ISDA PRESS REPORT - NOVEMBER 26, 2001 ASIA * Korean Regulation Change Will Allow Onshore Equity - Derivatives Week CREDIT DERIVATIVES * Condensed default swap confirmation launched - IFR * Banks move to boost credit derivatives liquidity - Risk News * Fitch Plans Credit Hiring Spree - Derivatives Week REGULATORY * Cross-Border Security Transactions Costing More Than Domestic Ones, EC Says - BNA * Enter the FSA - Financial Times * FSA to open securitised derivatives to retail sector - Risk News TAX * Dealers hope for clarity on swap books - IFR Korean Regulation Change Will Allow Onshore Equity Derivatives Week - November 26, 2001 The Financial Supervisory Service in Korea will permit local securities houses to trade over-the-counter equity derivatives next July; a move that players said will bolster the market. "[The regulations] will strengthen the competitiveness of the securities companies and offer investors a greater range of choices in the financial market," said Lee Young Gi, associate in the securities supervision department of the FSS in Seoul. "More participants will lead to greater liquidity," said Charles Chiang, equity derivatives trader at Nomura International in Hong Kong. He continued that offshore flow products such as index options and equity swaps for the Korean market totaled about USD100 million this year. Chiang added that with the new regulations enacted, the Korean OTC market is set to grow, likely expanding by over 50% in the first year and substantially higher after that. "We've been waiting for this for a long time," noted one equity derivatives regional head at a global firm in Hong Kong. "This is good news," he continued, "this will in effect open up the onshore market for international players." Currently, international firms trade primarily in the offshore market. Condensed default swap confirmation launched IFR - November 24, 2001 IP Morgan Chase and Morgan Stanley last week introduced a credit default swap master agreement to the European market, which reduces documentation to a one-page confirmation form. The master agreement is based on the 1999 International Swaps and Derivatives Association credit derivatives definitions, but 22 of the 30 clauses that are typically subject to agreement are standardised under the shorter master agreement, leaving only eight clauses to be agreed for each trade. The two banks said that use of the new master agreement would allow quicker trade confirmation, reduce operational risk and should eventually improve market liquidity. They did their first trade using the new master agreement last Tuesday and had closed a total of six deals using the new form by Friday. The two banks' London offices typically trade credit derivatives with one another five to 10 times a week. The new agreement had not been adopted by any other dealers by the end of last week, and traders expressed some surprise that the two US banks had launched the document on their own, without consultation under the aegis of trade group ISDA. "That would have taken quite a long time, and at the end of the day these are bilateral contracts," said Guy America, European head of credit derivatives trading at JP Morgan Chase. Both banks intend to use the agreement in their default swap trades with other dealers and expect it eventually to prove popular throughout the market. "I don't see any reason going forward why it would not be rolled out to end users of the product," said Annabel Littlewood, European head of credit derivatives trading at Morgan Stanley. She added that JP Morgan Chase and Morgan Stanley have agreed to use the new master document in trades between their New York dealing desks, with amendments to be made for local market practice. US dealers typically use the modified definition of restructuring as a credit event, and two weeks ago they dropped the use of the obligation acceleration clause as a standard feature of default swaps. Banks move to boost credit derivatives liquidity Risk News - November 23, 2001 By John Ferry JP Morgan Chase and Morgan Stanley have agreed to standardise most of the items on their European credit swap master agreements, in a move designed to increase liquidity in the credit derivatives market. By cutting the widely used International Swaps and Derivatives Association (ISDA) documentation down from several pages to just one, the banks aim to minimise the time taken to execute and confirm a trade while reducing documentation risk. "Frequent credit swap traders will be able to increase the volume of confirmed trades, thereby increasing market liquidity and growth of the credit derivatives business," said the banks in a joint statement. Standard ISDA master agreements for credit swaps have 30 negotiable items. JP Morgan and Morgan Stanley's shortened version leaves only eight items open to discussion. The banks said the one-page confirmation form contains only the "key commercial terms", including the name of the underlying company, the notional involved and the price and duration of the trade. The banks claim this will eliminate the risk of a party missing a modified term or adding terms that were not previously agreed. Guy America, head of European credit derivatives trading at JP Morgan Chase in London, said the development of the credit derivatives market will receive a boost as a result of the agreement. "The new agreement now looks very similar to an interest rate swap contract," he said. Annabel Littlewood, head of European credit derivatives trading at Morgan Stanley in London, said it took around a year to finalise the agreement. "It's been quite a struggle getting to the point where dealers agree on the major terms in the contracts." Fitch Plans Credit Hiring Spree Derivatives Week - November 26, 2001 Fitch plans to hire six or seven collateralized debt obligation professionals for its London-based CDO rating team because of the increase in the number of deals coming to the market. Mitchell Lench, senior director in London, said it has about 15 CDOs in the pipeline this month in comparison to five or six this time last year, approximately one-third of these are synthetic or balance sheet transactions. Lench expects the new recruits to start in the first half of next year and to come from structuring houses, investment firms or competitors. The hires will include a lawyer familiar with the International Swaps and Derivatives Association's documentation. There are currently 10 professionals in the CDO team in London. Lench said it is becoming easier for rating agencies to hire top personnel because the wage differential between the agencies and the sellside firms has decreased. He added recruits also join rating agencies for job security and to get a bird's eye view of the market. Cross-Border Security Transactions Costing More Than Domestic Ones, EC Says BNA - November 26, 2001 Despite an increase in the demand for securities by foreign investors because of the euro, there is a highly fragmented system in the European Union when it comes to cross-border clearing and settlement, concluded a new report published Nov. 23 on behalf of the European Commission. Moreover, the cost of clearing and settling a foreign security transaction can be 10 times as much as a domestic sale. "There is no European financial market right now and one has to wake up to this reality," said Alberto Giovannini, the chairman of a group that wrote the report. Legislative Proposal Planned As a result of the report, the EU executive body said it will begin a legislative process in 2002 to reverse the inefficiencies in the EU system. At the same time, the commission urged financial markets to find market-based solutions within the framework of the EU competition law. "The additional cost and risk associated with a fragmented clearing and settlement infrastructure represents a significant limitation on the scope for cross-border securities trading in the EU," said EU Economics Commissioner Pedro Solbes. "By extension it also represents an important limitation on exploiting the economic benefits of the internal market and the euro." Three Main Problems Cited The three main problems highlighted in the report are as follows: * national differences in technical requirements and market practice; * national differences in tax procedures; * issues relating to legal certainty. While the report says financial markets could do much when it comes to convergence and ensuring inter-operability as regards technical requirements and market practices across national systems, it is up to governments and the European Commission to deal with matters related to taxation and legal certainty. Enter the FSA Financial Times - November 26, 2001 Midnight on Friday will be a historic moment for Britain's financial services industry. At that hour its new system of regulation under the Financial Services Authority will come fully into effect, more than four years after it was first proposed by the Labour government. How the FSA handles its new powers, such as personal fines for wrongdoing by directors, will have a profound impact on the City of London and its place as a global financial centre. It will be closely watched by countries considering a similar move. The legislation that created the FSA - rightly amended to curb its powers to punish - is broadly sensible. The authority replaces 10 self-governing industry bodies that have not always regulated consistently or with sufficient bite. The aim is to make regulation more efficient and more alert to the scandals that have regularly plagued the City. The legislation leaves wide discretion to the authority. But Sir Howard Davies, its chairman, has promised a new and sensible risk-based approach: resources will be focused on preventing problems where failure is most likely rather than on routine visits to well run companies. Better businesses should enjoy a lighter regulatory touch. That is fine in principle but the City awaits the new policeman with apprehension. There are three main worries. First, that it will prove heavy-handed. There are widespread complaints that while senior FSA staff are excellent, more junior ones still suffer from a box-ticking mentality. Compliance costs, it is said, have been rising - a particular worry for small companies. Second, there is concern that the authority may stretch itself too thinly. A recent report on Equit-able Life criticised the FSA's role, including its poor internal co- ordination. Third, there is a fear the FSA will adopt an excessively aggressive approach in its pursuit of wrong-doing, particularly for the newly created offence of "market abuse", and might go for some early high-profile scalps. The authority denies this, as well it might. A reputation for inquisitions would serve it ill. Some of the City's concerns stem from natural tensions between regulator and regulated. But the FSA, which can sometimes appear overly sensitive to criticism, needs to be alert to these anxieties if it is to start on the right note. The main test will be to produce a flexible, low-cost regime that is firm yet fair, while encouraging innovation and London's growth as a global centre. This will be a difficult balance - but the FSA's short life so far offers hope that it will get it broadly right. FSA to open securitised derivatives to retail sector Risk News - November 21, 2001 The UK's financial watchdog, Financial Services Authority (FSA), plans to allow retail investors to invest directly in securitised derivatives for the first time by initiating a flexible listing regime. The proposals, which will be relevant to issuers of listed securities and derivatives, have been released in a consultation paper, 'Proposed Listing and Conduct of Business Rules for Securitised Derivatives', after discussions with market participants and international regulators. The idea to list retail covered warrants was first raised by the FSA in January this year. The new proposals offer a wider and more flexible regime that includes other types of derivatives. The paper details the determination of who can issue securitised derivatives and the information about these products that must be disclosed. The FSA's proposals focus on establishing the suitability of retail investors to purchase securitised derivatives and the qualification of IFAs (independent financial advisers) and brokers to advise on derivatives. The listing of securitised derivatives will also include a risk warning with full disclosure of the risks associated with these products, alongside details of the product, how it works and how the investor's return is calculated. Issuers of securitised derivatives will also need to be regulated by the FSA and permitted to conduct business in derivatives. Ken Rushton, director of listings at the FSA, said: "Market participants believe there will be a demand for these products, which are very popular in some European countries. The FSA believes there is the potential for the market in the UK for these products to be substantial if UK investors show a similar appetite for these products as they have for other products such as spread betting and options." Dealers hope for clarity on swap books IFR - November 24, 2001 Some clarification is expected this week on how the US courts may rule on the Internal Revenue Service's challenge to dealers' methods for valuing income from swaps. Closing arguments in Bank One Corporation v Commissioner are set to begin on Wednesday. Although no decision is expected before March or April next year, the nature of the questions asked by the judge during the closing arguments may be telling, industry executives believe. The IRS's case is that the method for valuing First Chicago's swaps portfolio between 1991 and 1993 included inappropriate downward adjustments for credit risk and administrative costs. This, the IRS alleges; led the dealer to underestimate the value of its income from derivatives, and thereby reduced its taxable income base. Bank One acquired First Chicago more than three years ago. Bank One claims that the method used was common practice at the time. In a brief filed this summer the bank also said that its numbers were more accurate with the adjustments than without. It is proposing to use an adjusted mid-market approach to valuing income from swaps. To the annoyance of some in the derivatives industry, the IRS's 600-page brief submitted in September did not tell dealers what recipe they should use for valuing income from swaps. "They only put forward a brief saying that the way Bank One did it was wrong," one firm's lawyer said. "[The government's position] can't be applied somewhere else. And it doesn't tell an IRS agent how to audit [another dealer]." The IRS was not under any obligation to come up with a better method, though this would have been helpful, the lawyer said. The problem with an across-the board use of a mid-market approach of the type used by Bank One is that banks using this approach rarely mark up their valuations because of their own credit risk, said Darrell Duffie, a professor of finance at Stanford University's business school who is one of two court-appointed experts for the case. One partial way to address this would be to disallow mark-downs from mid-market value when a counterparty has the same or higher credit quality, said Duffie. Under a slightly more refined guideline, banks would mark down swaps based on the credit quality of its counterparty relative to its own quality. "For example, if an A rated bank issuing debt at 20bp over Libor signs a swap with an A- counterparty issuing at 50bp over Libor, then the swap could be marked down based on a mean (relative) loss rate of 50-20=30bp per year, per dollar of expected exposure," said Duffie. "This is not text-book perfect, but would capture the majority of the effect of relative quality. [Also] it would not require new software, just a shift in model inputs for mean loss rates." **End of ISDA Press Report for November 26, 2001** THE ISDA PRESS REPORT IS PREPARED FOR THE LIMITED USE OF ISDA STAFF, ISDA'S BOARD OF DIRECTORS AND SPECIFIED CONSULTANTS TO ISDA ONLY. THIS PRESS REPORT IS NOT FOR DISTRIBUTION (EITHER WITHIN OR WITHOUT AN ORGANIZATION), AND ISDA IS NOT RESPONSIBLE FOR ANY USE TO WHICH THESE MATERIALS MAY BE PUT.

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ISDA PRESS REPORT - NOVEMBER 26, 2001