Last Updated: August 1, 2008

Swap Counterparty
In many securitization products or repackaged bonds (hereinafter referred to as “structured products”), if
a financial institution participates in the scheme as a swap counterparty, there are cases wherecreditworthiness of the swap counterparty may have an impact on the structured products themselves.
In rating for a structured product, JCR has been adopting in principle the “weak link approach,” inwhich the rating is linked to the weaker of the rating on the underlying assets of the structured product or therating on the counterparty, because a default of counterparty has been taken as a cause for winding-up of theswap contract itself in the ISDA-based swap contracts, etc. JCR will explain the way of factoring increditworthiness of a swap counterparty in rating for a structured product in a comprehensive manner below.
1.

Swap Counterparty in Structured Products
In a structured product, a swap can be used mainly in a synthetic CDO or repackaged bonds. A swap
here is a swap, which exchanges only an interest rate during period between the two parties(fixed-for-floating interest rate swap or interest rate swap in different currencies), a swap exchanging not
only an interest rate but also a cash flow from collateral assets at the time of redemption, or a credit
default swap in which one party provides a “guarantee” for credits referring to corporations to anotherparty.

2.

Way of Factoring in Creditworthiness of Swap Counterparty in Rating
In rating for a structured product, JCR adopts the weak link approach in principle, in which the ratingis also linked to creditworthiness of swap counterparty. For this reason, it is a fundamental rule that arating exceeding a rating on the swap counterparty cannot be given to a structured product.
However, application of the weak link approach shall be avoided by taking measures described“de-linking measures” below.

3.

De-linking Measures(1) In Case Where Rating on Structured Product is above AAWith a swap counterparty with a long-term rating of above AA- (equivalent to J-1+ for a short-term
rating) being an eligibility requirement initially, one of the following measures shall be specified to betaken in the initial swap contract:
If the rating becomes below AA- (equivalent to below J-1+ for a short-term rating),· Replacement of the counterparty with another counterparty which meets the eligibility requirements.
· Provision of a guarantee which JCR accepts as eligible.
· Establishment of a security agreement that can cover the required amount during period.
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In addition, in case of a simple swap contract where cost for rebuilding during period is consideredrelatively low, JCR applies the following requirements:
In case where a rating on a structured product is above AA-, with a swap counterparty with ashort-term rating of above J-1 being an eligibility requirement, one of the following measures shall bespecified to be taken in the initial swap contract:
If the short-term rating becomes below J-1,
· Replacement of the counterparty with another counterparty which meets the eligibility requirements.
· Provision of a guarantee which JCR accepts as eligible.
· Establishment of a security agreement that can cover the required amount during period.
In particular, in a case as in the case of a credit default swap where a swap counterparty shall pay
only a predetermined amount in each period, one of the following measures shall be specified to betaken in the initial swap contract:
If the short-term rating becomes below J-1,
· Replacement of the counterparty with another counterparty which meets the eligibility requirements.
· Provision of a guarantee which JCR accepts as eligible.
· Payment in advance equivalent to payment for one period of the entire period.
In addition, if the short-term rating becomes below J-2,
· Replacement of the counterparty with another counterparty which meets the eligibility requirements.
· Provision of a guarantee which JCR accepts as eligible.
· Payment in advance for the entire period in full.
(2) In Case Where Rating on Structured Product is above A- and below AAWith a swap counterparty with a long-term rating of above A- (equivalent to J-1 for a short-termrating) being an eligibility requirement, one of the following measures shall be specified to be taken in
the initial swap contract:
If the rating becomes below A- (equivalent to below J-1 for a short-term rating),· Replacement of the counterparty with another counterparty which meets the eligibility requirements.
· Provision of a guarantee which JCR accepts as eligible.
· Establishment of a security agreement that can cover the required amount during period.
As in the case of (1) above, for a swap contract where cost for rebuilding during period is
considered relatively low, JCR shall examine its handling individually.
The ratings on the counterparties here are in principle intended for only the entities rated by JCR.
As for other eligibility requirements for the counterparties by alternative reinforcement measures inschemes including provision of collateral, JCR shall examine the conditions for each structured product.
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The above de-linking measures are based on the assumption that a probability that the swap
counterparty goes into default all of a sudden and then it gives up its fulfillment of the swap contract
falls within a range of default rates estimated from the rating on the structured product.
For a financial institution to become a counterparty, JCR also examines whether or not it has anability to conduct in an appropriate manner its desk workflow associated with measures predetermined
for a situation if its creditworthiness worsens and it hits the downgrade trigger set in the structured
product, in addition to its creditworthiness represented by its rating, to determine the suitability as acounterparty finally.

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