ISDA PRESS REPORT - MAY 3, 2001

ISDA PRESS REPORT - MAY 3, 2001

* ISDA lobbies FASB on swaps - Financial Times
* Corporates warm to charms of credit derivatives - Reuters
* Fed Proposes Rules On Derivatives, Intraday Lending - Dow
Jones
* Banks urged to improve credit, operational risk disclosure - IFR
* Argentina crisis default swap ripples contained - IFR
* Fed Proposes First-Ever Regulation To Govern Limits on
Affiliate Transactions - BNA

ISDA lobbies FASB on swaps
Financial Times - May 3, 2001
By Vincent Boland

The International Swaps and Derivatives Association has expressed concern
that proposed changes to US accounting standards and tax regulations could
have a negative impact on swaps transactions. In a submission to the US
Federal Accounting Standards Board, ISDA said that definitions of
liabilities and equity as "residual interest" were adequate and that it had
asked the FASB to reconsider proposed changes and to retain the current
accounting model. It also said, in a submission to the Internal Revenue
Service, that it was concerned that proposed changes to hedging regulations
did not properly implement Congressional intent with regard to risk
management standards that qualify for hedging treatment.

Corporates warm to charms of credit derivatives.
Reuters English News Service - May 3, 2001
By Tom Bergin

European corporates are beginning to turn to credit derivatives, among the
more esoteric and complex of financial instruments, to hedge the risk their
debtors won't pay up, market participants said on Thursday.

Credit derivatives are insurance-like tools that allow users to hedge the
risk of default on a debt. They are mainly used by banks, hedge funds and
insurance companies to hedge or gain exposure to the risk of a bond issuer
defaulting.

Dealers said an environment of deteriorating credit quality and a growing
awareness among corporates that credit derivatives offer certain advantages
over established hedging tools was behind the increasing use of the
instruments.

The market remains small, with only around a dozen non-financial European
corporates regularly using credit derivatives to manage their credit
portfolio at present. But market professionals predict they will one day
become as commonplace in the corporate world as other hedging tools such as
interest rate swaps and currency options.

"We see (corporate use) as a big growth area for credit derivatives, maybe
the biggest," says Bryan Seyfried, vice-president of Enron Credit in London.

Enron Credit grew out of the efforts of energy company Enron Corp. to hedge
its own credit risk portfolio and now specialises in marketing credit risk
management solutions to other non-financial corporates.

Ralf Lierow, director of credit derivatives at Siemens Financial Services in
Munich, said the ability to buy and sell in a liquid market means credit
derivatives offer a flexibility that established tools like credit insurance
and forfaiting guarantees lack. Credit derivatives were are often cheaper
than the alternatives, too, he added.

"This is not a trading book thing. For us, the credit default swap is
another tool for credit risk management," Lierow said.

HELPS OPERATIONAL UNITS DO MORE BUSINESS

Siemens Financial Services acts as the centralised risk portfolio management
operation for companies within the Siemens electronics and industrial group.
It first started using credit derivatives in July 2000.

Large companies like Siemens can have hundreds of millions of dollars in
receivables on their books at any time. The efficiency with which these
companies manage the credit risk on their receivables has an impact on their
day to day business.

"The advantage for the operative area is that they can offload more
receivables and do more business," Lierow said.

Siemens uses credit default swaps , the most liquid type of credit
derivatives, to hedge its portfolio of debtors on a constant basis. As the
balance of cash owed by each name fluctuates over time, the company tries to
match this with default swap positions. Hence, if a customer fails to pay,
Siemens can recoup the debt from the default swap seller.

Other companies use credit derivatives less frequently.

"There are occasional corporate users that have secured one-off requirements
for balance-sheet management aims or to strip out the credit risk of a
commercial transaction," said Walter Gontarek, head of global credit
products at RBC Dominion Securities.

By hedging a country or company risk which a corporate may not be
comfortable in carrying, a credit derivative can facilitate a project that
may otherwise be unfeasible, dealers said.

NOT PUT OFF BY BAD PRESS

Corporates' adoption of credit derivatives is in spite of the negative
publicity the instruments have received in recent years. A number of
disputes over whether protection buyers could force banks to pay up on
contracts have ended up in court. However, traders insist that subsequent
work done on contract documentation minimises the risk of such disputes in
future.

Nonetheless a very practical concern for corporates remains, in that credit
derivatives documentation was designed by bankers with sovereign and
corporate bonds in mind. The International Swaps and Derivatives Association
(ISDA) standard documentation for credit default swaps allows for a pay-out
in relation to defaults on bond payments but not on a private debtor's
failure to pay.

"We use the ISDA framework but we need it redrafted in specific ways to fit
our needs. You cannot take a standard contract and trade on it if you want
to hedge trade receivables," Lierow said. These amendments add to the cost
of the credit derivative.

Another problem that corporates face is the complexity of credit
derivatives. There is little experience of the instruments, which are barely
a decade old, in the corporate world. Siemens had to get its expertise from
the financial markets, hiring Lierow from Bankgesellschaft Berlin.

Clive Banks, UK head of derivatives sales to buy-side clients at Schroder
Salomon Smith Barney, said much of the effort in marketing credit
derivatives to corporates involves educating them about the products and the
risks involved.

"It's about explaining credit risk management and what kind of volatility
and cost having credit risk introduces," he said.

OUTLOOK PROMISING

Yet some corporates are beginning to take full advantage of their new tool.
Lierow said that Siemens, which currently only buys credit protection,
planned to start acting as a default swaps seller in the coming months.

He said selling would facilitate better matching of protection levels to
actual exposures, and would enable diversification of risk away from
industry sectors where the company's activities are concentrated.

"You could improve the portfolio mix by buying protection on automotives and
selling protection on pharmaceuticals," he said.

Fed Proposes Rules On Derivatives, Intraday Lending
Dow Jones - May 3, 2001
By Dawn Kopecki

The Federal Reserve Board Wednesday proposed regulations that would place
restrictions on intraday lending as well as on derivatives contracts between
banks and their affiliates.

The Fed is seeking public comment on the proposal, which would apply rule
23A of the Federal Reserve Act to derivatives contracts as well as to
intraday extensions of credit. The proposal is designed to limit a bank's
exposure to risk from an ailing affiliate.

Section 23A limits the ability of an insured depository institution to
extend credit to or purchase assets from an affiliate. It also establishes
collateral requirements for credit transactions between banks and their
affiliates.

Fed officials also proposed to extend rule 23B, which requires that
transactions between banks and their affiliates be on market terms, to
derivatives and intraday loans.

Under the interim rule, over-the-counter (OTC) derivatives contracts would
have to be collateralized and the terms of the contract would have to
reflect market prices. Banks would also have to have procedures in place to
handle derivatives transactions and intraday lending.

The interim rule, which is not yet final and could change, would go into
effect Jan. 1, 2002.

"Its primary goal will be to establish barriers protecting depository
institutions from the problems of a failing affiliate," said Anthony
Santomero, president of the Federal Reserve Bank of Philadelphia, in a
speech earlier this year. "Even with the best of intentions, this regulation
will prove difficult to codify and will be subject to close scrutiny."

The proposal was precipitated by legislation passed in late 1999 that
overhauled the U.S. financial service sector. The Gramm-Leach-Bliley Act
also required the Fed to issue rules by May 12 on derivatives transactions
done by banks.

The Federal Reserve Board also unanimously adopted a new rule that exempts
certain transactions between banks and their affiliates from those same
collateral standards as well as from other restrictions.

For example, loans made by a bank to an unaffiliated borrower that then uses
the loan to buy securities underwritten or sold by a brokerage affiliated
with the bank would be exempt from rule 23A.

Banks urged to improve credit, operational risk disclosure
IFR - April 28, 2001

International banks will need to increase credit and operational risk
disclosure to regulators, according to a report issued by the Bank for
International Settlements last week. "There is still a long way to go
compared with the current practice," said an official at the regulatory
body. Disclosure related to credit derivatives and banks' use of internal
credit risk rating methods, as well as disclosure of methods for measuring
and assessing operational risk was lacking, the BIS report found.

Fewer than half of the banks that use credit derivatives disclosed their
strategies and objectives for the use of such instruments, it noted.
Furthermore, only 18% of banks disclosed a breakdown of type of credit
derivative instrument used, notional and fair values, and the amount of
credit risk bought or sold, it added.

Similarly, few banks provided summary information on the quality of on and
off-balance sheet credit exposures based on internal ratings or external
ratings, the report said, noting that this is an area where disclosure could
be improved.
According to the report, less than one quarter of the banks described how
internal ratings are used in the bank's capital allocation process. The
adequacy of disclosure related to the use of internal ratings will be an
area of increased importance under the new Basle Capital Accord as banks
will need to qualify to allow their internal based approaches to be
considered, the BIS report said.

Overall, banks did disclose their objectives and strategies in using
derivatives to hedge risks, with 81% of banks disclosing their objectives
for the use of non-trading derivatives. Fifty-seven banks from the 11 Basle
Committee member countries took part in the survey conducted by the BIS
transparency working group.

The report found that while 96% of respondents disclosed their risk-based
capital ratio in accordance with the methods prescribed in the Basle Capital
Accord, only 30% provided all of the information relevant to understanding
how Basle requirements for market risk under internal models have been
calculated. Further, only half of those surveyed disclosed whether they had
an internal process for assessing capital adequacy and for setting
appropriate levels of capital.

The absence of existing guidance at the time of the study is the likely
reason for the poor marks for disclosure on operational risk management.
"They should see how their [operational risk management] practices compare
with guidance released in January," said a BlS official.

A discussion paper elaborating on the tenets of the Basle Committee's
January proposal is slated for release toward the end of the summer. The aim
of the paper will be to assist banks in their implementation of the final
proposal, which is due for release at the end of the year. The Basle
Committee in its most recent draft proposals indicated its intention to levy
an operational risk capital charge.

Although the BIS conducts annual reports on bank disclosure practices, the
1999 survey cannot be compared directly with previous surveys as its focus
shifted away from trading and derivatives to cover other areas such as
operational risk.

Argentina crisis default swap ripples contained
IFR - April 28, 2001

Argentine default swaps drove out last week, as the sovereign teetered on
the brink of a forced restructuring of its debt. The ripple effect on credit
default swaps in other Latin American sovereigns was limited, however, and
even Argentine quotes were well off their highs by the end of the week.
Investment grade corporate default swaps mostly fell on the back of a wave
of CDO portfolio position unwinds.

There was one-year Argentina default swap trade as high as 2,450bp last
Monday, but by the end of the week, the maturity was quoted at
1,225bp/1,725bp. For much of the week, the market was illiquid, with major
dealers saying that they would only come inside bid/offer spreads to do
client trades.

There was mild curve inversion in Argentina by the end of the week, with
two-year quotes at 1,lOObp/1,600bp, the five-year at 1,060bp/1,520bp, and
the 10-year at 1,000bp/1,400bp.

The basis between default swaps and the asset swap value of Argentine FRB
debt was very wide. For much of the week FRBs were trading at levels at
least 300bp tighter than the apparent realistic mid-point for default swaps.

Before the most recent crisis in confidence over Argentina's ability to
raise funds, and to maintain its currency peg to the dollar, its default
swaps were trading at levels tighter than the asset swap value of comparable
FRBs.

Brazilian default swap levels were not hit as hard as those in Argentina,
and Mexican credit protection swaps did not suffer contamination from
Argentina's troubles. There was one-year trading in Brazil default swaps
seen at least as high as 475bp, but quotes in the maturity at the end of the
week were at 360bp/430bp.

Brazil's default curve also remained positive - with the three-year at
620bp/695bp at the end of the week, the five-year at 660bp/740bp and the
10-year at 740bp/820bp.

The basis between the asset swap value of Mexican dollar debt and its
default swap prices remained at a comparatively tight 2Obp-30bp, which
indicated that there had been no aggressive move to buy default swap
protection, Its one-year default swap quotes were holding in at 100bp/135bp
at the end of the week, its three-year quotes at 200bp/240bp, five-year
prices at 250bp/290bp (there was trade at 273bp) and its 10-year prices at
280bp/320bp.

There was a sharp decline in credit default swap quotes for many of the most
liquid corporate names on the back of off-loading of CDO positions by some
of the bigger dealers. Telecoms and auto conipany quotes fell as a result of
this swap selling, with many benchmark quotes falling by 10bp or more last
Thursday.

British Telecom was one of the biggest movers, trading at least as low as
120bp in the five-year, having been l5bp higher the session before. Its
quotes were well offered on the back of the announcement of the replacement
of chairman lain ValIance, and talk of a o5bn rights issue to replace debt,
as well as the effect of the CDO selling.

France Telecom dealt at levels below 70bp in the one-year and its five-year
mid quotes fell below l20bp.

DaimlerChrysler saw five-year trading below lOObp, and its mid quotes were
approaching 9Obp by the end of the week, having started the week at 1 l5bp,
while Ford and GMAC both saw five-year trade as low as 83bp.

Not all investment grade corporate default swaps fell, however.

Carnival continued to be strongly bid on the back of hedging of its recent
convertible bond, which was increased by US$ lOOm to US$600m.

There was five-year default swap trading in Carnival seen at levels
including 8Obp.

Fed Proposes First-Ever RegulationTo Govern Limits on Affiliate Transactions
BNA - May 3, 2001
By R. Christian Bruce and Richard Cowden

The Federal Reserve Board unveiled one of its most important regulatory
projects in recent years on May 2 and asked for comment on a proposed
regulation that would implement key provisions in federal law limiting
transactions between banks and their affiliates.

As required by Congress, the Fed also released an interim rule to cover
aspects of those transactions and finalized another rule that addresses
exemptions from the law.

The proposed Regulation W marks the first time the Fed has formulated rules
implementing restrictions under Sections 23A and 23B of the Federal Reserve
Act, two of the most important laws for federally-insured banks.

Although the Fed has offered advice and interpretation before with respect
to Sections 23A and 23B, it has done so using legal rulings and advisory
letters geared to specific cases.

Now the Fed is updating those interpretations and putting all of the
information in one place. "The proposed Regulation W seeks to provide users
with a single, comprehensive reference tool for complying with and analyzing
issues arising under sections 23A and 23B," the Fed said.

Action in Three Parts
In its May 2 meeting, the Fed took three distinct actions. The Fed issued an
interim rule, effective Jan. 1, 2002, that requires banks to establish
policies and procedures to monitor and control credit exposure from intraday
credits and derivatives transactions with affiliates. Although the effective
date is delayed, banks are expected to get to work on the new policies and
procedures as soon as possible. The interim rule also clarifies that both
types of transactions are covered under Section 23B, which means that banks
will have to treat those transactions as "arms-length" transactions, just as
they would with any other third party. The Fed expressly declined to rule on
whether derivative transactions between banks and affiliates are covered
transactions under Section 23A;
asked for comment on the main text, the proposed new Regulation W, which
would incorporate many existing Fed pronouncements and interpretations
applying Sections 23A and 23B, as well as adding some important new
wrinkles; and issued a final rule setting out various transactions that are
eligible for exemption from Section 23A. The rule was originally proposed
June 11, 1998. In addition, the Fed is allowing opportunity for further
comment on some of the exceptions during the comment process for the
proposed Regulation W.

Why the Rule Matters
The Fed's three-part initiative is significant because Sections 23A and 23B
are important statutes that protect banks from losses due to transactions
with affiliated institutions, such as securities units or mortgage firms.

According to the Fed, the increasing scope and complexity of bank operations
in recent years sparked more requests for guidance, especially in connection
with Section 23A, which places quantitative limits on affiliate
transactions.

And if transactions with affiliates were important before, they are even
more important now. In 1999, Congress passed the Gramm-Leach-Bliley Act, the
financial services modernization law that was expressly crafted to allow
even broader affiliations between banks, securities companies, and insurance
firms.
The GLB Act, which also amended key provisions in sections 23A and 23B, gave
the Fed until May 12 to adopt rules addressing credit exposure in connection
with intraday credits and derivatives transactions with affiliated
institutions. The Fed accomplished that task by issuing the interim rule.

Finally, the rule is important because it could make things easier for
everyone involved, at least in theory. By crafting an implementing rule for
Sections 23A and 23B, the Fed will be able to consolidate its doctrine. In
addition, the rulemaking process gives bankers the opportunity to shape the
final version of the rule.

Early Reaction
Observers were still poring over the Fed's initiative late May 2, especially
the interim rule and the newly proposed Regulation W. They welcomed the
Fed's decision to delay the interim rule's effective date, saying the time
between now and Jan. 1, 2002, will be put to good use.

Sarah A. Miller, general counsel of the American Bankers Association
Securities Association, told BNA May 2 that the Fed "took a fairly
responsible approach," especially in terms of taking limited action in the
interim rule and leaving many of the tougher issues for the comment process.

Above all, she said, bankers hope that the rule, once finished, will provide
much-needed clarity with respect to Section 23A and Section 23B issues.
"We're elated that the rule is out," she said.
Miller also said the final rule on exemptions will be helpful, especially
provisions addressing certain loans to third parties. She said the ABASA has
been working for such changes since at least 1997. "This is something our
guys have been very much anticipating," she told BNA.

Definitions at Issue
Another analyst noted that the Fed gave a fairly narrow definition of
intraday credits in the interim rule, carving out exceptions for securities
clearing and settlement transactions on behalf of affiliates.

"Clearly, they didn't want to interrupt normal day-to-day dealings that
don't present any real risk," the analyst told BNA.

However, there was some disquiet over other aspects of the Fed's action. For
example, analysts said the interim rule defines "derivative transaction"
quite broadly, so much so that many transactions will fall under the
coverage of Section 23B. According to the Fed, "derivative transaction"
means "any derivative contract covered by the Board's capital adequacy
guidelines [which includes most interest-rate, currency, equity, and
commodity derivative contracts] and any similar derivative contract,
including credit derivative contracts."

Another potential sticking point is how the proposed Regulation W addresses
independent credit judgments under 12 C.F.R. 250.250, an interpretive rule.
The proposal establishes a bright-line quantitative test, but goes on to
give bank examiners significant discretion to decide whether a bank has
shown the independence required to gain a critical exemption under the rule.
Under the proposal, even if the bank meets the quantitative test, it may
still be denied the exemption if the examiner decides that the bank is
providing substantial and ongoing funding to the affiliate.

More Exemptions Could Be on the Way
The Regulation W proposal also allows bankers to comment on potential
additions to the exemptions in the final rule. One would involve purchases
by a bank of municipal securities from a broker-dealer affiliate that is
registered with the Securities and Exchange Commission, according to a Fed
staffer. Among other requirements, the municipal securities must be eligible
for purchase by a state member bank and must be rated by a nationally
recognized rating organization or it must be part of a pool of securities of
less than $25 million.
Another would allow certain companies to charter a new bank and transfer
assets to the new bank from affiliated institutions outside the restrictions
of Section 23A.

A third possible exemption would govern certain credit card transactions. A
Fed official explained a typical case in which the proposed exemption would
apply. "If a [bank] loan to a third party is pursuant to a general purpose
credit card, like a Visa or Mastercard, and the third party buys a product
from an affiliate of the bank, we're going to basically ignore that
transaction," he said.

Another Fed official said the purpose of the exemption was to accommodate
extensions of credit that are not designed to subsidize an affiliate of the
bank through transactions that elude the Sections 23A and 23B limitations.

Comments Due in 90 Days
The proposed rule applies to all federally-insured banks. However, even
though Congress has extended coverage of Sections 23A and 23B to savings
associations, the Office of Thrift Supervision (OTS) will have to craft its
own rule, the Fed said. OTS officials told BNA May 2 that they are studying
the Fed's proposal.

Comments on the proposal are due 90 days after it is published in the
Federal Register. All existing Fed interpretations and staff opinions remain
in effect until the new Regulation W becomes final.

Scott Marra
Administrator for Policy & Media Relations
ISDA
600 Fifth Avenue
Rockefeller Center - 27th floor
New York, NY 10020
Phone: (212) 332-2578
Fax: (212) 332-1212
Email: smarra@isda.org