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Enron Mail |
Jane:
This responds to your questions relating to the gambling issues for weather derivatives which we discussed last week. This advice is based on discussions with Naoaki Eguchi and Shinji Toyohara. We have tried to provide a practical response to all of the issues raised. If you need further discussion on the theoretical underpinnings, please let me know. As background, the main advice to date on this issue has been our initial advice of January 14, 2000, a memorandum to John Viverito dated July 7, 2000 and an email to John Viverito dated July 13, 2000. Question 1: (Can/Should ToaRe and Enron Japan give a mutual representation to the effect that they are each entering into the transaction "to hedge weather related risks arising in the ordinary course of [their] business". If not, can the representation be deleted or amended?) ToaRe has taken the position that it is a "risk taker" in this transaction and that, accordingly, it cannot give the representation because it is not hedging risk. Similarly, Enron Japan does currently have weather exposure in Japan and, accordingly, cannot be said to be hedging weather risk. It follows, that the representation, as currently drafted, does not fit the actual circumstances of either party and needs to be modified or deleted. Our recommendation would be to modify the representation as follows: (a) each party represents to the other that it understands the transaction, it is entering into the transaction in the ordinary course of its business and that it has a legitimate business purpose for entering into the transaction; (b) ToaRe represents to Enron Japan that it has the power and authority to enter into the transaction under the Insurance Business Law. The modification to paragraph (a) removes the word "hedge" which would have been problematic to both parties, but retains the basic concept that this is a commercial transaction within the ordinary scope of business of both parties. We understand that Enron Japan's business purposes allow Enron Japan to engage in weather derivative transaction. We also note that the Financial Law Board (Paper on Derivatives Transactions and Gambling, issued on November 29, 1999; the Financial Law Board is an unofficial organisation of legal practitioners) has stated that a company that enters into derivative transactions as a business may be able to argue that it has a legitimate business purpose in entering into the transactions - particularly where the parties to the transaction are sophisticated and the transactions are conducted within reasonable parameters. Based on these factors, we believe that Enron Japan should be able to give both representations. However, Enron Japan should note that the issue is not entirely clear under Japanese law and there remains a remote possibility that a Japanese court might determine that Enron Japan did not have a legitimate business purpose in entering into the transaction. The representation in paragraph (b) is based on the provisions of the Insurance Business Law that enable insurance companies (including Japanese reinsurance companies) to enter into certain types of derivative transactions. We understand that the FSA has provided informal guidance to certain financial institutions to the effect that the provisions allowing financial institutions to enter into financial derivatives are wide enough to also allow financial institutions to enter into weather derivatives. However, this is a matter that ToaRe would need to confirm with the FSA directly, and we are not able to express a general view - all that is possible is for Enron Japan to request the representation from Toa Re. Please note that in cases where Enron Japan's counterparty is a manufacturing company, the representation, as originally drafted, should be given by the counterparty. Question 2: (Exposure for Enron Japan). As discussed in our earlier advice, the issue of whether weather derivatives constitute gambling under the Japanese Criminal Code is not clear, and we are not able to provide a definite opinion on these issues. There are two defenses to an allegation of gambling under the Criminal Code: "acts in accordance with law" and "legitimate business purpose". In principle, each counterparty must be able to show that one of the defenses applies to it. There is at least a suggestion in the Financial Law Board paper that if the "act in accordance with law" defense applies to one party, the counterparty should also be able to rely on this defense. However, this argument does not have judicial support, and the more conservative position is to ensure that each party meets one or more of the defenses. In this case, looking at each defense in turn: (a) ToaRe is a reinsurance company and will be entitled to rely on the provisions of the Insurance Business Law to argue that entering into a weather derivative transaction is an act in accordance with law, and thus does not constitute gambling; and (b) it is arguable that, consistent with the comments of the Financial Law Board discussed above, both ToaRe and Enron Japan have a legitimate business purpose in entering into the transaction on the basis that: * each party is carrying on a business of trading weather risk; * each party is a sophisticated investor (as Enron Japan is a new company, it would need to rely on the experience of Enron Japan traders previously located offshore to show "sophistication"); and * each party (at least in the case of Enron Japan) is conducting the transaction in accordance with reasonable parameters. Accordingly, assuming that ToaRe is able to give the representations referred to above, and that these representations are correct, both paragraph (a) and paragraph (b) appear to apply. Thus, we do not believe that the risk for Enron Japan in entering into this transactions with ToaRe will be any higher than would have been the case if Enron Japan had entered into the transaction with a legitimate end user (for example an air conditioning company). We have previously characterised this risk as being "relatively low". It is conceivable that Enron Japan may, in the future, enter into transactions with entities that are neither financial institutions nor end users (for example, other traders like Enron itself would fall into this category). In such a case, Enron Japan will not be able to rely on the "act in accordance with law" argument, and will be obliged to rely only on the "legitimate business purpose" argument based on the fact that the counterparty is a trader of financial products. In our view, the risk for Enron Japan in this scenario would increase, but could still be characterised as being "relatively low". In this situation, Enron Japan and the counterparty would give mutual representations to the effect of the representation set out in paragraph (a) under Question 1 above. Question 3: (Criminal Sanctions) From a technical point of view, criminal sanctions apply only to individuals, and not to companies. In this case, the criminal sanctions (if any) for gambling could potentially apply to the trader that entered into the transaction. The responsible managers may also have criminal liability on the basis that they controlled the acts of the trader, or solicited the acts of the trader. The penalties are: Simple gambling - up to Yen 500,000 fine Habitual gambling - imprisonment up to 3 years; Booking - imprisonment of between 3 months and 5 years. Question 4: (Conducting the transactions using an Enron affiliate located outside Japan) As noted in section 5 of our July 7, 2000 memorandum, we consider that the risk that the activity constituted gambling would be reduced if Enron were to enter into weather transactions from offshore. Embedded in the foregoing comments is the concept that the representations in the GTC's need to vary depending on whether the counterparty is a financial institution, another unregulated trader or an end user of weather derivatives. The representations previously proposed were proposed on the basis that the counterparty would be an end user. If appropriate, we would be happy to provide alternate forms of representations for your reference. Please let us know if you have any questions. Best regards Jeremy Pitts Registered Foreign Lawyer - Jurisdiction of Primary Qualification - New South Wales Designated Jurisdictions - England and Wales and the State of Victoria Direct Tel: (81-3) 3479 3839 Direct Fax: (81-3) 3479 0225 Voice/Fax Messaging: (81-3) 4464 6094 This is an e-mail from Baker & McKenzie - Tokyo Aoyama Law Office (Qualified Joint Enterprise Offices). The contents of this e-mail may be privileged and confidential and are intended only for the use of the addressee. No one else may copy, forward, disclose or use all or any of it in any form. If you are not an intended recipient, please notify us immediately (by reply e-mail) and delete this e-mail from your system. Thank you. -----Original Message----- From: Jane.McBride@enron.com [mailto:Jane.McBride@enron.com] Sent: Friday, October 20, 2000 6:18 PM To: Jeremy.Pitts@BAKERNET.com Cc: Alan.Aronowitz@enron.com; Mark.Evans@enron.com; Mark.Taylor@enron.com Subject: ... Urgent Weather Derivative Advice ... << File: Weather-HDD-Floor-OTC-ToaRejmb2000-10-20!.doc << Dear Jeremy, Pls see for your information my email to Alan, Mark and Alan. As discussed, your answers to my questions can be quite brief and pls cross reference previous advice rather than repeating it. I think the answer to question 1 - whether we can give the warranty - has got to be no. So short and sweet on this is fine. Re whether we can go ahead without the same ©(ii) from them (but with ©(iii)) is a harder question and I understand that all you can do is explain our risk and exposure, in light of the current factual situation. This is a risk appetite question at the end of the day. Jane ----- Forwarded by Jane McBride/AP/Enron on 10/20/2000 05:57 PM ----- Jane McBride To: Alan Aronowitz/HOU/ECT@ECT, Mark Taylor/HOU/ECT@ECT 10/20/2000 cc: Jeremy.Pitts@BAKERNET.com, John Viverito/Corp/Enron@Enron, 05:57 PM Jonathan Whitehead/AP/Enron@Enron, Mark Evans/Legal/LON/ECT@ECT, Paul.TYO.Davis@BakerNet.com, Morten E Pettersen/AP/Enron@Enron, Joseph P Hirl/AP/ENRON@ENRON Subject: ... Urgent Weather Derivative Advice ...(Document link: Jane McBride) Dear Alan and Mark, I am going to need you to help me make a risk decision. I welcome input from Mark Evans but he may be more comfortable leaving this up to Alan and Mark because Alan and Mark have been involved in this gambling issue from the beginning. Jeremy Pitts and I have had a brief conversation re my email to him below, this afternoon, but he will not be able to get written comments signed off by Japanese lawyers to me until Monday. The situation relates to the Tokyo's office's first weather derivatives deal, which is with a company called Toa Reinsurance. In a nutshell the situation is that negotiations have come to a standstill because neither side can move on their positions re the gambling warranties. The deal of course though has already been done over the telephone several weeks ago. In a nutshell then, based on discussions with Jeremy Pitts, but to be clarified by Japanese lawyer on Monday, the situation is: 1. In terms of Enron Japan's ability to trade weather derivatives here, we are operating in the grey even if we can get warranty 5©(ii) from them. 2. ToaRe will not give us the important warranty - 5©(ii) below, because they say they can't. They say they are not actually "entering into the deal to hedge weather related risks arising in the ordinary course of their business" - which is what the subject warranty says. B&M have advised that the obtaining of this warranty from a counter party helps keep us in the grey and out of the red in terms of what we are doing and also gives us comfort that the counter party can do the deal. 3. ToaRe is, in addition, separately asking us to give them the same warranty. Jane McBride analysis Re 3 - Given that our legal situation is grey at best, I do not think we should be giving the warranty they have requested. They say they will not give us that warranty. The issue then is whether we can go ahead without getting the warranty from them, bearing in mind that a binding telephone deal has been done. If you agree with me that we can't give the warranty, then we have to decide whether we can go ahead without getting the warranty referred to in (2) above, from them. I am not sure however that in practice we even have a choice given that the trade has been done. If we go ahead without giving and without getting the warranty, the risk to us is that we are more likely to be in breach of the prohibition on gambling in the Criminal Law. Are we willing to take this risk and who needs to give me this answer? Jane Jane McBride To: Jeremy.Pitts@BAKERNET.com 10/20/2000 cc: Paul.TYO.Davis@BakerNet.com, Alan Aronowitz/HOU/ECT@ECT, John 02:06 PM Viverito/Corp/Enron@Enron, Mark Evans/Legal/LON/ECT@ECT, Jonathan Whitehead/AP/Enron@Enron, Mark Taylor/HOU/ECT@ECT Subject: ... Urgent Weather Derivative Advice ...(Document link: Jane McBride) (See attached file: Weather-HDD-Floor-OTC-ToaRejmb2000-10-20!.doc) Dear Jeremy, I would like to refine the following instructions. There are two (only) issues on which we need specific written advice and they both relate to Warranty ©(ii) of the draft which says "XYZ is entering into a weather derivative transaction to hedge weather related risks arising in the ordinary course of its business". 1. (a) Can Enron Japan give the warranty at this stage in its growth? Have we already had any written advice from you on whether Enron Japan can warrant along these lines? If so, when? If not, the facts seem to be that: Enron Japan plans to trade commodities which are energy related but because we are still building up the business we are not trading these products yet. As you know, we are getting into the power market. If we have done a weather derivative, then we can of course offer better prices on the electricity deals we are negotiating. Other Enron companies are of course already trading many weather dependant commodities and power. It could be argued therefore that unless we can rely on the weather related risks of other Enron companies to justify our weather derivative transacting in these early days, that this is a speculative transaction constituting gambling (depending on how the law on this works). It is understandable that ToaRe would want us to warranty in effect that we are not gambling because we are asking them to do so. I know we have had sign off from B&M re our weather derivative trading but I wonder if anyone considered what the situation would be before we ourselves had other transactions giving us weather related risks. (b) If not, how could it be amended so that we can give it? © If still relevant in the context of your answers to (a) and (b) above, they did offer previously to take out all warranties so that neither party gives any warranties. The deal cannot be cancelled because it was done on the telephone late Sept. Accordingly, what is the practical risk of us proceeding without the benefit of any warranties from ToaRe (including the warranty that they are under the Insurance Business Law - ie an insurance company.)? 2. They are insisting they not give (ii) and that we be satisfied with (iii) only for the purposes of the Gambling Law Pls confirm in writing whether you think we can still go ahead on this basis. Thanks. Jane McBride Senior Legal Counsel Enron Japan Corp. Otemachi 1st Square Bldg. West 11th Floor 1-5-1 Otemachi, Chiyoda-ku Tokyo 100-0004 Japan Tel.: 81-3-5219-4500 (Main) 81-3-5219-4553 (Direct) Fax: 81-3-5219-4510 Assistant (Maggy Yamanishi) Tel.: 81-3-5219-4554 Email: Yo.Yamanishi@enron.com Jane McBride To: Jeremy.Pitts@BAKERNET.com, Paul.TYO.Davis@BakerNet.com 10/20/2000 cc: 10:57 AM Subject: RE: ToaRe documentation(Document link: Jane McBride)
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