year.

    The market price (Pm) on a redemption value of $100 can be calculated as follows:

    where

    M = days to maturity or days held

    D = discount basis (per cent).

    Schedule 2 GUIDELINES FOR EXCHANGING STANDARD SETTLEMENT INSTRUCTIONS (SSIs)

    These guidelines have been drawn up by the Bank of England in consultation with practitioners. While the parties to SSIs are free to agree changes to the detail on a bilateral basis, it is hoped that this framework will be useful and as such followed as closely as possible.

    When establishing SSIs with a counterparty for the first time these should be appropriately authorised internally before being issued. It is desirable that SSIs be established by post (and issued in duplicate, typically under two authorised signatories). However authenticated SWIFT message can also be used if necessary.

    Cancellation or amendment of a standard instruction should ideally be undertaken by authenticated SWIFT; tested telex is also an acceptable means when cancelling or making amendments. SWIFT broadcast is not an acceptable means for establishing, cancelling or amending SSIs.

    A mutually agreed period of notice for changing SSIs should be given; typically this will be between 10 working days and one month. Some parties may also wish to provide for changes to be made at shorter notice in certain circumstances.

    Recipients have a responsibility to acknowledge acceptance (or otherwise) of the proposed/amended SSI within the timescale agreed (see above). Failure to do so could result in a liability to compensate for any losses which result. In the case of written notification this should be undertaken by the recipient signing and returning the duplicate letter.

    Recipients should also confirm the precise date on which SSIs will be activated (via SWIFT or tested telex).

    Instructions should be issued for each currency and wholesale market product. Each party will typically nominate only one correspondent per currency for foreign exchange deals and one per currency for other wholesale market deals. The same correspondent may be used for foreign exchange and other wholesale market deals.

    As a general rule, all outstanding deals, including maturing forwards, should be settled in accordance with the SSI in force at their value date (unless otherwise and explicitly agreed by the parties at the time at which any change to an existing SSI is agreed).

    The SSI agreement for each business category should contain the following:

    • — the nature of the deals covered (for example whether they include same day settlement or only spot/forward forex deals).

    • — confirmation that a single SSI will apply for all such deals with the counterparty.

    • — the effective date.

    • — confirmation that it will remain in force ‘until advised’.

    • — recognition that no additional telephone confirmation of settlement details will be required.

    • — recognition that any deviation from the SSI will be subject to an agreed period of notice.

    When operating SSIs on this basis, the general obligations on both parties are to ensure that:

    • — they apply the SSI which is current on the settlement date for relevant transactions.

    • — confirmations are issued in accordance with the London Code of Conduct; the aim should be to send them out on the day a deal is struck.

    Confirmations are checked promptly upon receipt in accordance with the London Code. Any discrepancies should be advised by no later than 3.00 pm on the business day following trade date, if not sooner.

    [Annex 1 and 2 are omitted from this text.]

    Appendix III European Community Documents

    Appendix III 1 EC Directive on Deposit-Guarantee Schemes

    Council Directive1

    30 May 1994

    on deposit-guarantee schemes

    (94/19/EC)

    The European Parliament and the Council of the European Union,

    Having regard to the Treaty establishing the European Community, and in particular the first and third sentences of Article 57(2) thereof,

    Having regard to the proposal from the Commission,2

    Having regard to the opinion of the Economic and Social Committee,3

    Acting in accordance with the procedure referred to in Article 189b of the Treaty,4

    Whereas, in accordance with the objectives of the Treaty, the harmonious development of the activities of credit institutions throughout the Community should be promoted through the elimination of all restrictions on the right of establishment and the freedom to provide services, while increasing the stability of the banking system and protection for savers;

    Whereas, when restrictions on the activities of credit institutions are eliminated, consideration should be given to the situation which might arise if deposits in a credit institution that has branches in other Member States become unavailable; whereas it is indispensable to ensure a harmonized minimum level of deposit protection wherever deposits are located in the Community; whereas such deposit protection is as essential as the prudential rules for the completion of the single banking market;

    Whereas in the event of the closure of an insolvent credit institution the depositors at any branches situated in a Member State other than that in which the credit institution has its head office must be protected by the same guarantee scheme as the institution’s other depositors;

    Whereas the cost to credit institutions of participating in a guarantee scheme bears no relation to the cost that would result from a massive withdrawal of bank deposits not only from a credit institution in difficulties but also from healthy institutions following a loss of depositor confidence in the soundness of the banking system;

    Whereas the action the Member States have taken in response to Commission recommendation 87/63/EEC of 22 December 1986 concerning the introduction of deposit-guarantee schemes in the Community5 has not fully achieved the desired result; whereas that situation may prove prejudicial to the proper functioning of the internal market;

    Whereas the Second Council Directive 89/646/EEC of 15 December 1989 on the coordination of laws, regulations and administrative provisions relating to the taking up and pursuit of the business of credit institutions and amending Directive 77/780/EEC,6 provides for a system for the single authorization of each credit institution and its supervision by the authorities of its home Member State, which entered into force on 1 January 1993;

    Whereas a branch no longer requires authorization in any host Member State, because the single authorization is valid throughout the Community, and its solvency will be monitored by the competent authorities of its home Member State; whereas that situation justifies covering all the branches of the same credit institution set up in the Community by means of a single guarantee scheme; whereas that scheme can only be that which exists for that category of institution in the State in which that institution’s head office is situated, in particular because of the link which exists between the supervision of a branch’s solvency and its membership of a deposit-guarantee scheme;

    Whereas harmonization must be confined to the main elements of deposit-guarantee schemes and, within a very short period, ensure payments under a guarantee calculated on the basis of a harmonized minimum level;

    Whereas deposit-guarantee schemes must intervene as soon as deposits become unavailable;

    Whereas it is appropriate to exclude from cover, in particular, the deposits made by credit institutions on their own behalf and for own account; whereas that should not prejudice the right of a guarantee scheme to take any measures necessary for the rescue of a credit institution that finds itself in difficulties;

    Whereas the harmonization of deposit-guarantee schemes within the Community does not of itself call into question the existence of systems in operation designed to protect credit institutions, in particular by ensuring their solvency and liquidity, so that deposits with such credit institutions, including their branches established in other Member States, will not become unavailable; whereas such alternative systems serving a different protective purpose may, subject to certain conditions, be deemed by the competent authorities to satisfy the objectives of this Directive; whereas it will be for those competent authorities to verify compliance with those conditions;

    Whereas several Member States have deposit-protection schemes under the responsibility of professional organizations, other Member States have schemes set up and regulated on a statutory basis and some schemes, although set up on a contractual basis, are partly regulated by statute; whereas that variety of status poses a problem only with regard to compulsory membership of and exclusion from schemes; whereas it is therefore necessary to take steps to limit the powers of schemes in this area;

    Whereas the retention in the Community of schemes providing cover for deposits which is higher than the harmonized minimum may, within the same territory, lead to disparities in compensation and unequal conditions of competition between national institutions and branches of institutions from other Member States; whereas, in order to counteract those disadvantages, branches should be authorized to join their host countries’ schemes so that they can offer their depositors the same guarantees as are offered by the schemes of the countries in which they are located; whereas it is appropriate that after a number of years the Commission should report on the extent to which branches have made use of this option and on the difficulties which they or the guarantee schemes may have encountered in implementing these provisions; whereas it is not ruled out that home Member State schemes should themselves offer such complementary cover, subject to the conditions such schemes may lay down;

    Whereas market disturbances could be caused by branches of credit institutions which offer levels of cover higher than those offered by credit institutions authorized in their host Member States; whereas it is not appropriate that the level of scope of cover offered by guarantee schemes should become an instrument of competition; whereas it is therefore necessary, at least during an initial period, to stipulate that the level and scope of cover offered by a home Member State scheme to depositors at branches located in another Member State should not exceed the maximum level and scope offered by the corresponding scheme in the host Member State; whereas possible market disturbances should be reviewed after a number of years, on the basis of the experience acquired and in the light of developments in the banking sector;

    Whereas in principle this Directive requires every credit institution to join a deposit-guarantee scheme; whereas the Directives governing the admission of any credit institution which has its head office in a non-member country, and in particular the First Council Directive (77/780/EEC) of 12 December 1977 on the coordination of the laws, regulations and administrative provisions relating to the taking up and pursuit of the business of credit institutions,7 allow Member States to decide whether and subject to what conditions to permit the branches of such credit institutions to operate within their territories; whereas such branches will not enjoy the freedom to provide services under the second paragraph of Article 59 of the Treaty, nor the right of establishment in Member States other than those in which they are established; whereas, accordingly, a Member State admitting such branches should decide how to apply the principles of this Directive to such branches in accordance with Article 9(1) of Directive 77/780/EEC and with the need to protect depositors and maintain the integrity of the financial system; whereas it is essential that depositors at such branches should be fully aware of the guarantee arrangements which affect them;

    Whereas, on the one hand, the minimum guarantee level prescribed in this Directive should not leave too great a proportion of deposits without protection in the interest both of consumer protection and of the stability of the financial system; whereas, on the other hand, it would not be appropriate to impose throughout the Community a level of protection which might in certain cases have the effect of encouraging the unsound management of credit institutions; whereas the cost of funding schemes should be taken into account; whereas it would appear reasonable to set the harmonized minimum guarantee level at ECU 20 000; whereas limited transitional arrangements might be necessary to enable schemes to comply with that figure;

    Whereas some Member States offer depositors cover for their deposits which is higher than the harmonized minimum guarantee level provided for in this Directive; whereas it does not seem appropriate to require that such schemes, certain of which have been introduced only recently pursuant to recommendation 87/63/EEC, be amended on this point;

    Whereas a Member State must be able to exclude certain categories of specifically listed deposits or depositors, if it does not consider that they need special protection, from the guarantee afforded by deposit-guarantee schemes;

    Whereas in certain Member States, in order to encourage depositors to look carefully at the quality of credit institutions, unavailable deposits are not fully reimbursed; whereas such practices should be limited in respect of deposits falling below the minimum harmonized level;

    Whereas the principle of a harmonized minimum limit per depositor rather than per deposit has been retained; whereas it is therefore appropriate to take into consideration the deposits made by depositors who either are not mentioned as holders of an account or are not the sole holders; whereas the limit must therefore be applied to each identifiable depositor; whereas that should not apply to collective investment undertakings subject to special protection rules which do not apply to the aforementioned deposits;

    Whereas information is an essential element in depositor protection and must therefore also be the subject of a minimum number of binding provisions; whereas, however, the unregulated use in advertising of references to the amount and scope of a deposit-guarantee scheme could affect the stability of the banking system or depositor confidence; whereas Member States should therefore lay down rules to limit such references;

    Whereas, in specific cases, in certain Member States in which there are no deposit-guarantee schemes for certain classes of credit institutions which take only an extremely small proportion of deposits, the introduction of such a system may in some cases take longer than the time laid down for the transposition of this Directive; whereas in such cases a transitional derogation from the requirement to belong to a deposit-guarantee scheme may be justified; whereas, however, should such credit institutions operate abroad, a Member State would be entitled to require their participation in a deposit-guarantee scheme which it had set up;

    Whereas it is not indispensable, in this Directive, to harmonize the methods of financing schemes guaranteeing deposits or credit institutions themselves, given, on the one hand, that the cost of financing such schemes must be borne, in principle, by credit institutions themselves and, on the other hand, that the financing capacity of such schemes must be in proportion to their liabilities; whereas this must not, however, jeopardize the stability of the banking system of the Member State concerned;

    Whereas this Directive may not result in the Member States’ or their competent authorities’ being made liable in respect of depositors if they have ensured that one or more schemes guaranteeing deposits or credit institutions themselves and ensuring the compensation or protection of depositors under the conditions prescribed in this Directive have been introduced and officially recognized;

    Whereas deposit protection is an essential element in the completion of the internal market and an indispensable supplement to the system of supervision of credit institutions on account of the solidarity it creates amongst all the institutions in a given financial market in the event of the failure of any of them,

    Has Adopted This Directive:

    Article 1

    For the purposes of this Directive:

    • ‘deposit’ shall mean any credit balance which results from funds left in an account or from temporary situations deriving from normal banking transactions and which a credit institution must repay under the legal and contractual conditions applicable, and any debt evidenced by a certificate issued by a credit institution.

      Shares in United Kingdom and Irish building societies apart from those of a capital nature covered in Article 2 shall be treated as deposits.

      Bonds which satisfy the conditions prescribed in Article 22(4) of Council Directive 85/61 I/EEC of 20 December 1985 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS)8 shall not be considered deposits.

      For the purpose of calculating a credit balance, Member States shall apply the rules and regulations relating to set-off and counterclaims according to the legal and contractual conditions applicable to a deposit;

    • ‘joint account’ shall mean an account opened in the names of two or more persons or over which two or more persons have rights that may operate against the signature of one or more of those persons;

    • ‘unavailable deposit’ shall mean a deposit that is due and payable but has not been paid by a credit institution under the legal and contractual conditions applicable thereto, where either:

      • (i) the relevant competent authorities have determined that in their view the credit institution concerned appears to be unable for the time being, for reasons which are directly related to its financial circumstances, to repay the deposit and to have no current prospect of being able to do so.

      • The competent authorities shall make that determination as soon as possible and at die latest 21 days after first becoming satisfied that a credit institution has failed to repay deposits which are due and payable; or

      • (ii) a judicial authority has made a ruling for reasons which are directly related to the credit institution’s financial circumstances which has the effect of suspending depositors’ ability to make claims against it, should that occur before the aforementioned determination has been made;

    • ‘credit institution’ shall mean an undertaking the business of which is to receive deposits or other repayable funds from the public and to grant credits for its own account;

    • ‘branch’ shall mean a place of business which forms a legally dependent part of a credit institution and which conducts directly all or some of the operations inherent in the business of credit institutions; any number of branches set up in the same Member State by a credit institution which has its head office in another Member State shall be regarded as a single branch.

    Article 2

    The following shall be excluded from any repayment by guarantee schemes:

    • subject to Article 8(3), deposits made by other credit institutions on their own behalf and for their own account,

    • all instruments which would fall within the definition of ‘own funds’ in Article 2 of Council Directive 89/299/EEC of 17 April 1989 on the own funds of credit institutions,9

    • deposits arising out of transactions in connection with which there has been a criminal conviction for money laundering as defined in Article 1 of Council Directive 91/308/EEC of 10 June 1991 on prevention of the use of the financial system for the purpose of money laundering.10

    Article 3

    1. Each Member State shall ensure that within its territory one or more deposit-guarantee schemes are introduced and officially recognized. Except in the circumstances envisaged in the second subparagraph and in paragraph 4, no credit institution authorized in that Member State pursuant to Article 3 of Directive 77/780/EEC may take deposits unless it is a member of such a scheme.

    A Member State may, however, exempt a credit institution from the obligation to belong to a deposit-guarantee scheme where that credit institution belongs to a system which protects the credit institution itself and in particular ensures its liquidity and solvency, thus guaranteeing protection for depositors at least equivalent to that provided by a deposit-guarantee scheme, and which, in the opinion of the competent authorities, fulfils the following conditions:

    • the system must be in existence and have been officially recognized when this Directive is adopted,

    • the system must be designed to prevent deposits with credit institutions belonging to the system from becoming unavailable and have the resources necessary for that purpose at its disposal,

    • the system must not consist of a guarantee granted to a credit institution by a Member State itself or by any of its local or regional authorities,

    • the system must ensure that depositors are informed in accordance with the terms and conditions laid down in Article 9.

    Those Member States which make use of this option shall inform the Commission accordingly; in particular, they shall notify the Commission of the characteristics of any such protective systems and the credit institutions covered by them and of any subsequent changes in the information supplied. The Commission shall inform the Banking Advisory Committee thereof.

    2. If a credit institution does not comply with the obligations incumbent on it as a member of a deposit-guarantee scheme, the competent authorities which issued its authorization shall be notified and, in collaboration with the guarantee scheme, shall take all appropriate measures including the imposition of sanctions to ensure that the credit institution complies with its obligations.

    3. If those measures fail to secure compliance on the part of the credit institution, the scheme may, where national law permits the exclusion of a member, with the express consent of the competent authorities, give not less than 12 months’ notice of its intention of excluding the credit institution from membership of the scheme. Deposits made before the expiry of the notice period shall continue to be fully covered by the scheme. If, on the expiry of the notice period, the credit institution has not complied with its obligations, the guarantee scheme may, again having obtained the express consent of the competent authorities, proceed to exclusion.

    4. Where national law permits, and with the express consent of the competent authorities which issued its authorization, a credit institution excluded from a deposit-guarantee scheme may continue to take deposits if, before its exclusion, it has made alternative guarantee arrangements which ensure that depositors will enjoy a level and scope of protection at least equivalent to that offered by the officially recognized scheme.

    5. If a credit institution the exclusion of which is proposed under paragraph 3 is unable to make alternative arrangements which comply with the conditions prescribed in paragraph 4, then the competent authorities which issued its authorization shall revoke it forthwith.

    Article 4

    1. Deposit-guarantee schemes introduced and officially recognized in a Member State in accordance with Article 3(1) shall cover the depositors at branches set up by credit institutions in other Member States.

    Until 31 December 1999 neither the level nor the scope, including the percentage, of cover provided shall exceed the maximum level or scope of cover offered by the corresponding guarantee scheme within the territory of the host Member State.

    Before that date, the Commission shall draw up a report on the basis of the experience acquired in applying the second subparagraph and shall consider the need to continue those arrangements. If appropriate, the Commission shall submit a proposal for a Directive to the European Parliament and the Council, with a view to the extension of their validity.

    2. Where the level and/or scope, including the percentage, of cover offered by the host Member State guarantee scheme exceeds the level and/or scope of cover provided in the Member State in which a credit institution is authorized, the host Member State shall ensure that there is an officially recognized deposit-guarantee scheme within its territory which a branch may join voluntarily in order to supplement the guarantee which its depositors already enjoy by virtue of its membership of its home Member State scheme.

    The scheme to be joined by the branch shall cover the category of institution to which it belongs or most closely corresponds in the host Member State.

    3. Member States shall ensure that objective and generally applied conditions are established for branches’ membership of a host Member State’s scheme in accordance with paragraph 2. Admission shall be conditional on fulfilment of the relevant obligations of membership, including in particular payment of any contributions and other charges. Member States shall follow the guiding principles set out in Annex II in implementing this paragraph.

    4. If a branch granted voluntary membership under paragraph 2 does not comply with the obligations incumbent on it as a member of a deposit-guarantee scheme, the competent authorities which issued the authorization shall be notified and, in collaboration with the guarantee scheme, shall take all appropriate measures to ensure that the aforementioned obligations are complied with.

    If those measures fail to secure the branch’s compliance with the aforementioned obligations, after an appropriate period of notice of not less than 12 months the guarantee scheme may, with the consent of the competent authorities which issued the authorization, exclude the branch. Deposits made before the date of exclusion shall continue to be covered by the voluntary scheme until the dates on which they fall due. Depositors shall be informed of the withdrawal of the supplementary cover.

    5. The Commission shall report on the operation of paragraphs 2, 3 and 4 no later than 31 December 1999 and shall, if appropriate, propose amendments thereto.

    Article 5

    Deposits held when the authorization of a credit institution authorized pursuant to Article 3 of Directive 77/780/EEC is withdrawn shall continue to be covered by the guarantee scheme.

    Article 6

    1. Member States shall check that branches established by a credit institution which has its head office outwith the Community have cover equivalent to that prescribed in this Directive.

    Failing that, Member States may, subject to Article 9(1) of Directive 77/780/EEC, stipulate that branches established by a credit institution which has its head office outwith the Community must join deposit-guarantee schemes in operation within their territories.

    2. Actual and intending depositors at branches established by a credit institution which has its head office outwith the Community shall be provided by the credit institution with all relevant information concerning the guarantee arrangements which cover their deposits.

    3. The information referred to in paragraph 2 shall be made available in the official language or languages of the Member State in which a branch is established in the manner prescribed by national law and shall be drafted in a clear and comprehensible form.

    Article 7

    1. Deposit-guarantee schemes shall stipulate that the aggregate deposits of each depositor must be covered up to ECU 20 000 in the event of deposits’ being unavailable.

    Until 31 December 1999 Member States in which, when this Directive is adopted, deposits are not covered up to ECU 20 000 may retain the maximum amount laid down in their guarantee schemes, provided that this amount is not less than ECU 15 000.

    2. Member States may provide that certain depositors or deposits shall be excluded from guarantee or shall be granted a lower level of guarantee. Those exclusions are listed in Annex I.

    3. This Article shall not preclude the retention or adoption of provisions which offer a higher or more comprehensive cover for deposits. In particular, deposit-guarantee schemes may, on social considerations, cover certain kinds of deposits in full.

    4. Member States may limit the guarantee provided for in paragraph 1 or that referred to in paragraph 3 to a specified percentage of deposits. The percentage guaranteed must, however, be equal to or exceed 90% of aggregate deposits until the amount to be paid under the guarantee reaches the amount referred to in paragraph 1.

    5. The amount referred to in paragraph 1 shall be reviewed periodically by the Commission at least once every five years. If appropriate, the Commission shall submit to the European Parliament and to the Council a proposal for a Directive to adjust the amount referred to in paragraph 1, taking account in particular of developments in the banking sector and the economic and monetary situation in the Community. The first review shall not take place until five years after the end of the period referred to in Article 7(1), second subparagraph.

    6. Member States shall ensure that the depositor’s rights to compensation may be the subject of an action by the depositor against the deposit-guarantee scheme.

    Article 8

    1. The limits referred to in Article 7(1), (3) and (4) shall apply to the aggregate deposits placed with the same credit institution irrespective of the number of deposits, the currency and the location within the Community.

    2. The share of each depositor in a joint account shall be taken into account in calculating the limits provided for in Article 7(1), (3) and (4).

    In the absence of special provisions, such an account shall be divided equally amongst the depositors.

    Member States may provide that deposits in an account to which two or more persons are entitled as members of a business partnership, association or grouping of a similar nature, without legal personality, may be aggregated and treated as if made by a single depositor for the purpose of calculating the limits provided for in Article 7(1), (3) and (4).

    3. Where the depositor is not absolutely entitled to the sums held in an account, the person who is absolutely entitled shall be covered by the guarantee, provided that that person has been identified or is identifiable before the date on which the competent authorities make the determination described in Article l(3)(i) or the judicial authority makes the ruling described in Article l(3)(ii). If there are several persons who are absolutely entitled, the share of each under the arrangements subject to which the sums are managed shall be taken into account when the limits provided for in Article 7(1), (3) and (4) are calculated.

    This provision shall not apply to collective investment undertakings.

    Article 9

    1. Member States shall ensure that credit institutions make available to actual and intending depositors the information necessary for the identification of the deposit-guarantee scheme of which the institution and its branches are members within the Community or any alternative arrangement provided for in Article 3(1), second subparagraph, or Article 3(4). The depositors shall be informed of the provisions of the deposit-guarantee scheme or any alternative arrangement applicable, including the amount and scope of the cover offered by the guarantee scheme. That information shall be made available in a readily comprehensible manner.

    Information shall also be given on request on the conditions for compensation and the formalities which must be completed to obtain compensation.

    2. The information provided for in paragraph 1 shall be made available in the manner prescribed by national law in the official language or languages of the Member State in which the branch is established.

    3. Member States shall establish rules limiting the use in advertising of the information referred to in paragraph 1 in order to prevent such use from affecting the stability of the banking system or depositor confidence. In particular, Member States may restrict such advertising to a factual reference to the scheme to which a credit institution belongs.

    Article 10

    1. Deposit-guarantee schemes shall be in a position to pay duly verified claims by depositors in respect of unavailable deposits within three months of the date on which the competent authorities make the determination described in Article l(3)(i) or the judicial authority makes the ruling described in Article l(3)(ii).

    2. In wholly exceptional circumstances and in special cases a guarantee scheme may apply to the competent authorities for an extension of the time limit. No such extension shall exceed three months. The competent authorities may, at the request of the guarantee scheme, grant no more than two further extensions, neither of which shall exceed three months.

    3. The time limit laid down in paragraphs 1 and 2 may not be invoked by a guarantee scheme in order to deny the benefit of guarantee to any depositor who has been unable to assert his claim to payment under a guarantee in time.

    4. The documents relating to the conditions to be fulfilled and the formalities to be completed to be eligible for a payment under the guarantee referred to in paragraph 1 shall be drawn up in detail in the manner prescribed by national law in the official language or languages of the Member State in which the guaranteed deposit is located.

    5. Notwithstanding the time limit laid down in paragraphs 1 and 2, where a depositor or any person entitled to or interested in sums held in an account has been charged with an offence arising out of or in relation to money laundering as defined in Article 1 of Directive 91/308/EEC, the guarantee scheme may suspend any payment pending the judgment of the court.

    Article 11

    Without prejudice to any other rights which they may have under national law, schemes which make payments under guarantee shall have the right of subrogation to the rights of depositors in liquidation proceedings for an amount equal to their payments.

    Article 12

    Notwithstanding Article 3, those institutions authorized in Spain or in Greece and listed in Annex III shall be exempt from the requirement to belong to a deposit-guarantee scheme until 31 December 1999.

    Such credit institutions shall expressly alert their actual and intending depositors to the fact that they are not members of any deposit-guarantee scheme.

    During that time, should any such credit institution establish or have established a branch in another Member State, that Member State may require that branch to belong to a deposit-guarantee scheme set up within its territory under conditions consonant with those prescribed in Article 4(2), (3) and (4).

    Article 13

    In the list of authorized credit institutions which it is required to draw up pursuant to Article 3(7) of Directive 77/780/EEC the Commission shall indicate the status of each credit institution with regard to this Directive.

    Article 14

    1. The Member States shall bring into force the laws, regulations and administrative provisions necessary for them to comply with this Directive by 1 July 1995. They shall forthwith inform the Commission thereof.

    When the Member States adopt these measures they shall contain a reference to this Directive or shall be accompanied by such reference on the occasion of their official publication. The methods of making such reference shall be laid down by the Member States.

    2. The Member States shall communicate to the Commission the texts of the main provisions of national law which they adopt in the field governed by this Directive.

    Article 15

    This Directive shall enter into force on the day of its publication in the Official Journal of the European Communities.

    Article 16

    This Directive is addressed to the Member States.

    Done at Brussels, 30 May 1994.

    For the European ParliamentFor the Council
    The PresidentThe President
    E. KLEPSCHG. ROMEOS

    ANNEX I

    List of exclusions referred to in Article 7(2)

    • Deposits by financial institutions as defined in Article 1(6) of Directive 89/646/EEC.

    • Deposits by insurance undertakings.

    • Deposits by government and central administrative authorities.

    • Deposits by provincial, regional, local and municipal authorities.

    • Deposits by collective investment undertakings.

    • Deposits by pension and retirement funds.

    • Deposits by a credit institution’s own directors, managers, members personally liable, holders of at least 5% of the credit institution’s capital, persons responsible for carrying out the statutory audits of the credit institution’s accounting documents and depositors of similar status in other companies in the same group.

    • Deposits by close relatives and third parties acting on behalf of the depositors referred to in 7.

    • Deposits by other companies in the same group.

    • Non-nominative deposits.

    • Deposits for which the depositor has, on an individual basis, obtained from the same credit institution rates and financial concessions which have helped to aggravate its financial situation.

    • Debt securities issued by the same institution and liabilities arising out of own acceptances and promissory notes.

    • Deposits in currencies other than:

      • those of the Member States,

      • ecus.

    • Deposits by companies which are of such a size that they are not permitted to draw up abridged balance sheets pursuant to Article 11 of the Fourth Council Directive (78/660/EEC) of 25 July 1978 based on Article 54(3)(g) of the Treaty on the annual accounts of certain types of companies.11

    ANNEX II

    Guiding principles

    Where a branch applies to join a host Member State scheme for supplementary cover, the host Member State scheme will bilaterally establish with the home Member State scheme appropriate rules and procedures for paying compensation to depositors at that branch. The following principles shall apply both to the drawing up of those procedures and in the framing of the membership conditions applicable to such a branch (as referred to in Article 4(2)):

    • (a) the host Member State scheme will retain full rights to impose its objective and generally applied rules on participating credit institutions; it will be able to require the provision of relevant information and have the right to verify such information with the home Member State’s competent authorities;

    • (b) the host Member State scheme will meet claims for supplementary compensation upon a declaration from the home Member State’s competent authorities that deposits are unavailable. The host Member State scheme will retain full rights to verify a depositor’s entitlement according to its own standards and procedures before paying supplementary compensation;

    • (c) home Member State and host Member State schemes will cooperate fully with each other to ensure that depositors receive compensation promptly and in the correct amounts. In particular, they will agree on how the existence of a counterclaim which may give rise to set-off under either scheme will affect the compensation paid to the depositor by each scheme;

    • (d) host Member State schemes will be entitled to charge branches for supplementary cover on an appropriate basis which takes into account the guarantee funded by the home Member State scheme. To facilitate charging, the host Member State scheme will be entitled to assume that its liability will in all circumstances be limited to the excess of the guarantee it has offered over the guarantee offered by the home Member State regardless of whether the home Member State actually pays any compensation in respect of deposits held within the host Member State’s territory.

    ANNEX III

    List of credit institutions mentioned in Article 12

    • (a) Specialized classes of Spanish institutions, the legal status of which is currently undergoing reform, authorized as

      • Entidades de Financiación o Factoring,

      • Sociedades de Arrendamiento Financiero,

      • Sociedades de Crédito Hipotecario.

    • (b) The following Spanish state institutions:

      • Banco de Crédito Agricola, SA,

      • Banco Hipotecario de España, SA,

      • Banco de Crédito Local, SA.

    • (c) The following Greek credit cooperatives:

      • Lamia Credit Cooperative,

      • Ioannina Credit Cooperative,

      • Xylocastron Credit Cooperative,

        as well as those of the credit cooperatives of a similar nature listed below which are authorized or in the process of being authorized on the date of the adoption of this Directive:

      • Chania Credit Cooperative,

      • Iraklion Credit Cooperative,

      • Magnissia Credit Cooperative,

      • Larissa Credit Cooperative,

      • Patras Credit Cooperative,

      • Thessaloniki Credit Cooperative.

    Appendix III 2 EC Directive on Unfair Terms in Consumer Contracts

    Council Directive1

    5 April 1993

    on unfair terms in consumer contracts

    (93/13/EEC)

    The Council of the European Communities,

    Having regard to the Treaty establishing the European Economic Community, and in particular Article 100A thereof,

    Having regard to the proposal from the Commission,2

    In cooperation with the European Parliament,3

    Having regard to the opinion of the Economic and Social Committee,4

    Whereas it is necessary to adopt measures with the aim of progressively establishing the internal market before 31 December 1992; whereas the internal market comprises an area without internal frontiers in which goods, persons, services and capital move freely;

    Whereas the laws of Member States relating to the terms of contract between the seller of goods or supplier of services, on the one hand, and the consumer of them, on the other hand, show many disparities, with the result that the national markets for the sale of goods and services to consumers differ from each other and that distortions of competition may arise amongst the sellers and suppliers, notably when they sell and supply in other Member States;

    Whereas, in particular, the laws of Member States relating to unfair terms in consumer contracts show marked divergences;

    Whereas it is the responsibility of the Member States to ensure that contracts concluded with consumers do not contain unfair terms;

    Whereas, generally speaking, consumers do not know the rules of law which, in Member States other than their own, govern contracts for the sale of goods or services; whereas this lack of awareness may deter them from direct transactions for the purchase of goods or services in another Member State;

    Whereas, in order to facilitate the establishment of the internal market and to safeguard the citizen in his role as consumer when acquiring goods and services under contracts which are governed by the laws of Member States other than his own, it is essential to remove unfair terms from those contracts;

    Whereas sellers of goods and suppliers of services will thereby be helped in their task of selling goods and supplying services, both at home and throughout the internal market; whereas competition will thus be stimulated, so contributing to increased choice for Community citizens as consumers;

    Whereas the two Community programmes for a consumer protection and information policy5 underlined the importance of safeguarding consumers in the matter of unfair terms of contract; whereas this protection ought to be provided by laws and regulations which are either harmonized at Community level or adopted directly at that level;

    Whereas in accordance with the principle laid down under the heading ‘Protection of the economic interests of the consumers’, as stated in those programmes: ‘acquirers of goods and services should be protected against the abuse of power by the seller or supplier, in particular against one sided standard contracts and the unfair exclusion of essential rights in contracts’;

    Whereas more effective protection of the consumer can be achieved by adopting uniform rules of law in the matter of unfair terms; whereas those rules should apply to all contracts concluded between sellers or suppliers and consumers; whereas as a result inter alia contracts relating to employment, contracts relating to succession rights, contracts relating to rights under family law and contracts relating to the incorporation and organization of companies or partnership agreements must be excluded from this Directive;

    Whereas the consumer must receive equal protection under contracts concluded by word of mouth and written contracts regardless, in the latter case, of whether the terms of the contract are contained in one or more documents;

    Whereas, however, as they now stand, national laws allow only partial harmonization to be envisaged; whereas, in particular, only contractual terms which have not been individually negotiated are covered by this Directive; whereas Member States should have the option, with due regard for the Treaty, to afford consumers a higher level of protection through national provisions that are more stringent than those of this Directive;

    Whereas the statutory or regulatory provisions of the Member States which directly or indirectly determine the terms of consumer contracts are presumed not to contain unfair terms; whereas, therefore, it does not appear to be necessary to subject the terms which reflect mandatory statutory or regulatory provisions and the principles or provisions of international conventions to which the Member States or the Community are party; whereas in that respect the wording ‘mandatory statutory or regulatory provisions’ in Article 1(2) also covers rules which, according to the law, shall apply between the contracting parties provided that no other arrangements have been established;

    Whereas Member States must however ensure that unfair terms are not included, particularly because this Directive also applies to trades, business or professions of a public nature;

    Whereas it is necessary to fix in a general way the criteria for assessing the unfair character of contract terms;

    Whereas the assessment, according to the general criteria chosen, of the unfair character of terms, in particular in sale or supply activities of a public nature providing collective services which take account of solidarity among users, must be supplemented by a means of making an overall evaluation of the different interests involved; whereas this constitutes the requirement of good faith; whereas, in making an assessment of good faith, particular regard shall be had to the strength of the bargaining positions of the parties, whether the consumer had an inducement to agree to the term and whether the goods or services were sold or supplied to the special order of the consumer; whereas the requirement of good faith may be satisfied by the seller or supplier where he deals fairly and equitably with the other party whose legitimate interests he has to take into account;

    Whereas, for the purposes of this Directive, the annexed list of terms can be of indicative value only and, because of the cause of the minimal character of the Directive, the scope of these terms may be the subject of amplification or more restrictive editing by the Member States in their national laws;

    Whereas the nature of goods or services should have an influence on assessing the unfairness of contractual terms;

    Whereas, for the purposes of this Directive, assessment of unfair character shall not be made of terms which describe the main subject matter of the contract nor the quality/price ratio of the goods or services supplied; whereas the main subject matter of the contract and the price/quality ratio may nevertheless be taken into account in assessing the fairness of other terms; whereas it follows, inter alia, that in insurance contracts, the terms which clearly define or circumscribe the insured risk and the insurer’s liability shall not be subject to such assessment since these restrictions are taken into account in calculating the premium paid by the consumer;

    Whereas contracts should be drafted in plain, intelligible language, the consumer should actually be given an opportunity to examine all the terms and, if in doubt, the interpretation most favourable to the consumer should prevail;

    Whereas Member States should ensure that unfair terms are not used in contracts concluded with consumers by a seller or supplier and that if, nevertheless, such terms are so used, they will not bind the consumer, and the contract will continue to bind the parties upon those terms if it is capable of continuing in existence without the unfair provisions;

    Whereas there is a risk that, in certain cases, the consumer may be deprived of protection under this Directive by designating the law of a non-Member country as the law applicable to the contract; whereas provisions should therefore be included in this Directive designed to avert this risk;

    Whereas persons or organizations, if regarded under the law of a Member State as having a legitimate interest in the matter, must have facilities for initiating proceedings concerning terms of contract drawn up for general use in contracts concluded with consumers, and in particular unfair terms, either before a court or before an administrative authority competent to decide upon complaints or to initiate appropriate legal proceedings; whereas this possibility does not, however, entail prior verification of the general conditions obtaining in individual economic sectors;

    Whereas the courts or administrative authorities of the Member States must have at their disposal adequate and effective means of preventing the continued application of unfair terms in consumer contracts,

    Has Adopted this Directive:

    Article 1

    1. The purpose of this Directive is to approximate the laws, regulations and administrative provisions of the Member States relating to unfair terms in contracts concluded between a seller or supplier and a consumer.

    2. The contractual terms which reflect mandatory statutory or regulatory provisions and the provisions or principles of international conventions to which the Member States or the Community are party, particularly in the transport area, shall not be subject to the provisions of this Directive.

    Article 2

    For the purposes of this Directive:

    • (a) ‘unfair terms’ means the contractual terms defined in Article 3;

    • (b) ‘consumer’ means any natural person who, in contracts covered by this Directive, is acting for purposes which are outside his trade, business or profession;

    • (c) ‘seller or supplier’ means any natural or legal person who, in contracts covered by this Directive, is acting for purposes relating to his trade, business or profession, whether publicly owned or privately owned.

    Article 3

    1. A contractual term which has not been individually negotiated shall be regarded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer.

    2. A term shall always be regarded as not individually negotiated where it has been drafted in advance and the consumer has therefore not been able to influence the substance of the term, particularly in the context of a preformulated standard contract.

    The fact that certain aspects of a term or one specific term have been individually negotiated shall not exclude the application of this Article to the rest of a contract if an overall assessment of the contract indicates that it is nevertheless a pre-formulated standard contract.

    Where any seller or supplier claims that a standard term has been individually negotiated, the burden of proof in this respect shall be incumbent on him.

    3. The Annex shall contain an indicative and non-exhaustive list of the terms which may be regarded as unfair.

    Article 4

    1. Without prejudice to Article 7, the unfairness of a contractual term shall be assessed, taking into account the nature of the goods or services for which the contract was concluded and by referring, at the time of conclusion of the contract, to all the circumstances attending the conclusion of the contract and to all the other terms of the contract or of another contract on which it is dependent.

    2. Assessment of the unfair nature of the terms shall relate neither to the definition of the main subject matter of the contract nor to the adequacy of the price and remuneration, on the one hand, as against the services or goods supplies in exchange, on the other, in so far as these terms are in plain intelligible language.

    Article 5

    In the case of contracts where all or certain terms offered to the consumer are in writing, these terms must always be drafted in plain, intelligible language. Where there is doubt about the meaning of a term, the interpretation most favourable to the consumer shall prevail. This rule on interpretation shall not apply in the context of the procedures laid down in Article 7(2).

    Article 6

    1. Member States shall lay down that unfair terms used in a contract concluded with a consumer by a seller or supplier shall, as provided for under their national law, not be binding on the consumer and that the contract shall continue to bind the parties upon those terms if it is capable of continuing in existence without the unfair terms.

    2. Member States shall take the necessary measures to ensure that the consumer does not lose the protection granted by this Directive by virtue of the choice of the law of a non-Member country as the law applicable to the contract if the latter has a close connection with the territory of the Member States.

    Article 7

    1. Member States shall ensure that, in the interests of consumers and of competitors, adequate and effective means exist to prevent the continued use of unfair terms in contracts concluded with consumers by sellers or suppliers.

    2. The means referred to in paragraph 1 shall include provisions whereby persons or organizations, having a legitimate interest under national law in protecting consumers, may take action according to the national law concerned before the courts or before competent administrative bodies for a decision as to whether contractual terms drawn up for general use are unfair, so that they can apply appropriate and effective means to prevent the continued use of such terms.

    3. With due regard for national laws, the legal remedies referred to in paragraph 2 may be directed separately or jointly against a number of sellers or suppliers from the same economic sector or their associations which use or recommend the use of the same general contractual terms or similar terms.

    Article 8

    Member States may adopt or retain the most stringent provisions compatible with the Treaty in the area covered by this Directive, to ensure a maximum degree of protection for the consumer.

    Article 9

    The Commission shall present a report to the European Parliament and to the Council concerning the application of this Directive five years at the latest after the date in Article 10(1).

    Article 10

    1. Member States shall bring into force the laws, regulations and administrative provisions necessary to comply with this Directive no later than 31 December 1994. They shall forthwith inform the Commission thereof.

    These provisions shall be applicable to all contracts concluded after 31 December 1994.

    2. When Member States adopt these measures, they shall contain a reference to this Directive or shall be accompanied by such reference on the occasion of their official publication. The methods of making such a reference shall be laid down by the Member States.

    3. Member States shall communicate the main provisions of national law which they adopt in the field covered by this Directive to the Commission.

    Article 11

    This Directive is addressed to the Member States.

    Done at Luxembourg, 5 April 1993.

    For the Council

    The President

    N. HELVEG PETERSEN

    Annex

    TERMS REFERRED TO IN ARTICLE 3(3)

    1. Terms which have the object or effect of:

    (a) excluding or limiting the legal liability of a seller or supplier in the event of the death of a consumer or personal injury to the latter resulting from an act or omission of that seller or supplier;

    (b) inappropriately excluding or limiting the legal rights of the consumer vis-à-vis the seller or supplier or another party in the event of total or partial non-performance or inadequate performance by the seller or supplier of any of the contractual obligations, including the option of offsetting a debt owed to the seller or supplier against any claim which the consumer may have against him;

    (c) making an agreement binding on the consumer whereas provision of services by the seller or supplier is subject to a condition whose realization depends on his own will alone;

    (d) permitting the seller or supplier to retain sums paid by the consumer where the latter decides not to conclude or perform the contract, without providing for the consumer to receive compensation of an equivalent amount from the seller or supplier where the latter is the party cancelling the contract;

    (e) requiring any consumer who fails to fulfil his obligation to pay a disproportionately high sum in compensation;

    (f) authorizing the seller or supplier to dissolve the contract on a discretionary basis where the same facility is not granted to the consumer, or permitting the seller or supplier to retain the sums paid for services not yet supplied by him where it is the seller or supplier himself who dissolves the contract;

    (g) enabling the seller or supplier to terminate a contract of indeterminate duration without reasonable notice except where there are serious grounds for doing so;

    (h) automatically extending a contract of fixed duration where the consumer does not indicate otherwise, when the deadline fixed for the consumer to express this desire not to extend the contract is unreasonably early;

    (i) irrevocably binding the consumer to terms with which he had no real opportunity of becoming acquainted before the conclusion of die contract;

    (j) enabling the seller or supplier to alter the terms of the contract unilaterally without a valid reason which is specified in the contract;

    (k) enabling the seller or supplier to alter unilaterally without a valid reason any characteristics of the product or service to be provided;

    (l) providing for the price of goods to be determined at the time of delivery or allowing a seller of goods or supplier of services to increase their price without in both cases giving the consumer the corresponding right to cancel the contract if the final price is too high in relation to the price agreed when the contract was concluded;

    (m) giving the seller or supplier the right to determine whether the goods or services supplied are in conformity with the contract, or giving him the exclusive right to interpret any term of the contract;

    (n) limiting the seller’s or supplier’s obligation to respect commitments undertaken by his agents or making his commitments subject to compliance with a particular formality;

    (o) obliging the consumer to fulfil all his obligations where the seller or supplier does not perform his;

    (p) giving the seller or supplier the possibility of transferring his rights and obligations under the contract, where this may serve to reduce the guarantees for the consumer, without the latter’s agreement;

    (q) excluding or hindering the consumer’s right to take legal action or exercise any other legal remedy, particularly by requiring the consumer to take disputes exclusively to arbitration not covered by legal provisions, unduly restricting the evidence available to him or imposing on him a burden of proof which, according to the applicable law, should lie with another party to the contract.

    2. Scope of subparagraphs (g), (j) and (1)

    (a) Subparagraph (g) is without hindrance to terms by which a supplier of financial services reserves the right to terminate unilaterally a contract of indeterminate duration without notice where there is a valid reason, provided that the supplier is required to inform the other contracting party or parties thereof immediately.

    (b) Subparagraph (j) is without hindrance to terms under which a supplier of financial services reserves the right to alter the rate of interest payable by the consumer or due to the latter, or the amount of other charges for financial services without notice where there is a valid reason, provided that the supplier is required to inform the other contracting party or parties thereof at the earliest opportunity and that the latter are free to dissolve the contract immediately.

    Subparagraph (j) is also without hindrance to terms under which a seller or supplier reserves the right to alter unilaterally the conditions of a contract of indeterminate duration, provided that he is required to inform the consumer with reasonable notice and that the consumer is free to dissolve the contract.

    (c) Subparagraphs (g), (j) and (1) do not apply to:

    • transactions in transferable securities, financial instruments and other products or services where the price is linked to fluctuations in a stock exchange quotation or index or a financial market rate that the seller or supplier does not control;

    • contracts for the purchase or sale of foreign currency, traveller’s cheques or international money orders denominated in foreign currency;

    (d) Subparagraph (1) is without hindrance to price-indexation clauses, where lawful, provided that the method by which prices vary is explicitly described.

    This text is reproduced with permission of the GATT Secretariat. The GATS is part of the Final Act Embodying the Results of the Uruguay Round of Multilateral Trade Negotiations, December 15, 1993, reprinted in The Results of the Uruguay Round of Multilateral Trade Negotiations: The Legal Texts 327 (1994).

    This condition is understood in terms of number of sectors, volume of trade affected and modes of supply. In order to meet this condition, agreements should not provide for the a priori exclusion of any mode of supply.

    Typically, such integration provides citizens of the parties concerned with a right of free entry to the employment markets of the parties and includes measures concerning conditions of pay, other conditions of employment and social benefits.

    The term “relevant international organizations” refers to international bodies whose membership is open to the relevant bodies of at least all Members of the WTO.

    It is understood that the procedures under paragraph 5 shall be the same as the GATT 1994 procedures.

    The public order exception may be invoked only where a genuine and sufficiently serious threat is posed to one of the fundamental interests of society.

    Measures that are aimed at ensuring the equitable or effective imposition or collection of direct taxes include measures taken by a Member under its taxation system which:

    • (i) apply to non-resident service suppliers in recognition of the fact that the tax obligation of non-residents is determined with respect to taxable items sourced or located in the Members’ territory; or

    • (ii) apply to non-residents in order to ensure the imposition or collection of taxes in the Member’s territory; or

    • (iii) apply to non-residents or residents in order to prevent the avoidance or evasion of taxes, including compliance measures; or

    • (iv) apply to consumers of services supplied in or from the territory of another Member in order to ensure the imposition or collection of taxes on such consumers derived from sources in the Member’s territory; or

    • (v) distinguish service suppliers subject to tax on worldwide taxable items from other service suppliers, in recognition of the difference in the nature of the tax base between them; or

    • (vi) determine, allocate or apportion income, profit, gain, loss, deduction or credit of resident persons or branches, or between related persons or branches of the same person, in order to safeguard the Member’s tax base.

    Tax terms or concepts in paragraph (d) of Article XIV and in this footnote are determined according to tax definitions and concepts, or equivalent or similar definitions and concepts, under the domestic law of the Member taking the measure.

    A future work programme shall determine how, and in what time-frame negotiations on such multilateral disciplines will be conducted.

    If a Member undertakes a market-access commitment in relation to the supply of a service through the mode of supply referred to in subparagraph 2(a) of Article 1 and if the cross-border movement of capital is an essential part of the service itself, that Member is thereby committed to allow such movement of capital. If a Member undertakes a market-access commitment in relation to the supply of a service through the mode of supply referred to in subparagraph 2(c) of Article 1, it is thereby committed to allow related transfers of capital into its territory.

    Subparagraph 2(c) does not cover measures of a Member which limit inputs for the supply of services.

    Specific commitments assumed under this Article shall not be construed to require any Member to compensate for any inherent competitive disadvantages which result from the foreign character of the relevant services or service suppliers.

    With respect to agreements on the avoidance of double taxation which exist on the date of entry into force of the WTO Agreement, such a matter may be brought before the Council for Trade in Services only with the consent of both parties to such an agreement.

    Where the service is not supplied directly by a juridical person but through other forms of commercial presence such as a branch or a representative office, the service supplier, (i.e. the juridical person) shall, nonetheless, though such presence be accorded the treatment provided for service suppliers under the Agreement. Such treatment shall be extended to the presence through which the service is supplied and need not be extended to any other parts of the supplier located outside the territory where the service is supplied.

    The sole fact of requiring a visa for natural persons of certain members and not for those of others shall not be regarded as nullifying or impairing benefits under a specific commitment.

    This text is reproduced with permission from the GATT Secretariat. The Understanding is part of the Final Act Embodying the Results of the Uruguay Round of Multilateral Trade Negotiations, December 15, 1993, reprinted in The Results of the Uruguay Round of Multilateral Trade Negotiations: The Legal Texts 478 (1994).

    December 8, 11, 14, and 17, 1992, Canada - Mexico - United States.

    This text is reproduced with permission from the Foreign Exchange Committee. It was prepared by the Foreign Exchange Committee in association with the British Bankers’ Association and is dated November 1993.

    This text is reproduced with permission from the Foreign Exchange Committee. It was prepared by the British Banker’s Association and the Foreign Exchange Committee and is dated April 1992.

    1

    This text is reproduced with permission from the International Swap Dealers Association, Inc.

    Delete as applicable.

    This text is reproduced with permission from the Group of Thirty. It is an excerpt from Derivatives: Practices and Principles (July 1993), prepared by the Global Derivatives Study Group and published by the Group of Thirty, Washington, D.C.

    This text is reproduced with permission from the Basle Committee on Banking Supervision and the Technical Committee of the International Organization of Securities Commissions (IOSCO). It is an excerpt from Framework for Supervisory Information about the Derivatives Activities of Banks and Securities Firms (May 1995), prepared by the Basle Committee on Banking Supervision and the Technical Committee of the International Organization of Securities Commissions.

    Risk Management Guidelines for Derivatives, Basle Committee on Banking Supervision, July 1994, and Operational and Financial Risk Management Control Mechanisms for Over-the-Counter Derivatives Activities of Regulated Securities Firms. Technical Committee of IOSCO, July 1994.

    Annex 1 and 2 are not reprinted herein.

    Credit risk is of most concern in the case of OTC derivative contracts since exchange clearing houses for derivatives employ risk management systems that substantially mitigate credit risks to their members. Both futures and options exchanges typically mark exposures to market each day. In the case of futures exchanges, members’ exposures to the clearing house are eliminated each day, and often intra-day, through variation margin payments. In the case of options exchanges, clearing house exposures to written options are fully collateralised.

    Effective notional principal is obtained by adjusting the notional amount to reflect the true exposure of contracts that are leveraged or otherwise enhanced by the structure of the transaction.

    For example, supervisors could obtain additional insights through information on OTC contracts with collateral recognized under the Basle Capital Accord (for banks) and OTC contracts with other readily marketable, high quality securities as collateral.

    Market illiquidity may stem from the customized nature of some OTC contracts which can include fundamental elements of market risk in combinations that may not be easily replicated using standardized exchange-traded contracts or other OTC instruments.

    Under mark-to-market accounting, value-at-risk will equal earnings-at-risk because changes in value are reflected in earnings. If accrual accounting is applied to certain positions, value-at-risk and earnings-at-risk will differ because all changes in value are not reflected in earnings.

    The report of the Euro-currency Standing Committee, a discussion paper entitled, Public Disclosure of Market and Credit Risks by Financial Intermediaries, issued in September 1994 (Fisher Report), discusses factors to consider in interpreting value-at-risk measures, among other topics.

    As industry participants have recognized, trading revenue components may include: (1) origination revenue that results from the initial calculation of the market value of new transactions; (2) credit spread revenue that results from changes during the period in the unearned credit spread; and (3) other trading revenues resulting from changes in the value of the portfolio due to market movements and the passage of time.

    This text is reproduced with permission from the Basle Committee on Banking Supervision. It is an excerpt from Risk Management Guidelines for Derivatives (July 1994), prepared by the Basle Committee on Banking Supervision.

    This text is dated October 27, 1993. It comprises excerpts from the banking circular prepared by the Office of the Comptroller of the Currency.

    This text is reproduced with permission from the drafting group. This undated text was released on August 17, 1995.

    This text is reproduced with permission from the Bank for International Settlements. These minimum standards, known as the Lamfalussy Standards, are from the Committee on Interbank Netting Schemes of the Central Banks of the Group of Ten Countries, Report of the Committee on Interbank Netting Schemes of the Central Banks of the Group of Ten Countries 26 (November 1990).

    This text is reproduced with permission from the Bank for International Settlements. It is from the Report on Netting Schemes 6 (February 1989), prepared by the Group of Experts on Payment Systems of the Central Banks of the Group of Ten Countries.

    This text is reproduced with permission from the Basle Committee on Banking Supervision. It is the Annex to Basle Capital Accord: Treatment of Potential Exposure for Off-Balance-Sheet Items (April 1995) by the Basle Committee on Banking Supervision. The Report on International Convergence of Capital Measurement and Capital Standards (July 1988), known as the Basle Capital Accord, is reprinted in 1 Current Legal Issues Affecting Central Banks 487 (Robert C. Effros ed., 1992), and the 1992 amendment is reprinted in 3 Current Legal Issues Affecting Central Banks 296 (Robert C. Effros ed., 1995).

    The corresponding page number in the version reprinted in 1 Current Legal Issues Affecting Central Banks, supra, is page 510.

    Some national authorities may permit individual banks to choose which method to adopt, it being understood that once a bank has chosen to apply the current exposure method, it would not be allowed to switch back to the original exposure method.

    Where appropriate, national supervisors may allow an additional transition period, but in no case longer than 12 months.

    For interest rate contracts, there is national discretion as to whether the conversion factors are to be based on original or residual maturity. For exchange rate contracts and gold, the conversion factors are to be calculated according to the original maturity of the instrument.

    Payments netting, which is designed to reduce the operational costs of daily settlements, will not be recognized in the capital framework since the counterparty’s gross obligations are not in any way affected.

    In cases where an agreement as described in (a) has been recognized prior to July 1994, the supervisor will determine whether any additional steps are necessary to satisfy itself that the agreement meets the requirements set out below.

    Thus, if any of these supervisors is dissatisfied about enforceability under its laws, the netting contract or agreement will not meet this condition and neither counterparty could obtain supervisory benefit.

    AGross equals the sum of individual add-on amounts (calculated by multiplying the notional principal amount by the appropriate add-on factors set out in this Annex) of all transactions subject to legally enforceable netting agreements with one counterparty.

    National authorities may permit a choice of calculating the NGR on a counterparty by counterparty or on an aggregate basis for all transactions subject to legally enforceable netting agreements. If supervisors permit a choice of methods, the method chosen by an institution is to be used consistently. Under the aggregate approach, net negative current exposures to individual counterparties cannot be used to offset net positive current exposures to others, i.e., for each counterparty the net current exposure used in calculating the NGR is the maximum of the net replacement cost or zero. Note that under the aggregate approach, the NGR is to be applied individually to each legally enforceable netting agreement so that the credit equivalent amount will be assigned to the appropriate counterparty risk weight category.

    The corresponding page number in the version reprinted in 1 Current Legal Issues Affecting Central Banks, supra, is page 512.

    The corresponding page number in the version reprinted in 1 Current Legal Issues Affecting Central Banks, supra, is page 512.

    Some member countries reserve the right to apply the full 100% weight.

    This text is reproduced with permission from the Basle Committee on Banking Supervision. It consists of Chapter IX of the Report on International Developments in Banking Supervision (Report number 8, September 1992), prepared and distributed by the Basle Committee on Banking Supervision.

    (The chapter reproduces the text of an analysis by a working group of the Basle Committee. Although it has not been formally approved, the Committee felt it would be useful to make the report available to other supervisors for information.)

    This annex is not reprinted herein.

    This text is reproduced with the permission of the Bank of England. The foreword, table of contents, and annexes to this text are omitted. This July 1995 text supersedes that issued in May 1992.

    Pages 818–19 of this text.

    Pages 818–19 of this text.

    Available from the British Bankers’ Association, 10 Lombard Street, London EC3V 9EL.

    There are two exceptions to this rule. The first covers the specialist inter-dealer brokers, involved primarily in US Treasury bills, notes and bonds, which act as matched principals. The other exception is when name-passing broking firms are investing their own money; in such transactions, brokers must make clear to the relevant counterparties that they are acting as principals.

    The relationship between an institution offering a discretionary or advisory management service and its clients in any of the financial products described in the box on page 2 [pages 818–19 of this text] falls outside the scope of this Code and, if it constitutes investment business within the terms of the Financial Services Act 1986, should be conducted in accordance with the requirements of the relevant Self-Regulating Organisation.

    Pages 818–19 of this text.

    Pages 818–19 of this text.

    All requests for settlement via these arrangements should be marked for the attention of The Secretary, Foreign Exchange Joint Standing Committee, Bank of England Dealing Room (HO-G), Bank of England, Threadneedle Street, London EC2R 8AH. They should be accompanied by a written report of the circumstances resulting in the difference.

    The annexes are omitted from this text.

    OJ No. L 135, 31.5.1994, p. 5.

    OJ No. C 163, 30.6.1992, p.6 and OJ No. C 178, 30.6.1993, p.14.

    OJ No. C 332, 16.12.1992, p. 13.

    OJ No. C 115, 26.4.1993, p. 96, and Decision of the European Parliament of 9 March 1994, OJ No. C 91, 28.3.1994, p. 85.

    OJ No. L 33, 4.2.1987, p. 16.

    OJ No. L 386, 30. 12.1989, p. 1. Directive as amended by Directive 92/30/EEC, OJ No. L 110, 28.4.1992, p. 52.

    OJ No. L 322, 17.12.1977, p. 30. Directive as last amended by Directive 89/646/EEC, OJNo.L 386, 30.12.1989, p. 1.

    OJ No. L 375, 31.12.1985, p. 3. Directive as last amended by Directive 88/220/EEC, OJ No. L 100, 19.4.1988, p. 31.

    OJ No. L 124, 5.5.1989, p. 16. Directive as last amended by Directive 92/16/EEC, OJ No. L 75, 21.3.1992, p. 48.

    OJ No. L 166, 28.6.1991, p. 77.

    OJ No. L 222, 14.8.1978, p. 11. Directive as last amended by Directive 90/605/EEC, OJ No. L 317, 16.11.1990, p. 60.

    OJ No. L 95, 21.4.93, p. 29.

    OJ No.C 73, 24.3.1992, p. 7.

    OJ No. C 326, 16.12.1991, p. 108 and OJ No. C 21, 25.1.1993.

    OJ No. C 159, 17.6.1991, p. 34.

    OJ No. C 92, 25.4.1975, p. 1 and OJ No. C 133, 3.6.1981, p. 1.

    Notes

    Introduction(Effros)

    Baron de Montesquieu, The Spirit of the Laws 157 (Anne M. Cohler et al. eds. and trans., 1989).

    The Federalist No. 47, at 302 (James Madison) (Clinton Rossiter ed., 1961).

    Id. at 302–03.

    Myers v. United States, 272 U.S. 52, 291 (1926) (Brandeis, J., dissenting).

    John Locke, Two Treatises of Government 362–63 (Peter Laslett ed., student ed. 1988).

    J.F. Garner, Administrative Law 49 (6th ed. 1985).

    See John H. Reese, Administrative Law Principles and Practice 74 (1995). Cf J.F. Garner, Administrative Law 122 (5th ed. 1979).

    See Reese, supra note 7, at 74.

    12 United States Code [U.S.C.] § 325 (1994).

    Id. § 1844(c).

    Id. §§ 248(i), 1844(b).

    5 U.S.C. §§ 554–59 (1994).

    12 U.S.C. § 1818(b) (1994).

    Id. § 1818(e).

    Id. § 1818(i)(2).

    Martin S. Flaherty, The Most Dangerous Branch, 105 Yale Law Journal 1725, 1827 (1996).

    The Swedish central bank law provides:

    After the end of each year the Board of Directors of the Riksbank shall submit to the Banking Committee of the Riksdag a report on the position, business, and administration of the Riksbank. This report shall be printed and made public. The Sveriges Riksbank Act 1934, Chapter 6, Art. 37 (as amended June, 1949).

    12 U.S.C. § 225a (1994).

    See The Centre for Economic Policy Research, Independent and Accountable—A New Mandate for the Bank of England 4.3 (1993) (report of an independent panel chaired by Eric Roll).

    12 U.S.C. § 241 (1994).

    This criterion is modeled after Article 14.2 of the Protocol on the Statute of the European System of Central Banks and of the European Central Bank to the Maastricht Treaty. The Protocol is reprinted in 3 Current Legal Issues Affecting Central Banks 359 (Robert C. Effros ed., 1995).

    12 U.S.C. § 242(1994).

    Bank of England Act, 1946, 9 & 10 Geo. 6, Chapter 26, § 4(1).

    Crown Proceedings Act, 1947, 10 & 11 Geo. 6, Chapter 44, §§ 1–2.

    L. Neville Brown & John S. Bell, Trench Administrative Law 176 (4th ed. 1993).

    Id. at 174. The general liability that Blanco attributed to the state applies as well to all public authorities. See id. at 176 (discussing Feutry, Tribunal des Conflits 29 February 1908).

    Central Bank Act, Chapter 79:02, § 44(H) (1980).

    Banking Act 1987, Chapter 22, § 1(4).

    28 U.S.C. § 1346(b) (1994).

    See Home v. Federal Reserve Bank of Minneapolis, 344 F.2d 725 (8th Cir. 1965) and Raichle v. Federal Reserve Bank of New York, 34 F.2d 910 (2d Cir. 1929) discussed at the text cited in notes 63–66. However, for a decision sustaining a bill in equity brought against a Federal Bank and its officers when they were exceeding their statutory authority, see the opinion of Justice Holmes in American Bank & Trust Company v. Federal Reserve Bank, 256 U.S. 350 (1921). Here the Bank was charged with accumulating checks of country banks and presenting them in large quantities to compel them to become members of the Federal Reserve System. The Supreme Court of the United States stated in the course of its opinion that “the United States did not intend by that statute [the Federal Reserve Act] to sanction this sort of warfare. . . .” Id. at 359.

    28 U.S.C. § 2680(a) (1994).

    United States v. Gaubert, 499 U.S. 315 (1991).

    The Conseil d’Etat has other functions as well. All bills submitted to Parliament by the Government must be first submitted to the Conseil for its advice. Aside from the legislative process, the Conseil d’Etat acts as general legal adviser to individual ministers. The Conseil d’Etat submits an annual report to the President of the Republic, reviewing its work and proposing reforms of an administrative or legislative nature. See Brown & Bell, supra note 25, at 61–63.

    See id. at 252.

    See generally Garner, supra note 6, at 122–218.

    Associated Provincial Picture Houses Ltd. v. Wednesbury Corp., [1948] 1 King’s Bench 223 (Eng. C.A. 1947).

    Zaim M. Nedjatigil, Judicial Control of Administrative Discretion: A Comparative

    Study, 14 Anglo-American Law Review 97, 101 (1985).

    Banking Act 1987, Chapter 22, § 1(4).

    Id. §§ 27–31.

    [1988] 1 Appeal Cases 175 (P.C. 1987), [1987] 2 All England Law Reports [All E.R] 705 (1987).

    [1990] 2 All E. R 536 (1990), [1990] 1 Weekly Law Reports 821 (1990).

    But see States of Guernsey v. Firth (unreported), 14 May 1981, Court of Appeal of Guernsey (Civil Division) (Appeal No. 10 Civil) which is distinguished in the Yuen case at [1988] 1 App. Cas. 175, 197 (P.C. 1987).

    See Three Rivers District Council and Others v. Bank of England, [1996] 3 All E.R. 558 (Queen’s Bench Division (Commercial Court)).

    Brown & Bell, supra note 25, at 223.

    Garner, supra note 6, at 166.

    Brown & Bell, supra note 25, at 245–50.

    In questions of law, a U.S. court may decide whether an administrative agency has exceeded its statutory authority. Thus, if the law that the agency is charged to interpret requires that it take into account certain factors or interests, the court may find that the agency failed to take such into account in coming to its decision or that it wrongly substituted other factors that were not relevant or countenanced by the statutory delegation. A court may also decide that the enabling statute is unambiguous so that it does not admit the interpretation adopted by the agency or that such interpretation is unreasonable. When the court reviews the fact-finding of an agency, ordinarily it may defer to the special expertise of the agency. Accordingly, its test should be whether the agency’s fact-finding was reasonable: Is there substantial evidence upon which a reasonable fact finder may come to such a conclusion? Such an approach limits the court’s review because it should not ordinarily seek to substitute its own fact-finding de novo for that of the agency. When a court reviews the agency’s exercise of discretion, the standard for its review may be described as determining whether the agency’s action was arbitrary, capricious, or otherwise constituting an abuse of discretion. Other examples may be (i) when the agency’s decision is inconsistent with its own rules, which must be accorded the force of law until changed; (ii) when the agency’s decision departs from its prior adjudicative decisions, if the reasons for the departure are not satisfactorily explained; (iii) when the agency’s decision constitutes a departure from certain principles inherent in the applicable jurisprudence (such as estoppel or resjudicata); or (iv) if a retroactive decision penalizes conduct that reasonably was believed to be lawful. Similar standards may be employed by a review court when it is called on to judicially review rules that an administrative agency issues in exercising its legislative functions. See generally Ernest Gellhorn & Ronald M. Levin, Administrative Law and Process 75–117 (1990).

    Public Law No. 79–404, Chapter 324 (1946) (codified as amended at 5 U.S.C. §§ 551–59, 701–706, 1305, 3105, 5372, and 7521 (1994 & Supp. I 1995)).

    See generally Gellhorn & Levin, supra note 47, at 75–117.

    5 U.S.C. § 706(2)(B) (1994).

    Id. § 706(2)(C).

    Id. § 706(2)(E).

    Id. § 706(2)(F).

    Id. § 706(2)(A).

    Id. § 706(2)(D).

    Id. § 702.

    Relief for damages against the United States on breach of contract or a taking of property without just compensation can be sought. 28 U.S.C. § 1491 (1994).

    Id. §§ 1346, 2671–80.

    Id. § 2680(a). See United States v. S.A. Empresa de Viacao Area Rio Grandense (Varig Airlines), 467 U.S. 797 (1984); Berkovitz v. United States, 486 U.S. 531 (1988).

    United States v. Gaubert, 499 U.S. 315 (1991).

    The pertinent language concerning the FDIC appears in 12 U.S.C. § 1819 Fourth (1994).

    See Federal Deposit Insurance Corp. v. Citizens Bank & Trust Co., 592 F.2d 364 (7th Cir. 1979).

    344 F.2d 725 (8th Cir. 1965).

    Id. at 728.

    34 F.2d 910 (2d Cir. 1929).

    Id. at 915.

    235 F. Supp. 877 (D. Mont. 1964).

    See Bernard Schwartz, Trench Administrative Law and the Common-Law World 179 (1954).

    Id. (quoting Waline, Traité élémentaire de droit administratif 1 16 (6th ed. 1951)).

    See Gold v. Ernst & Ernst (In re Franklin National Bank Securities Litigation), 445 F. Supp. 723 (E.D.N.Y. 1978); see also First Federal Savings & Loan v. First Federal Savings &Loan, 446 F. Supp. 210 (N.D. Ala. 1979).

    First State Bank v. United States, 599 F.2d 558 (3d Cir. 1979); Emch v. United States, 630 F.2d 523 (7th Cir. 1980).

    Harmsen v. Smith, 586 F.2d 156 (9th Cir. 1978).

    Davis v. Federal Deposit Insurance Corp., 369 F. Supp. 277 (D. Colo. 1974).

    Federal Court of Justice, Ruling of February 15 and July 12, 1979, Wertpapier-Milleilungen 1979 [Securities Information 1979], cited in Berthold Wahlig, A German Perspective (Chapter 18B).

    Banking Act, Division 2 § 6(3) (as amended July 1985).

    Id. A related issue concerns whether in the exercise of its powers as conservator or receiver of a failed bank, an injunction can be brought against the banking supervisory authority to stay it from taking action. In a recent U.S. case, James Madison Ltd., By Hecht v. Ludwig, 82 F.3d 1085 (D.C. Cir. 1996), the Court of Appeals for D.C. took note of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989. This provision states: “Except as provided in this section no court may take any action, except at the request of the Board of Directors [of the FDIC] to restrain or affect the exercise of powers or functions of the [FDIC] as a conservator or a receiver.” 12 U.S.C. § 1821(j) (1994). The court concluded that the provision operates “to prevent courts from interfering with the FDIC only when the agency acts within the scope of its authorized powers, not when the agency was improperly appointed in the first place.” Hecht, 82 F.3d at 1093. However, the court rejected an argument that considerations of due process require a hearing by the government prior to disposition of the failed bank’s assets. Id. at 1099. The court noted that

    the Government has a substantial interest in moving quickly to seize insolvent institutions. We have previously recognized that requiring a pre-seizure hearing could expose both depositors and the FDIC insurance fund to further losses from the continued operation of a failed institution by its management. Haralson v. Federal Home Loan Bank Bd., 837 F.2d 1123, 1127 (D.C.Cir. 1988). Equally strong is the Government’s interest in swiftly disposing of assets and liabilities after a seizure takes place in order to ensure the smooth transfer of a bank’s deposits and branches to other institutions, as well as to minimize losses for both depositors and taxpayers that could occur if the Government had to hold on to a bank’s assets when the value of those assets is declining.

    Hecht, 82 F.3d at 1100.

    12 Code of Federal Regulations § 261.8 (1996).

    Id. § 261.7.

    Id. § 281.2.

    Id. § 261b.5.

    In addition, there is an audit by the General Accounting Office. Board of Governors of the Federal Reserve System, The Federal Reserve System: Purposes & Functions 7 (1994).

    Bank of England, Report & Accounts 1996 at 44 (1996).

    Id.

    Id. at 47.

    Elizabeth Hennessy, A Domestic History of the Bank of England, 1930–1960 at 193–94 (1992).

    Report & Accounts 1996, supra note 82, at 15. Prior to September 1993, the draft of this report was reviewed by the Treasury. Since that time, the report has been published unseen by the Treasury; however, the report cannot contain any views or projections that the Bank has not already addressed with the Treasury in private. Rupert Pennant-Rea, The Bank Yesterday, Today, Tomorrow, in The Bank of England 1930–1960 at 221 (1992).

    Report & Accounts 1996, supra note 82, at 15.

    Christos Hadjiemmanuil, Banking Regulation and the Bank of England 407 (1996).

    Pennant-Rea, supra note 86, at 222.

    An Old Lady with Attitude, The Economist, U.K. edition, July 30, 1994, at 52.

    The principle has been described in Eight Little Piggies: Reflections in Natural History:

    Ichthyosaurs are a group of marine reptiles with bodies so fishlike in external form that they have become the standard textbook example of “convergence”—evolved similarity from two very different starting points as independent adaptive responses to a common environment and mode of life (wings of birds and bats, eyes of squids and fishes).

    Stephen J. Gould, Eight Little Piggies: Reflections in Natural History 81 (1993).

    See generally Rosa Lastra, Central Banking and Banking Regulation 49–59 (1996) discussing the accountability of central banks).

    First Report from the Select Committee on Nationalised Industries, “Bank of England” Session 1969–70, Part IV, paragraph 269 (British House of Commons Report).

    Id. paragraph 258.

    Chapter 1A, “Some Specific Legal Features of the International Monetary Fund” (Gianviti)

    The ESAF Trust also holds resources transferred from the Special Disbursement Account.

    International Monetary Fund, Articles of Agreement, Art. I(v) (April 1993).

    International Monetary Fund, Articles of Agreement, Art. V, § 3(«)(i) (July 22, 1944)(providing “[t]he member desiring to purchase the currency represents that it is presently needed for making in that currency payments which are consistent with the provisions of this Agreement …”), reprinted in III The International Monetary Fund 1945–1965 at 185, 191 (J. Keith Horsefield ed., 1969).

    Id. Art. VI, § 1.

    Articles of Agreement, supra note 2, Art. I(ii).

    Id. Art. VIII, § 2(a).

    Id. Art. VI, § 3.

    Id. Art. I(v).

    From the member’s perspective, crediting the Fund’s account with its currency requires either available budgetary resources or a loan (for example, from the central bank), while a promissory note is costless. Moreover, once foreign exchange is received from the Fund, it can be converted into local currency, which, if received in exchange for a promissory note, will increase the local currency resources available to the member. From the Fund’s perspective, there may be a need to receive currency rather than a promissory note, if that currency is needed for its operations and transactions. In that case, the Fund may require the member to convert all or part of the promissory note into an equivalent amount of the member’s currency. Id. Art. III, § 4.

    Id. Art. V, § 11.

    As in all purchases of the Fund’s resources, the member must represent that it has a need to make the purchase, but, in this case, the Fund cannot challenge the request Id. Art. V, § 3(c). Moreover, reserve tranche purchases can be made even to finance a large or sustained outflow of capital. Id. Art. VI, § 2.

    A member declared ineligible to use the Fund’s general resources cannot make a reserve tranche purchase or any other purchase.

    Decision No. 287–3 (March 17, 1948), reprinted in Selected Decisions and Selected Documents of the International Monetary Fund 63 (20th issue, 1995).

    Articles of Agreement, supra note 2, Art. XXX(b).

    Article V, § 3(c) provides:

    The Fund shall examine a request for a purchase to determine whether the proposed purchase would be consistent with the provisions of this Agreement and the policies adopted under them, provided that requests for reserve tranche purchases shall not be subject to challenge.

    Decision No. 10348-(93/61) STF (April 23, 1993, as amended), reprinted in Selected Decisions, supra note 13, at 186.

    Vienna Convention on Succession of States in Respect of Treaties, August 22, 1978, U.N. Doc. A/Conf. 80/31 (1978), U.N. Doc. A/Conf. 80/31/Corr.2 (1978), reprinted in 17 International Legal Materials [I.L.M.] 1488 (1978); Vienna Convention on Succession of States in Respect of State Property, Archives and Debts, April 7, 1983, U.N. Doc. A/Conf. 117/14 (1983), reprinted in 22 I.L.M. 306 (1983).

    The two republics were united in a federation, the Federal Republic of Yugoslavia, which claimed to continue the existence of the Socialist Federal Republic of Yugoslavia.

    The terms “Republic of Macedonia” and “Macedonia” were used informally before the Fund decided to adopt, as a provisional designation, the terms “former Yugoslav Republic of Macedonia” until a name could be agreed upon between that country and the Fund.

    See U.N. Security Council Resolution 777, 3116th Meeting, September 19, 1992; U.N. General Assembly Resolution 4 7 / 1, 7th plenary meeting, September 22, 1992.

    Arbitration Committee of the Conference on Yugoslavia, Opinion No. 1 (Delivered November 29, 1991), reprinted as an annex to Alain Pellet, The Opinions of the Badinter Arbitration Committee: A Second Breath for the Self-Determination of Peoples, 3 European Journal of International Law 178, 182 (1992).

    Another reason could have been a disagreement on the proposed allocation of the quota, assets, and liabilities of the Socialist Federal Republic of Yugoslavia, but in fact this issue did not arise.

    The imposition of sanctions by the UN Security Council was not legally an obstacle to the membership of the Federal Republic of Yugoslavia (Serbia and Montenegro) in the Fund.

    Similarly, the allocation of Czechoslovakia’s quota, assets, and liabilities in the Fund was acceptable to the two successor states.

    Chapter 1B, “The Relationship Between the International Monetary Fund and the United Nations” (Holder)

    U.N. Charter Art. 1.

    International Monetary Fund, Articles of Agreement, Art. IX, § 2 (April 1993); U.N. Charter Art. 104.

    Articles of Agreement, supra note 2, Art. X.

    U.N. Charter Art. 57(1).

    Agreement Between the United Nations and the International Monetary Fund, November 15, 1947, Art. I, paragraph 2 [hereinafter Relationship Agreement], reprinted in Selected Decisions and Selected Documents of the International Monetary Fund 543 (20th issue, 1995).

    Committee on Negotiations with Specialized Agencies, Report on Negotiations with the International Bank for Reconstruction and Development and the International Monetary Fund, U.N. Economic and Social Council Doc. E/564, at 3 (August 16, 1947).

    Relationship Agreement, supra note 5.

    Agreement Between the United Nations and the International Bank for Reconstruction and Development, November 15, 1947, Art. IV, paragraph 3, reprinted in Agreements Between the United Nations and the Specialized Agencies and the International Atomic Energy Agency at 53, U.N. Doc. ST/ SG/ 14, U.N. Sales No. 61.X.1 (1961). The International Finance Corporation and the International Development Association entered into agreements on the same terms as those of the IBRD, in 1957 and 1961, respectively. Agreement Between the United Nations and the International Bank for Reconstruction and Development (Acting for and on Behalf of the International Finance Corporation) on the Relationship Between the United Nations and the International Finance Corporation, February 20, 1957, reprinted in Agreements Between the United Nations and the Specialized Agencies, supra, at 88; Agreement Between the United Nations and the International Development Association, March 27, 1961, reprinted in Agreements Between the United Nations and the Specialized Agencies, supra, at 111.

    Report on Negotiations with the International Bank for Reconstruction and Development and the International Monetary Fund, supra note 6, at 3. Under the World Bank’s Articles of Agreement, its involvement in “political” activity is prohibited. International Bank for Reconstruction and Development, Articles of Agreement, Art. IV, § 10 (1989). Loans are to be used for the purposes for which they were granted, and “without regard to political or other non-economic influences or considerations.” Id. Art. III, § 5(b).

    General Assembly Resolution 172 (Part D), U.N. GAOR, 36th Session, 102d plenary meeting, at 41–42 (1981).

    General Assembly Resolution 2, U.N. GAOR, 37th Session, 40th plenary meeting, at 14(1982).

    International Monetary Fund, Press Release No. 82/52 (November 3, 1982).

    Article 48 of the U.N. Charter provides:

    • The action required to carry out the decisions of the Security Council for the maintenance of international peace and security shall be taken by all the Members of the United Nations or by some of them, as the Security Council may determine.

    • Such decisions shall be carried out by the Members of the United Nations directly and through their action in the appropriate international agencies of which they are members.

    U.N. Charter Art. 48.

    Under that proposal, the Fund would have recognized

    … the obligations which are imposed upon members of the United Nations by Article 48 of the Charter to carry out decisions of the Security Council for the maintenance of international peace and security, both directly and through their actions in the related appropriate agencies of which they are members.

    Legal Department, International Monetary Fund, Agreement with the United Nations—Report of the General Counsel on Negotiations with the Committee on Negotiations with Specialized Agencies of the Economic and Social Council, Executive Board Document No. 191, Revision 1, Supplement 3, at 4 (August 20, 1947).

    By way of example, the International Labor Organization agreement states: The International Labour Organisation agrees to transmit its proposed budget to the United Nations annually at the same time as such budget is transmitted to its members. The General Assembly shall examine the budget or proposed budget of the Organisation and may make recommendations to it concerning any item or items contained therein.

    Agreement Between the United Nations and the International Labour Organisation, December 14, 1946, Art. XIV, paragraph 4, reprinted in Agreements Between the United Nations and the Specialized Agencies, supra note 8, at 1.

    Relationship Agreement, supra note 5, Art. X, paragraph 3, first sentence.

    Id. Art. II. The clause on attendance at Executive Board meetings was narrowed during negotiation: the UN draft provided for attendance at all Board meetings.

    Id. Art. IV.

    Id. Art. I, paragraph 3.

    Id. Art. XIII, paragraph 1.

    Id. Art. XIII, paragraph 2.

    Id. Art. XIII, paragraph 3.

    General Assembly Resolution 264, U.N. GAOR, 45th Session, Supp. No. 49 A, at 2, 3 (Annex paragraph 4(a)), U.N. Doc. A/45/49/Add. 1 (1992).

    Supplementary report prepared by Mr. Francis Blanchard on the functioning of the ACC, ACC/1993/CRP.1, March 29, 1993.

    Id. at 3–4.

    Chapter 2, “Developments at the International Bank for Reconstruction and Development: The Restructuring of the Global Environment Facility” (Rigo)

    See Mohamed El-Ashry, The New Global Environment Facility, Finance & Development 48 (June 1994).

    See id.; Agenda-21, U.N. Doc. A/CONF. 151/26 (Vol. 1), August 12, 1992.

    See Declaration of the United Nations Conference on the Human Environment, U.N. Doc. A/CONF. 48/14, June 16, 1972, reprinted in International Organization and Integration LA. 14.1.a (P.J.G. Kapteyn et al. eds., 1981).

    World Commission on Environment and Development, Our Common Future (1987); World Resources Institute, Natural Endowments: Financing Resource Conservation for Development (1989).

    Report of the Independent Evaluation of the Global Environment Facility, Pilot Phase, at vi (1993).

    Procedural Arrangements Among the International Bank for Reconstruction and Development (World Bank), the United Nations Environment Program (UNEP), and the United Nations Development Program (UNDP) for Operational Cooperation Under the Global Environment Facility (October 28, 1991).

    Id. paragraph 1.

    Ibrahim F.I. Shihata, The World Bank and the Environment: A Legal Perspective, in The World Bank in a Changing World 135 (Franziska Tschofen & Antonio R. Parra eds., 1991).

    Montreal Protocol on Substances that Deplete the Ozone Layer, adopted at Montreal, Canada, September 16, 1987, as amended [hereinafter Montreal Protocol], reprinted in Inter-American Development Bank, International Environmental Law 52 (1993).

    Id.

    Vienna Convention for the Protection of the Ozone Layer, adopted in Vienna, March 22, 1985, reprinted in International Environmental Law, supra note 9, at 30.

    Agreement Between the Executive Committee of the Interim Multilateral Fund for the Implementation of the Montreal Protocol and the International Bank for Reconstruction and Development (World Bank) (June 19, 1991); Adjustment and Amendment to the Montreal Protocol on Substances that Deplete the Ozone Layer, done in London, June 29, 1990, paragraph T, reprinted in International Environmental Law, supra note 9, at 68 (providing for the creation of the Multilateral Fund).

    GEF Administrator’s Office, The Global Environment Facility: Beyond The Pilot Phase 3 (April 24, 1992).

    Agenda-21, supra note 2; United Nations Framework Convention on Climate Change, adopted in Rio de Janerio, Brazil, June 4, 1992, reprinted in International Environmental Law, supra note 9, at 159; United Nations Convention on Biological Diversity, done at Rio de Janerio, Brazil, June 5, 1992, reprinted in International Environmental Law, supra, at 189.

    International Bank for Reconstruction and Development, Instrument for the Establishment of the Restructured Global Environment Facility (March 1994) [hereinafter RGEF Instrument].

    Id. paragraphs 11–24.

    Id. paragraph 25.

    See Edith Brown Weiss, International Environmental Law: Contemporary Issues and the Emergence of a New World Order, 81 Georgetown Law Journal 675, 703 (1993); A. Dan Tarlock, Environmental Protection: The Potential Misfit Between Equity and Efficiency, 63 University of Colorado Law Review 871 (1992) (discussing the issue of efficiency versus equity).

    See supra notes 9 and 15.

    RGEF Instrument, supra note 15, introduction; IBRD, Executive Directors’ Resolution No. 94–2, Global Environment Facility Trust Fund: Restructuring and First Replenishment of the Global Environment Facility (adopted May 24, 1994) in RGEF Instrument, supra, at 37; IBRD Board of Governors, Resolution No. 487, Protection of the Global Environment (adopted July 7, 1994) in RGEF Instrument, supra, at 38; Governing Council of the United Nations Environment Program, Adoption of the Instrument for the Establishment of the Restructured Global Environment Facility, SS.IV.l (adopted June 18, 1994) in RGEF Instrument, supra, at 36; Executive Board of the United Nations Development Program and of the United Nations Population Fund, Report on the Second Regular Session, DP/ 1994/ 9, Part VIII.A (adopted May 13, 1994) in RGEF Instrument, supra, at 35.

    Chapter 3, “Developments at the International Finance Corporation” (Sullivan)

    International Finance Corporation, Annual Report 1994, at 1.

    Id. at 5; IFC, Annual Report 1993 at 1, 17.

    IFC, Annual Report 1993 at 62–63, 66.

    Id. at 63.

    Id. at 47.

    Chapters 2 and 3, Comment (Berenson)

    International Bank for Reconstruction and Development, Instrument for the Establishment of the Restructured Global Environment Facility, paragraph 21 (March 1994).

    Id. paragraphs 13, 14.

    Id. paragraphs 15–17.

    Id. paragraph 25.

    Chapter 4, “The First Three Years of the European Bank for Reconstruction and Development: Legal Issues and Solutions” (Newburg)

    Sir Joseph Gold, The Rule of Law in the International Monetary Fund, IMF Pamphlet Series No. 32, at 1 (1980).

    Id.

    The Agreement Establishing the European Bank for Reconstruction and Development [hereinafter Agreement] was signed in Paris on May 29, 1990 by 40 countries, the European Community, and the European Investment Bank, which subscribed to substantially all of the Bank’s capital stock of ECU 10 billion. The Agreement is reprinted in Appendix I of Ibrahim F.I. Shihata, The European Bank for Reconstruction and Development: A Comparative Analysis of the Constituent Agreement (1990).

    Asian Development Bank, Articles of Agreement, in Basic Documents of the Asian Development Bank (1971); International Bank for Reconstruction and Development (IBRD), Articles of Agreement (1989).

    Indeed, the Agreement has been criticized for repeating certain clauses that have fallen into disuse or proven unduly cumbersome in practice. The European Bank for Reconstruction and Development, supra note 3, at 5–6. Mr. Shihata believes that more use could have been made of more recent agreements, such as the amended articles of the IMF and the Agreement Establishing the Multilateral Investment Guarantee Agency. He also criticizes the use of the charter of the Asian Development Bank (ADB) as a model for the provisions relating to private sector development, as opposed to the Articles of Agreement of the International Finance Corporation (IFC), which he finds more relevant.

    It has been argued that the practices of other international financial institutions should not serve as an aid to the interpretation of the EBRD’s Agreement for a number of reasons: the EBRD’s overt political purpose; the existence of explanatory notes in the Chairman’s Report, see infra note 10; the lack of judicial decisions relating to international financial institutions; the fact that the Vienna Convention on the Law of Treaties, May 23, 1969, 1155 U.N.T.S. 331, does not recognize administrative practices of international organizations as aids to the interpretation of treaties; the EBRD’s merchant bank character; and the urgency of the EBRD’s tasks (which may lend a “special momentum to the evolution of the Bank and may impart a progressive meaning to the text of the Bank’s constituent document”). See D.R.R. Dunnett, The European Bank for Reconstruction and Development: A Legal Survey, 28 Common Market Law Review 571, 574 (1991).

    Agreement, supra note 3, Art. 1.

    Id. Art. 8.2.

    Id. Art. 2.1(vii).

    Id. Art. 2.1.

    See Chairman’s Report on the Agreement Establishing the European Bank for Reconstruction and Development, note 1 to Art. 2, reprinted in The European Bank for Reconstruction and Development, supra note 3, Appendix V [hereinafter Chairman’s Report] (stating that the focus of the Bank is to be the private sector but that the Bank should also “support the public sector in its transition”).

    See IBRD, Articles of Agreement, supra note 4, Art. IV, § 10; see also ADB, Articles of Agreement, supra note 4, Art. 36.2. Both prohibit political activity and state that “[o]nly economic considerations shall be relevant to decisions.”

    See, e.g., Ibrahim F.I. Shihata, The World Bank and Human Rights, in The World Bank in a Changing World97 (Franziska Tschofen & Antonio Parra eds., 1991) (distinguishing the World Bank’s human rights and environmental activities from political interference in the affairs of its members).

    Opening statement by Jacques de Larosiere, President of the EBRD, Proceedings of the Third Annual Meeting of the Board of Governors, St. Petersburg, April 18–19, 1994 [hereinafter Proceedings of the Third Annual Meeting].

    Procedures to Implement the Political Aspects of the Mandate of the European Bank for Reconstruction and Development, BDS91–16 (May 28, 1991). The procedures of this policy paper are developed further in a policy paper on Political Aspects of the Mandate of the European Bank in Relation to Ethnic Minorities, BDS92–103 (October 5, 1992) and in a staff paper on War and Democracy, SGS92–714 (January 4, 1993).

    Convention for the Protection of Human Rights and Fundamental Freedoms, November 4, 1950, 213 United Nations Treaty Series [U.N.T.S.] 221, reprinted in 3 International Law <& World Order II.B.2 (Burns H. Weston ed., 1994); Statute of the Council of Europe, May 5, 1949, 87 U.N.T.S. 103, reprinted in II International Organization and Integration II.B.3.a (PJ.G. Kapteyn et al. eds., 1983).

    Agreement, supra note 3, Art. 8.3.

    Id. Art. 20.1(vi) (stating that the Bank may provide technical advice and assistance which serve its purpose and come within its functions).

    Id. Art. 2.1.(vii).

    See Environmental Procedures, BDS91-71 (February 14, 1992); Environmental Management: The Bank’s Policy Approach, BDS91-72 (February 14, 1992) [hereinafter Environmental Policy]; see also Chris A. Wold & Durwood Zaelke, Promoting Sustainable Development and Democracy in Central and Eastern Europe: The Role of the European Bank for Reconstruction and Development, 7 American University Journal of International Law & Policy 559 (1992); Kamen Zahariev, European Bank for Reconstruction and Development: Environmental Aspects of Operations, 2 Recueil 31 (1993) (providing an overview of the environmental procedures).

    Environmental Policy, supra note 19, at 2.

    EBRD, 1993 Annual Report 29 (1994).

    Proceedings of the Third Annual Meeting, supra note 13.

    Agreement, supra note 3, Arts. 3.2, 24.2(i).

    It appears that the German Democratic Republic parliament, immediately before going out of existence, ratified the Agreement, but that the instrument of ratification was never received by the French Government, the depository under the Agreement. See Jacques Attali, Europe(s) 90 (1994).

    See Paul A. Menkveld, Origin and Role of the European Bank for Reconstruction and Development 60 (1991); see also Dunnett, supra note 5, at 577.

    The Bank’s authorized capital stock of ECU 10 billion is divided into one million shares having a par value of ECU 10,000 each. At the time of signature of the Agreement, 125 shares were not subscribed and designated as nonallocated. Agreement, supra note 3, Annex A.

    Albania became a member on December 18, 1991, Estonia on February 28, 1992, Lithuania on March 5, 1992, and Latvia on March 18, 1992. Having regard to the shareholding and voting power of existing recipient countries, the Board of Governors allocated 1,000 shares to each of these new members.

    See Agreement, supra note 3, Art. 3 (stating that membership is open “to (1) European countries and (2) non-European countries which are members of the International Monetary Fund …”); see also id. Art. 8 (captioned “Recipient Countries and Use of Resources” and providing that the Bank may conduct its operations in Central and Eastern European countries). The eight original recipient countries are listed under the heading “Recipient Countries” in Annex A to the Agreement, which sets out the subscriptions to the capital stock. Id. Annex A. A footnote to Annex A states that “Recipient Countries are referred to elsewhere in the Agreement as Central and Eastern European countries.” Id.

    Membership Issues Following the Dissolution of the USSR, BDS92-2 (January 28, 1992) [hereinafter Membership Issues].

    Id. at 1.

    Id.

    Id. at 4.

    See Attali, supra note 24, at 65–67 (describing the circumstances of the negotiations).

    Agreement, supra note 3, Art. 8.4.

    Id. The “limited purposes” consist of technical assistance and of financing of the private sector, to facilitate privatization and to help state-owned enterprises move to participation in the market economy. They do not include the financing of infrastructure, one of the methods of operation of the Bank used to the extent “necessary for private sector development and the transition to a market-oriented economy.” Id. Art. 1 l.l(v). In view of the quantitative limitation, significant infrastructure financing would not in any event seem practicable.

    Letter to the Chairman of the Conference on the Establishment of the European Bank for Reconstruction and Development from the Head of the Soviet Delegation, Chairman of the Board of the State Bank of the U.S.S.R, Victor Gerashchenko.

    Id. This additional expression of self-restraint would appear to have been superfluous in view of a further clause in Article 8.4 to the effect that, at the end of the three-year period, a decision to permit normal Bank operations in a country that had made a request pursuant to Article 8.4 would require action by a supermajority of not less than three-fourths of the Governors representing not less than 85 percent of total voting power. Agreement, supra note 3, Art. 8.4. This effectively gave a veto power to any two of the Bank’s six largest shareholders: France, Germany, Italy, Japan and the United Kingdom, each of which holds about 8.5 percent, and the United States, which holds 10 percent of the Bank’s capital stock.

    Agreement, supra note 3, Art. 8.4(i).

    Id. Art. 8.4(iii).

    Id. Art. 56.2(ii)(requiring a supermajority vote for amendment of Article 8.4).

    See, e.g.., Vienna Convention on the Law of Treaties, supra note 5, Art. 62.

    Agreement, supra note 3, Art. 57.

    Limitation on Financing and Operations Applicable to the Former USSR: Resolution of the Board of Directors, BDS92-2 (February 28, 1992). In view of the matter at issue, the Board of Directors referred its decision to the Board of Governors for approval by the super majority vote required by Article 8.4 for removal of the financing limitation, and also by Article 56.2(ii) for any amendment of Article 8.4. At the same time, a final decision of the Board of Governors under Article 57.2 was requested by Japan, which had indicated its dissent on procedure. By Resolution No. 22, adopted on March 28, 1992, the Board of Governors approved the decision of the Board of Directors.

    Agreement, supra note 3, Art. 13(v).

    Id. Art. 29.3.

    EBRD Board of Governors Resolution No. 30 (adopted October 9, 1992).

    Agreement, supra note 3, Art. 5.1 (providing for a minimum initial subscription of 100 shares).

    EBRD Board of Governors Resolution No. 31 (adopted October 9, 1992).

    EBRD Board of Governors Resolution No. 34 (adopted January 15, 1993). As of this writing, neither the Republic of Bosnia and Herzegovina nor the Federal Republic of Yugoslavia (Serbia and Montenegro) has been admitted as a member of the Bank.

    The four requisite characteristics for statehood under international law (a defined territory, a stable population, a government with authority over such population, and the capacity to enter into relations with other international legal persons) do not include the existence of a universally accepted name. See Montevideo Convention on Rights and Duties of States, December 26, 1933, Art. 1. The definition in the Restatement (Third) of the Foreign Relations Law of the United States § 201 (1986) is nearly identical.

    EBRD Board of Governors Resolution No. 35 (adopted February 13, 1993).

    EBRD Board of Governors Resolution No. 33 (adopted January 15, 1993). The effective date of membership was January 1, 1993, the date on which the Czech and Slovak Federal Republic ceased to exist and the two new states came into existence.

    See Agreement, supra note 3, Art. 11.

    Chairman’s Report, supra note 10, Art. 2, note 1.

    Agreement, supra note 3, Art. ll. l(v).

    Article 11.3 sets forth as follows the proportion of the Bank’s ordinary operations that may be devoted to the state sector:

    • (i) Not more than forty (40) per cent of the amount of the Bank’s total committed loans, guarantees and equity investments, without prejudice to its other operations referred to in this Article, shall be provided to the state sector. Such percentage limit shall apply initially over a two (2) year period, from the date of commencement of the Bank’s operations, taking one year with another, and thereafter in respect of each subsequent financial year.

    • (ii) For any country, not more than forty (40) per cent of the amount of the Bank’s total committed loans, guarantees and equity investments over a period of five (5) years, taking one year with another, and without prejudice to the Bank’s other operations referred to in this Article, shall be provided to the state sector. Id. Art. 11.3(i), (ii).

    The Portfolio Ratio, BDS92-101 (November 17, 1992).

    Agreement, supra note 3, Art. 11.3(iii)(a).

    Id. Art. 11.3(iii)(b).

    The Portfolio Ratio, supra note 57.

    See Portfolio Risk Management and Lending Policies, BDS91-50 (December 10, 1993).

    Agreement, supra note 3, Annex A, “Recipient Countries.”

    Id.

    Chairman’s Report, supra note 10, Art. 2, note 1.

    Agreement, supra note 3, Art. 2.2.

    See id. Art. 24.2 (requiring such cooperation agreements to be authorized by the Board of Governors).

    Kazakstan, the Kyrgyz Republic, and Uzbekistan have joined the ADB, while Azerbaijan, Tajikistan, and Turkmenistan are completing the formalities for membership.

    All of the countries in which the Bank operates are now also members of the IBRD and the IFC.

    IBRD, General Conditions Applicable to Loan and Guarantee Agreements for Single Currency Loans Dated February 9, 1993, § 9.03 (titled “Negative Pledge”).

    Id. § 9.03(a).

    Id. § 9.03(a)(ii).

    See Chairman’s Report, supra note 10, note to Art. 14 (urging that state guarantees be used sparingly in the case of loans to state-owned enterprises moving to participation in the market economy). It notes that

    a state-owned enterprise would be more likely to respond quickly to market forces, and to make the transition to market-oriented economies, if that enterprise could not rely on a government guarantee to discharge its responsibilities under a Bank loan.

    Id.

    In its sovereign lending, the EBRD has the same interest as the IBRD in preventing other creditors from asserting a prior claim to the sovereign’s foreign exchange assets or revenues. The EBRD’s standard terms and conditions for loans to, or guaranteed by, a recipient state are modeled after the IBRD’s General Conditions and contain a similar negative pledge undertaking.

    The International Union of Credit and Investment Insurers (the Berne Union) works for “(i) the international acceptance of sound principles of export credit insurance and the establishment and maintenance of discipline in the terms of credit for international trade; and (ii) international cooperation in encouraging a favourable investment climate and in developing and maintaining sound principles of foreign investment insurance.” 1 Yearbook of International Organizations 1079 (31st ed. 1994). Its membership consists of organizations from 33 countries. Id.

    Waivers have been granted to the Russian Federation and Uzbekistan.

    Chairman’s Report, supra note 10.

    Id. Introduction.

    The European Bank for Reconstruction and Development, supra note 3, at 5.

    Dunnett, supra note 5, at 576.

    Gold, supra note 1, at 11.

    Chapter 4, Comment (Munk)

    22 U.S.C. § 286a(a)(1994).

    Agreement Establishing the European Bank for Reconstruction and Development, Art. 4, paragraph 2, reprinted in Ibrahim F.I. Shihata, The European Bank for Reconstruction and Development: A Comparative Analysis of the Constituent AgreementAppendix I (1990); see Shihata, supra, at 8.

    22 U.S.C. § 262m-7 (1994).

    See Bradford W. Morse & Thomas R. Berger, Sardar Sarovar: The Report of the Independent Commission (1992).

    See id.

    Id. at 349-353.

    22 U.S.C. § 2370(a)(1994).

    Id. § 2370a(b).

    Chapter 5, “European Monetary Union and the European System of Central Banks” (C. Lichtenstein)

    Special thanks are due to the law offices of S.G. Archibald, Paris, for their aid in the preparation of this paper while the author was resident in Paris.

    Treaty Establishing the European Community, February 7, 1992, incorporating changes made by the Treaty on European Union, done at Maastricht, February 7, 1992, 1992 Official Journal of the European Communities [O.J.] (C 224), reprinted in 31 International Legal Materials 247 (1992). The amended treaty is hereinafter referred to as the E.C. Treaty. Selected provisions of the E.C. Treaty are reprinted in 3 Current Legal Issues Affecting Central Banks 325 (Robert C. Effros ed., 1995).

    For a discussion of why the summer 1993 difficulties of the ERM may have strengthened the case for getting on with economic and monetary union, see Europe’s Monetary Future, From Here to EMU, The Economist, U.K. Edition, October 23, 1993, at 25.

    E.C. Treaty, supra note 2, Art. 109f(3).

    A report prepared by Professor Jean-Victor Louis, Head of the Legal Department of the National Bank of Belgium, for the International Monetary Law Committee of the International Law Association describes this process. Jean-Victor Louis, The Present State of the Monetary Integration Process in Europe—The European Monetary Institute, Report to the Monetary Law Committee of the International Law Association (January 1994).

    E.C. Treaty, supra note 2, Art. 189.

    Two introductory texts are T.C. Hartley, The Foundations of European Community Law (2d ed. 1991) and P.J.G. Kapteyn & P. Verloren van Themaat, Introduction to the Law of the European Communities. (Lawrence Gormley ed., 1991).

    Factortame Ltd. v. Secretary of State for Transportation, 1 All England Law Reports 70 (1991).

    E.C. Treaty, supra note 2, Art. 164.

    Id. Art. 169.

    Id. Art. 171(1).

    Id. Art. 171(2).

    Id. Arts. 173, 175.

    Id. Arts. 176, 171.

    Id. Art. 177.

    Id.

    Id. Arts. 169, 177.

    Louis, supra note 5, at 9.

    E.C. Treaty, supra note 2, Art. 109f, last paragraph.

    Louis, supra note 5, at 18.

    E.C. Treaty, supra note 2, Arts. 173, 175-177, 180. Article 180(d) gives to the Council of the ECB in respect of national central banks the same powers as the Commission has over member states under Article 169. See supra text accompanying note 10.

    Id. Art. 109f(6). In fact, the EMI may have some real power in the area of reviewing member state draft legislation. Article 109f(6) of the E.C. Treaty and Article 5.3 of the EMI’s Statute provide that, within the limits and conditions of the Council’s implementing legislation, the EMI “shall be consulted by the authorities of the member states” on draft legislation. The Council has enacted the implementing legislation. (Council Decision 93/717 of 22 November 1993 on the Consultation of the European Monetary Institute by the Authorities of the Member States on Draft Legislative Provisions, 1993 O.J. (L 332).) This Decision gives a list of legislative matters considered to be within the EMI’s competence, including (among others) “the status and powers of national central banks and the instruments of monetary policy” and “rules applicable to financial institutions in so far as they influence the stability of financial institutions and markets.” Id. Art. 1. One can speculate that, if a member state were to exempt its large financial houses from, say, prudential supervision of participants in the derivative markets without consulting the EMI, the EMI might very well have a judiciable complaint.

    E.C. Treaty, supra note 2, Art. 109f(2), (3).

    Id. Art. 109f(3).

    Protocol on the Statute of the European Monetary Institute, annexed to the E.C. Treaty, supra note 2, Art. 15.

    Id. Art. 15.4.

    Id. Arts. 15.4,3.1.

    E.C. Treaty, supra note 2, Art. 109j.

    Id.; Protocol on the Statute of the European System of Central Banks and the European Central Bank, annexed to the E.C. Treaty, supra note 2, [hereinafter ESCB Protocol].

    ESCB Protocol, supra note 29, Art. 1.1; E.C. Treaty, supra note 2, Art. 4a.

    E.C. Treaty, supra note 2, Art. 105(2).

    Id.

    Id. Art. 105(5), (6).

    Id. Art. 105a(l).

    E.C. Treaty, supra note 2, Art. 106(3).

    ESCB Protocol, supra note 29, Art. 8.

    Id. Art. 9.2.

    Id. Art. 14.3.

    Id.; E.C. Treaty, supra note 2, Art. 180, discussed in text at note 21 supra.

    E.C. Treaty, supra note 2, Art. 173.

    Id. Art. 109b(l)and(2).

    Id. Art. 173.

    Id. Art. 105(6).

    Id. Art. 105(5).

    Id. Art. 105(4); see text at note 22 supra for the similar point in the EMI.

    The Council has set forth limits and conditions on consultations with the EMI. See supra note 22.

    Protocol on Certain Provisions Relating to Denmark, annexed to the E.C. Treaty, supra note 2; Protocol on Certain Provisions Relating to the United Kingdom of Great Britain and Northern Ireland, annexed to the E.C. Treaty, supra note 2.

    E.C. Treaty, supra note 2, Art. 109k; ESCB Protocol, supra note 29, Chapter IX.

    E.C. Treaty, supra note 2, Art. 109k(l).

    Id. Arts. 105, 105a, 108a, 109.

    Id. Art. 109a(2)(b); Protocol on Certain Provisions Relating to the United Kingdom of Great Britain and Northern Ireland, annexed to the E.C. Treaty, supra note 2, paragraph 7.

    ESCB Protocol, supra note 29, Art. 43.2. Remember, however, that national law has been amended in accordance with the E.C. Treaty, affecting, for example, the independence of the central bank.

    Id. Art. 47.

    Chapter 5, Comment (Lastra)

    The Treaty Establishing the European Economic Community, March 25, 1957, 298 United Nations Treaty Series 11 [hereinafter E.C. Treaty] was amended by the Treaty on European Union, done February 7, 1992, 1992 Official Journal of the European Communities [O.J.] (C 224) 1 [hereinafter Maastricht Treaty], reprinted in 31 International Legal Materials 247 (1992). Selected provisions of the E.C. Treaty are reprinted in 3 Current Legal Issues Affecting Central Banks 325 (Robert C. Effros ed., 1995).

    Article G(A) of the Maastricht Treaty, supra note 1, provides that throughout the Treaty, “[t]he term’ European Economic Community’ shall be replaced by the term’ European Community’.”

    See id. Art. A; Ruling of the German Federal Constitutional Court of October 12, 1993, Part A.I.l(a).

    See E.C. Treaty, supra note 1, Art. 8a (as revised by the Single European Act, 1987 OJ. (L 169), reprinted in I Treaties Establishing the European Communities 207, 227 (1987)).

    The Single European Act, supra note 4, inserted a new Chapter 1, entitled “Cooperation in Economic and Monetary Policy (Economic and Monetary Union),” in Part Three, Title II of the E.C. Treaty, supra note 1. The new Article 102a, which was the only provision in the new chapter, reads as follows:

    • In order to ensure the convergence of economic and monetary policies which is necessary for the further development of the Community, Member States shall cooperate in accordance with the objectives of Article 4. In so doing, they shall take account of the experience acquired in cooperation within the framework of European Monetary System (EMS) and in developing the ECU, and shall respect existing powers in this field.

    • Insofar as further development in the field of economic and monetary policy necessitates institutional changes, the provisions of Article 236 shall be applicable. The Monetary Committee and the Committee of Governors of the Central Banks shall also be consulted regarding institutional changes in the monetary area.

    The EMI also replaced the European Monetary Cooperation Fund. See E.C. Treaty, supra note l, Art. 109f.

    Mr. Tietmeyer, the Bundesbank’s president, speaking at the annual meeting of the World Economic Forum in Davos, ruled out transferring any of its currency reserves to the newly established European Monetary Institute. Ian Rodger, Bundesbank Will Not Pass Reserves to EMI, Financial Times, January 31, 1994, at 2. Mr. Tietmeyer stressed the advisory role of the EMI and said that “he did not believe lasting monetary union could be achieved without a parallel political union of EU countries.” Id.

    Although the Bundesrat and the Bundestag approved the Maastricht Treaty in December 1992, full ratification came only after the favorable ruling of the German Federal Constitutional Court of October 12, 1993. Germany was the last country to ratify the Maastricht Treaty, even though the ESCB has been largely patterned upon the Bundesbank model.

    See, e.g., Charles Goodhart, ERM and EMU (1993)(unpublished mimeo presented in 1993 at the Columbia School of International and Public Affairs).

    Id. at 23.

    Mr. Lamfalussy said that wider ERM bands “should be preserved in order to defend currencies against speculative pressures.” Lionel Barber, Eurocurrency’A Realistic Option’: Lamfalussy Offers Optimistic Assessment of EU Economies, Financial Times, September 7, 1994, at 22.

    Article 109j(l) of the E.C. Treaty, supra note 1, spells out these criteria of economic convergence:

    • the achievement of a high degree of price stability; this will be apparent from a rate of inflation which is close to that of, at most, the three best performing Member States in terms of price stability.

    • the sustainability of the government financial position; this will be apparent from having achieved a government budgetary position without a deficit that is excessive as determined in accordance with Article 104c(6);

    • the observance of the normal fluctuation margins provided for by the Exchange Rate Mechanism of the European Monetary System, for at least two years, without devaluing against the currency of any other Member State;

    • the durability of convergence achieved by the Member State and its participation in the Exchange Rate Mechanism of the European Monetary System being reflected in long-term interest rate levels.

    Article N(2) of the Maastricht Treaty, supra note 1, reads as follows: A conference of representatives of the governments of the Member States shall be convened in 1996 to examine those provisions of this Treaty for which revision is provided, in accordance with the objectives set out in Articles A and B.

    E.C. Treaty, supra note 1, Art. 104c.

    Id.

    Id. Art. 104c(6).

    Ruling of the German Federal Constitutional Court of October 12, 1993, Part C.II.2.d2(3)and d2(5).

    See The Second Stage of European Economic and Monetary Union, 46 Deutsche Bundesbank Monthly Reports 23–24 (January 1994). For previous declarations on this issue, see also The Recent Monetary Policy Decisions and Developments in the European Monetary System, 45 Deutsche Bundesbank Monthly Reports 19, 27 (August 1993); The Maastricht Decisions on the European Economic and Monetary Union, 44 Deutsche Bundesbank Monthly Reports 43, 52 (February 1992).

    A vague expression from a legal point of view.

    Maastricht Treaty, supra note 1, Art. N(l).

    Ruling of the German Constitutional Court of October 12, 1993, Part C.II.2.d2(l) (emphasis added).

    Maastricht Treaty, supra note 1, Art. N(l).

    The European Parliament ratified the accession treaties of Austria, Finland, Norway, and Sweden on May 5, 1994. However, the people of Austria, Finland, and Sweden voted in favor of EU membership in referendums held, respectively, in June, October, and November 1994, while the Norwegians rejected membership in the Union in a referendum also held in November 1994. Several Eastern European countries are pursuing membership in the Union.

    See Council Regulation 3603/93 of 13 December 1993 Specifying Definitions for the Application of the Prohibition Referred to in Articles 104 and 104b(l) of the Treaty, 1993 O.J. (L 332) 1, reprinted in 3 Current Legal Issues Affecting Central Banks, supra note 1, at 349. Council Regulation 3604/93 of 13 December 1993 Specifying Definitions for the Application of the Prohibition of Privileged Access Referred to in Article 104a of the Treaty, 1993 O.J. (L332) 4, reprinted in 3 Current Legal Issues Affecting Central Banks, supra note l, at 354.

    See Council Regulation 3065/93 of 22 November 1993 on the Application of the Protocol on the Excessive Deficit Procedure, Art. 4, 1993 O.J. (L 332) 7, reprinted in 3 Current Legal Issues Affecting Central Banks, supra note 1, at 382.

    Protocol on the Excessive Deficit Procedure, annexed to the E.C. Treaty, supra note 1, Art. 1, reprinted in 3 Current Legal Issues Affecting Central Banks, supra note 1, at 380.

    See Council Decision 93/716/EC of 22 November 1993 on the Statistical Data to be used for the Determination of the Key for the Financial Resources of the European Monetary Institute, 1993 O.J. (L 332) 12.

    See Council Decision 93/717/EC of 22 November 1993 on the Consultation of the European Monetary Institute by the authorities of the Member States on Draft Legislative Provisions, 1993 O.J. (L 332) 14.

    E.C. Treaty, supra note 1, Art. 108; see Robert C. Effros, The Maastricht Treaty, Independence of the Central Bank, and Implementing Legislation, in Frameworks for Monetary Stability: Policy Issues and Country Experiences 279 (Tomas J.T. Balino & Carlo Cottarelli eds., 1994).

    Autonomia del Banco de España [Law of the Autonomy of the Banco de España], Law 13/1994 of June 1, 1994, Boletín Oficial del Estado [Official State Gazette] No. 13, June 2, 1994; see Gesetz zur Änderung von Vorschriften über die Deutsche Bundesbank, Bundesgesetzblatt, Teil 1 [German Federal Law Gazette, Title 1], July 8, 1994.

    Law of the Autonomy of the Banco de España, supra note 30.

    Gesetz zur Änderung von Vorschriften über die Deutsche Bundesbank, supra note 30.

    Id.

    Id.

    E.C. Treaty, supra note 1, Arts. 108, 109e(5).

    See Centre for Economic Policy Research, Independent and Accountable: A New Mandate for the Bank of England (1993) (report of an independent panel chaired by Eric Roll); House of Commons Treasury and Civil Service Select Committee, 1 The Role of the Bank of England (First Report, together with the Proceedings of the Committee, 1993–94 Session)(December 8, 1993).

    Following this “wave of change,” economic literature in the field of central bank independence has flourished in the last few years: Robin Bade & Michael Parkin, Central Bank Laws and Monetary Policy (1978)(unpublished mimeo); Don Fair, The Independence of Central Banks, 129 The Banker 31 (October 1979); King Banaian et al, Central Bank Independence: An International Comparison, Economic Review, Federal Reserve Bank of Dallas 1 (March 1983); Alberto Alesina, Macroeconomics and Politics, in NBER Macroeconomic Annual 1988 at 1 (Stanley Fischer ed., 1988) and Politics and Business Cycles in Industrial Democracies, 4 Economic Policy 57 (1989); Marta Castello-Branco & Mark Swinburne, Central Bank Independence: Issues and Experience, IMF Working Paper No. 91/58 (1991); Vittorio Grilli et al, Political and Monetary Institutions and Public Financial Policies in the Industrial Countries, 6 Economic Policy 342 (1991); Alex Cukierman, Central Bank Strategy, Credibility, and Independence: Theory and Evidence (1992); Adam Posen, Why Central Bank Independence Does Not Cause Low Inflation: There is No Institutional Fix for Politics, The Amex Bank Review (1993); Charles Goodhart, Central Bank Independence, London School of Economics and Political Science Working Paper No. 57 (N