Last Updated: July 14, 2009

Repackaged Financial Instruments
1. Repackaged Financial Instruments
A repackaged note means the note newly repackaged using derivatives such as currency and interest
rate swaps to make cash flows of secondary market notes more appealing to investors. Notes, loans (asset
backed loans) and trust beneficiary interests of which the underlying assets, as stated in the table 1, arerepackaged by using SPV (Special Purpose Vehicle), as stated in the table 2, are collectively referred to as
repackaged financial instruments hereinafter.
Table 1 Underlying Asset· Notes (including convertible notes and warrant notes)· Loan Receivables, Leasing Receivables, Installment Claims, Deposit Claims· Fund Claims to Life Insurance Companies· Hybrid Instruments issued by Corporation or Financial Institution (like a Preferred Stock)· Trust Beneficiary Interests composed of the foregoing assets
Table 2 SPV (Special Purpose Vehicle)· Trust· Tokutei Mokuteki Kaisha (Special Purpose Company) established in Japan pursuant to the Law
Regarding Securitization of Specified Assets by a Special Purpose Company· Limited Liability Company, Stock Company, Special Limited Liability Company incorporated inJapan pursuant to the Companies Act
The difference between a repackaged financial instrument and CBO (Collateralized Bond
Obligation) is that cash flows of a repackaged financial instrument consistently correspond to that of theunderlying asset on one-on-one basis although cash flows of the underlying assets are transformed
through swaps. On the contrary, CBO has senior/subordination structure (senior note/junior note or senior
note/mezzanine note/junior note) as there are plural numbers of cash flows of numerous issues ofunderlying assets backing up CBO. Accordingly, a credit rating of a repackaged financial instrument isdetermined based on the results of analysis of contractual aspects relating to the issue (creditworthinessof underlying assets, contract performing ability of parties related to cash flows and legal protection). As
for CBO, on the other hand, based on the analysis of an issue structure, and then the actual rating shall be
determined after assessing credit enhancing measures.

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2. Key points of a Credit Rating(1) Framework of a credit rating
JCR generally assigns a credit rating to a repackaged financial instrument based on the
weak-link-approach method. In other words, the final credit rating is determined based on the
weak-link-approach of the following:(A) The credit rating of the underlying asset(B) The credit rating of the swap-counterparty (or other derivatives-counterparty or the provider of thecredit enhancement or liquidity supplement)
According to the weak-link-approach method, the final credit rating for the repackaged financial
instrument shall not be higher than the rating of the weakest element among numerous elements bywhich the repackaged financial instrument is backed. In other words, the credit rating of the repackaged
financial instrument shall converge and link to the credit rating of the weakest element (hereinafter
called the “Weakest Entity”). If one element relating to the repackaged financial instrument becomesunable to function, timely repayment of principal and interest of the repackaged financial instrument
cannot be assured. When the lowest rating among the underlying assets or swap counterparties is revised
as a result of a rating review, the rating of the repackaged financial instrument will be revised as well.
As for the foregoing swap counterparty (A), however, if its short-term rating becomes lower than acertain level, it is also possible not to designate the rating of such swap counterparty as an upper limit
for the rating of such repackaged financial instrument by incorporating such provisions as (a) replacing
the counterparty by another counterparty who fulfills the qualifications, (b) submitting a guaranty whichis admitted to be qualified by JCR (c) concluding a collateral contract which covers the necessaryamount throughout the contract term.1 In these cases, although a swap counterparty should, in principle,
be limited to whom JCR assigns a rating including “p” rating (rating mainly based on publishedinformation), relaxation of such qualifications for a swap-counterparty could be considered for eachcases under the premise that the relevant scheme shall be reinforced.
(2) Credit Rating of Underlying Assets (Creditworthiness)
Various expenses for maintenance of a scheme, interest payment and principal redemption of arepackaged financial instrument are covered primarily by cash flows generated from underlying assets.
The credit rating of underlying assets constitutes a core part for the final credit rating of a repackaged
financial instrument.
If a repackaged financial instrument has plural numbers of underlying assets, the asset of whichrating is the lowest is focused on. If the elements of creditworthiness of underlying assets are
independent, the increase in the number of underlying assets would simply increase the risk for
impairing the principal amount. In other words, if even one cash flow of the underlying assets becomes1

For details, refer to the report of “On the Structured Products and Creditworthiness of the Swap-Counterparty”.
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delinquent, the repackaged financial instrument would fall into default or be redeemed before maturity.
Hence, JCR considers that the increase in the number of underlying assets would heighten theprobability of default and JCR has a policy to assign credit rating in a prudent manner to a repackaged
financial instrument which is backed by large number of underlying assets.
In light of statistics, the weak-link approach is premised on that the correlation coefficient ofdefault probability of elements is 1 (i.e. perfectly correlated). If it is presumed that a default of elements
occurs at random (i.e. the correlation coefficient is 0), in an extreme argument, the default probability ofa repackaged financial instrument could be recognized as “the simple sum of estimated default
probability of each element”.
To estimate a “default correlation” between several underlying assets at pinpoint preciseness is
considerably difficult, but in general, in case of a repackaged financial instrument with several
underlying assets, the credit worthiness of such repackaged financial instrument ranks in between “theweak-link” and “the simple sum”. When the correlation coefficient of default probability is high, it ismuch appropriate to adopt the “Weak-Link “and the “Simple Sum” is suitable for the case of a low
correlation coefficient. The rating should be conducted in a prudent manner under the foregoing
premise.
(3) Rating of Swap-Counterparty (Contract Performing Ability)
If an event of default occurs to the swap counterparty, the swap contract will be terminated and therepackaged financial instrument should be redeemed before maturity, which would jeopardize interestsof investors. In case where the cash flows from underlying assets are to be transferred before the receiptof the counter value by the SPV, if the swap counterparty falls into default before the SPV receives suchcounter value, the cash flow of a repackaged financial instrument would be impaired. Therefore, therating (contract performing ability) of the swap counterparty is the element of creditworthiness bracing
up a repackaged financial instrument. In the case that JCR does not assign a rating to the swap
counterparty, or estimation of the contract performing ability is difficult (e.g., swap house subsidiaries
of large financial institutions), a guaranty of a parent company will be usually furnished for swap
obligations.
(4) Assurance of cash flows for investors
Whether cash flows from a SPV (from underlying assets in actuality) to investors are practically or
legally secured will be confirmed.
To assess the assuredness of cash flows in practice, the foregoing rating of underlying assets andthe rating (contract performing ability) of other parties involved with the cash flows (swap counterpartyor etc) should be assessed, and for the purpose of a swap contract, whether the date and the amount ofprincipal and interest payment from a SPV to the swap counterparty and the payment received from theswap counterparty match those of the payment regarding the repackaged financial instrument will be
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confirmed. On the other hand it is necessary that a repackaged financial instrument should be structured
so that a bankruptcy of any of the other related parties involved with cash flows would not exert adverse
impact on them.
In the case of deposit claims, fund claims to life insurance companies or preferred stocks, if
underlying assets are subject to a withholding tax with respect to their interest or dividend payment, it isessential in its scheme that the cash flows from the underlying assets do not cause any discrepancy on its
schedule with the cash flows of the repackaged financial instrument (e.g. conclusion of a cash flow
swap contract for replenishing an equivalent amount of the withholding tax or establishing a credit
facility).
Provisions related to cash flows in a contract should be confirmed for judging whether cash flows
of a repackaged financial instrument are secured for investors from legal aspects.
The summaries of checking points are as follow.
(A) Whether or not the cash flow is rigidly segregated for each series of issues which are rated (in casewhere the SPV is a Multi-Issue Company that issues plural numbers of repackaged financial
instruments).
(B) Whether or not the cash flow from underlying assets leaks out in the midst of the fund flow.
Conditions satisfying the above (A) are that the cash flow from underlying assets (repayment
source) is secured individually, and that the default of other series of issues by the identical SPV will notexert adverse impact on the cash flow from the series of issues covered by the relevant rating (thecreditors’ right to claim for payment related to other notes will have no impact from practical and legal
aspects on the cash flow of the series of issues covered by the relevant rating, that is a Ring Fencing).
About a repackaged financial instrument issued in Euro market, provisions concerning a Ring Fencing
are stipulated in Trust Deed, Agency Agreement and Swap Agreement, etc.
If there are series of issues in the past by such SPV, whether all of such series satisfies theconditions for a Ring Fencing will be confirmed by legal opinions, etc. Further, while an unredeemedbalance remains for the series covered by the rating, the same conditions should also be satisfied by any
additional series to be issued in the future. Same as a securitizing instrument issued in the domestic
market, pledging collateral over the underlying assets in favor of the investors in a repackaged financial
instrument is not always an essential condition, but it is desirable to pledge collateral if other conditions
allow.
Concerning above (B), for the case of a repackaged financial instrument issued in Euro market, acustodian separately controls the underlying assets for each series of issues, and whether the underlying
asset is strictly segregated from the deposits of other customers even if such custodian falls into
bankruptcy should be checked. The custodian’s obligations are stipulated in Agency Agreement. The
agreement must include provisions which grant solely to the Trustee, as a representative of beneficiaries,
the right to exercise claims against the SPV. Such Trustee monitors SPV’s compliance with covenantclauses. Otherwise, it is also necessary to confirm that lawyer consultation fees or charges shall not run
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short.
(5) Bankruptcy Remoteness of SPV
Table 3 Main Measures to Assure Bankruptcy Remoteness(A) Measures to Prevent Bankruptcy: Prohibition of Businesses other than Issuance of theRepackaged Financial Instrument, Prohibition of Incurring Debts other than the Repackaged
Financial Instrument, Cut-off of the Voting Right from the Principal Entity,(B) Measures to Prevent Commencement of Bankruptcy Proceedings: Independent Managers, Non
Petition Clause, (in the case of a Multi-Issue Company) Ring Fencing Clauses, etc
Bankruptcy remoteness of a SPV is also an important matter in examining assuredness of cash
flows for investors. Businesses of a SPV should be limited to a purchase of underlying assets, issuanceof repackaged financial instrument, interest payment and redemption of them, and execution of swap
contracts (or execution of other derivative contracts, credit/liquidity enhancement contracts). Morespecifically, for the purpose of protecting investors, a SPV must not be liable for any risks other thanthose related to the issuance of such repackaged financial instruments to prevent third persons frominitiating unpredictable bankruptcy proceeding, and if a SPV bears other liabilities (in case ofMulti-Issue Company), measures are required to be taken so that even if any event of default occurs to
debts other than such repackaged financial instruments, cash flows of such repackaged financial
instruments will never be influenced by it. In assigning a credit rating, it is important to verify whether
legal measures are taken to enable a SPV to smoothly move ahead with the issuance, interest payment
and redemption of repackaged financial instruments.2
One of the way to cut-off the voting right of a special purpose vehicle, limited liability company,
stock company (including special limited liability company) incorporated in the domestic domicile(hereinafter called a “Domestic SPV”) from the principal entity of the domestic SPV is to let a Cayman
SPV holds the whole stocks of the domestic SPV (excluding preferred stocks of the SPV, same asfollowing). And further it includes not only the way in which a charitable trust holds whole ordinary
stocks with voting right of the relevant Cayman SPV but also such way in which an Ordinary
Incorporated Association established under the OIA Act (including Incorporated Associationtransformed from the Chuukan Houjin as a result of the revision of the relevant laws) holds whole2

For example, in case of a repackaged product issued in Euro market, the scope of limited activities of SPV shall be
confirmed by the TRUST DEED.*In general, main restrictive activities are as follows:■ Establishment of subsidiaries (branches) and merger with other company■ Bearing of liabilities other than those for issued notes**■ Dividend payment, distribution of earnings■ Additional issuance of stocks■ Disposition of assets and earnings*
Not so if agreed by Trustee.
** Multi-Issue Company is allowed to perform additional issuance of notes and related businesses.
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stocks of the domestic SPV. The necessary conditions for bankruptcy remoteness shall be individually
examined for each case by procuring legal opinions.
(6) Application mutatis mutandis to Single Debtor Type Credit-Linked Note and Loan
■ Brief Description of Single Debtor Type Credit-Linked Note and Loan
Credit-Linked Note is the note of which a credit risk of the relevant issued notes is linked to thecredit of the other corporation by way of a credit default swap contract (“CDS contract). In case of thatthe number of the corporation to which the note is linked is single, it is hereinafter called a “Single
Debtor Type Credit-Linked Note and Loan” (in case of plural corporations and structuring with seniorand subordination tranches, it is called a “Synthetic CDO”).
In the case that a SPV is an issuer, the SPV purchases Euro Yen notes issued by X Company andthen the SPV issues a Credit-Linked Note and Loan to investors by pledging such notes as collateral.
Also the SPV concludes CDS contract in which Y Company is referred to with Z Company, being a
CDS counterparty.
When a credit event occurs, the principal shall not be redeemed in full amount but in such an
amount based on the pre-agreed value like as then current value of the liabilities of Y Company as thereference entity.

Sheme of Single Debtor Type Credit-Linked Note

IssuerSPC

Investors

Underwriter

Issue of
CreditLinked Note
（AA）
Sale of
Credit-Linked Note
to be rated
Proceeds ofNote Issuance

CDS Counterparty
Z Company（AA）

CDS Premium
Payment

Purchase of
Collateral Bonds
Euroyen Bonds
Issued by
X Comapny（AAA）

Reference Entity
Transfer of Credit
Risk by way of CDS（in accordance with
ISDA Credit
Derivatives■ Rating Methodology of a Single Debtor Type Credit-Linked Note and Loan
In principle,(A) The rating of underlying assets(B) The rating of a reference entity
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Y Company（AAA）

(C) The rating of a CDS counter party
Among which, the rating shall be determined according to the weak-link approach. In other words
the rating shall be converged and linked to that of the weakest element.
However, whether or not the probability of occurrence of the credit event as defined in a CDS
contact (at usual case, as per the definition of ISDA) is equal to the default probability assumed for ausual rating, it is necessary to examine an individual contract. It is individually examined whether the
rating of the relevant reference entities should be adopted without adjustments.
In case of that the issuer is a financial institution; the credit-linked note becomes a financial
institution note containing CDS contracts. Therefore the rating of the credit-linked note and loan shallbe determined based on the weak-link approach, i.e. either of(A) The rating of the issuer of the credit-linked note and loan
(B) The rating of the reference entity
A first-to-default note is the note which about 5 to 10 large corporations are selected as reference
entity and when even one corporation falls into default, the note shall be redeemed at the market valueof the relevant failing corporation’s debt (or redeemed in kind).3 In case of a first-to-default note, theweak-link approach shall not be adopted unlike the case of a single debtor type credit-linked note andloan. In turn, the rating methodology for the synthetic CDO shall be adopted by taking into account the
number of underlying assets and following factors, i.e. a credit worthiness of referring entities (current
rating or historical rating transition), correlation in default probability (verification in light of regional,
industrial and systematical aspect).4(7) Other points(A) Issues related to Money Lending Business Control and Regulation Law and Law on Bond Issuancefor Financial Companies
There is a scheme to use a loan receivable instead of secondary market note as underlying asset
as a modified form of repackaged note. In such case, it is possible that a SPV is regarded as a money
lender specified in Paragraph 1 of Article 2 of the Money Lending Business Control and Regulation
Act and that money lending business registration is required to complete. Further, if a SPV is
recognized as a money lender, it is necessary to examine if it is required to register in accordancewith the Law on Bond Issuance for Financial Companies since this is a scheme for the SPV to issue
corporate bond for the purpose of raising funds for its lending. Cautious examination is needed tosee if the overall scheme is not aiming to virtually circumvent the foregoing two laws.

3
4

Refer to the report “Q&A: what is a First-to-Default Note” April, 2004.
For the details of the rating methodology of a synthetic CDO; refer to the report “Corporate Value Model and
Synthetic CDO, Quantitative Analytical Method”
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(B) Matching of cash flow
Prospectus for the issuance of an underlying asset and a repackaged financial instrument should
be confirmed particularly to see if there is any difference between each of provisions related to acash flow such as redemption method. If there are any different provisions, measures (agreements)
responding to such points of difference including those of preventing some additional risk derivation
are necessary to be covered by agreements related to a repackaged financial instrument.
(C) Eligible bank accountRating criteria for the bank with which a SPV should keep its accounts are referred to in thereport of “An eligible bank account for collection and an eligible investment instruments andsettlement deposit in securitization” December 2006.
3. Monitoring Criterion
Since the rating of a repackaged financial instrument is converged and linked to the rating of theweakest entity, for a rating review of a repackaged financial instrument, in principle, the rating committee
of a repackaged financial instrument shall be held at the same time of that of the weakest entity.

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Materials requesting to submit in assigning credit ratings for repackaged notes
to be issued in Euro Market

1.

Program Setting Up-

Memorandum and Articles of Association-

Declaration of Trust-

Board Resolutions-

Management Agreement (Administration Agreement)-

Principal Trust Deed-

Offering Circular (Information Memorandum, Programme Memorandum)-

Agency Agreement-

Custody Agreement-

Dealer Agreement

2.

Each Series(1)

Repackaged notes-

Supplemental Trust Deed-

Pricing Supplement (Supplemental Offering Circular, Supplemental Programme
Memorandum)(2)-

Swap Master Agreement (with Schedule) and Confirmation-

Supplementary Agency Agreement-

Dealer Confirmation-

Signing and Closing Agenda

Collateral notes-

Offering Circular (Information Memorandum)

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