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Guarantee Supplement to the 2003 ISDA Credit Derivatives Definitions

The 2003 Credit Derivatives Definitions include an attempt to clarify the provisions relating to the guarantee obligations. Soon after the 2003 Credit Derivatives Definitions was published (on 11 February 2003) however, there emerged a potential bifurcation of market practices given the perceived uncertainty under the legal system in a number of countries with respect to the enforceability of ‘upstream’ and ‘sidestream’ guarantees. Dealers in US for example typically trade on Qualifying Affiliated Guarantees (see below) only whereas Europe and Japan trade on All Guarantees (see below).

As a result ISDA released (on 23 April 2003) a proposed Guaranteed Obligations and Multiple Holder Obligation Supplements to the 2003 Credit Derivatives Definitions (the “April Supplement”) in an attempt to resolve the difference.

In the end, the proposed April Supplement was not adopted. Instead, the Credit Derivatives Market Practice Committee approved the May 2003 Supplement to the 2003 Credit Derivatives Definitions (the “Guarantee Supplement”).

The parties may now adopt the May 2003 Supplement by specifying that the same is applicable e.g. by inserting the following words in the Confirmation:
‘The definitions and provisions contained in the 2003 ISDA Credit Derivatives Definitions, as supplemented by the May 2003 Supplement to the 2003 ISDA Credit Derivatives Definitions, as published by the International Swaps and Derivatives Association, Inc., are incorporated into this Confirmation.’

Qualifying Guarantees

The 2003 Credit Derivatives Definitions basically clarify that the obligations of a Reference Entity can be:

  • direct obligations of the Reference Entity
  • an obligation of a downstream affiliate (i.e. a “Qualifying Affiliate Guarantee”)
  • an obligation of other parties guaranteed by the Reference Entity (i.e. a “Qualifying Guarantee”)
  • Under the 2003 Credit Derivatives Definitions, to constitute a Qualifying Guarantee, a guarantee must be:

    • irrevocable
    • given in respect of the Underlying Obligation of the Underlying Obligor that is Not Subordinated (Section 2.19(b)(i)) to any unsubordinated Borrowed Money

    Qualifying Guarantee includes Qualifying Affiliate Guarantee as well as upstream, sidestream and third party guarantees.

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    Qualifying Affiliate Guarantees

    Qualifying Affiliate Guarantee is a Qualifying Guarantee given by a Reference Entity to a Downstream Affiliate. Under the 2003 Credit Derivatives Definitions, if the parties specify that “All Guarantee” is applicable, then a Credit Event may occur with respect to a guarantee regardless of the relationship between the Reference Entity and the Underlying Obligor. If “All Guarantee” is specified to be not applicable, only a Qualifying Affiliate Guarantee (i.e. guarantees provided by a Reference Entity to a downstream affiliate) may be used.

    Obligation Characteristics and Deliverable Obligation Characteristics

    Under the 2003 Credit Derivatives Definitions, both the Qualifying Guarantee and the Underlying Obligation must have certain Obligation Characteristics and Deliverable Obligation Characteristics specified in the Confirmation:

    • Specified Currency
    • Not Sovereign Lender
    • Not Domestic Currency
    • Not Domestic Law

    In addition, the Qualifying Guarantee must be Not Subordinated

    The Guarantee Supplement

    • The date of determining the affiliation of the Downstream Affiliate changes from the time of Credit Event or Delivery Date to the issue date of the guarantee (the new Section 2.25(a))
    • The requirement that a Qualifying Guarantee is Not Subordinated is removed (unless the parties choose “Not Subordinated”) (by the deletion of Section 2.21(d)(ii))
    • Multiple Holder Obligation (Section 4.9) is modified in respect of Bond in that the two-thirds consent requirement in respect of a Restructuring is deemed to be satisfied.

    derivativeslawyer.com

    Last updated 30 May 2006

    The above notes are intended to provide only general outlines and should be read in conjunction with, and are qualified in their entirety by, the full provisions of the relevant ISDA provisions and definitions. They should never be used in place of professional advice. We accept no responsibility for any loss arising from any action taken or not taken by anyone using this material or using this material in conjunction with any ISDA documentation in reliance thereof.

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