Interest Rate Swaps for Borrower’s Counsel

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Interest Rate Swaps for Borrower’s Counsel
May 11, 2016 | 1:00 PM Eastern
Sponsored By
The ABA Section of Real Property, Trust & Estate Law
Co-Sponsored By
The ABA Business Law Section
Eric Berman
Practical Law Company
New York, NY
David Sprentall
Snell & Wilmer LLP
Phoenix, AZ
Anthony Marino
Quarles & Brady LLP
Milwaukee, WI
Bart Wall
Bryan Cave
St. Louis, MO

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The materials contained herein represent the opinions of the authors and editors and should not be construed to
be the action of the American Bar Association, Section of Real Property, Trust & Estate Law for Continuing Legal
Education unless adopted pursuant to the bylaws of the Association.
Nothing contained in this book/material is to be considered as the rendering of legal advice for specific cases,
and readers are responsible for obtaining such advice from their own legal counsel. This book/material and any
forms and agreements herein are intended for educational and informational purposes only.
© 2016 American Bar Association. All rights reserved.

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BIOS
• Eric Berman
Eric Berman has been Senior Legal Editor at Practical Law Finance for seven years, where he creates
legal know-how resources and provides detailed analysis of legal and regulatory developments in the
areas of Swaps & Derivatives and Securitization/Structured Finance. Eric came to Practical Law from the
New York office of Sidley Austin LLP where he worked on the Derivatives team in the Corporate Finance
group on a wide range of derivatives and structured finance matters including representation of banks
and funds in ISDA negotiation for CDS, interest rate swaps, and other derivatives transactions, as well as
representation of a variety of parties in interest in CLO, MBS, ABS, and other securitization transactions.
Prior to Sidley, Eric practiced in the areas of bankruptcy, commercial lending, securitization, repos,
securities lending and other types of financial transactions. Eric represented a number of Enron
derivatives counterparties in Enron bankruptcy cases and prepared Enron North America (ENA)
Examiner's report on Enron off-balance-sheet structured finance activity and related accounting fraud.
• Anthony Marino
Tony Marino is a partner in the Milwaukee office of Quarles & Brady LLP. He has extensive experience
representing both end-users and financial institutions in negotiating and documenting all aspects of
derivative transactions. He routinely represents lenders and borrowers in negotiating and documenting
secured and unsecured financing transactions of all types and sizes, including single bank and
syndicated commercial loans, asset-based financings, asset securitizations, equipment leasing,
mezzanine debt financings, New Market Tax Credit financings, construction loans, private placements,
revenue bond credit enhancements and direct purchases, and workouts.

BIOS (cont.)
• David Sprentall
Dave Sprentall is a partner in the Phoenix office of Snell & Wilmer. He primarily
represents banks and other institutional lenders in term, construction and
development financings, including syndicated debt and senior/mezzanine
structures. He also represents lenders in connection with loans to public and
private homebuilders, subscription financing and land banking transactions.
• Bart Wall
Bart Wall is a partner in the St. Louis office of Bryan Cave LLP. Mr. Wall’s
practice concentrates on advising corporate end-users in a variety of
transactions to hedge currency, commodity, interest rate and credit risk through
swaps and derivative products. He also represents domestic and international
financial institutions, private equity firms, small business investment companies
and other investors in working capital and fixed asset financings, leveraged
acquisition and mezzanine financings, letter of credit facilities, and receivable
securitization transactions.

OVERVIEW
• 1. ISDA document structure and key points
• 2. Regulation of swaps – new developments
• 3. SWAP provisions in loan documents

HYPOTHETICAL
• Your client, High Hopes Development LLC, develops multi-tenant
office projects. High Hopes is obtaining a construction/mini-perm
loan for a new building. The loan will be made by Bank A and two
other banks under a typical co-lending arrangement.
• The loan will have an 18-month construction period followed by a
two year interest-only period in order for the occupancy to stabilize
and for the borrower to obtain permanent financing. The interest
rate on the loan will be 30-day LIBOR plus 200 basis points
changing on the first day of each month.
• Your client is concerned that interest rates could rise during the term
of the loan which could require more equity or mean that the rental
income would make it more difficult to service the loan. Bank A has
suggested that an interest rate swap might help address High
Hope’s concerns.

TERMINOLOGY
• Interest Rate Swap. Borrower and the
counterparty agree to “exchange” cash flows.
Borrower pays at a fixed rate while the
counterparty pays at a variable rate based on the
notional amount. Payments would be “netted”.
• Notional Amount. This is the “hypothetical”
principal amount of the hedging transaction used
for the purpose of making calculations under the
swap.
• Counterparty. Refers to the other party to the
transaction.

TERMINOLOGY (cont.)
• Interest Rate Cap. A cap simply provides that if
the variable rate on the loan exceeds a certain
rate (the “cap”), the counterparty will pay the
excess. Operates like an insurance policy and
carries with it an upfront or monthly cost.
• Interest Rate Collar. Like a cap but provides a
ceiling and a floor. If the loan’s variable interest
rate goes over the cap the counterparty pays and
if it drops below the floor the borrower pays.

MASTER AGREEMENT STRUCTURE
Master Agreement
• Contains basic representations,
covenants and events of default
• Methodology for terminating all
transactions and calculating a
final settlement amount
• Any elections, changes and
additions to standard provisions
are included in Schedule
• Incorporates confirmations by
reference
Credit Support Documents
 Guarantees
 Credit Support Annex
 Other collateral documents
Confirmations
• Specifies economic terms of the
swap
• Includes changes to standard
master agreement terms
• Incorporates definitions by
reference
Definitions
Standard definitions
for each product type

SWAP DOCUMENTATION
• Master Agreement
- Preprinted form
- Generic framework for the parties’ relationship
• Schedule to Master Agreement
- Includes negotiated modifications
- Supplements the Master Agreement
• Confirmation
- Business terms of a specific transaction
- Incorporations standard definitions
- Allows for efficient trading and documentation

SWAP DOCUMENTATION (cont.)
• Credit Support Documents
- Guarantees
- Security agreements
- Mortgages
• Credit Support Annex
- Optional preprinted form
- Negotiate modifications in paragraph 13
- Primarily used to deliver cash or securities
collateral

MASTER AGREEMENT
• 1992 or 2002 Version
- Preprinted forms
- Elections and negotiated terms are in the Schedule
• Differences Between Versions
- Close-out: market quotations/loss v. close-out
amount
- Events of default
o 1992 cure periods are more generous
o 2002 includes force majeure termination
event
- 2002 includes set-off provision

COMPARISON OF DEFAULT
CURE PERIODS
Event of Default 1992 Master Agreement 2002 Master Agreement
Failure to make a payment 3 Local Business Days after
notice
1 Local Business Day after
notice
Failure to make a delivery 3 Local Business Days after
notice
1 Local Delivery Day after notice
Other breaches of master
agreement
30 days after notice 30 days after notice
Involuntary bankruptcy 30 days 15 days
Enforcement action by a
secured party to take
possession of all or substantially
all of party’s assets
30 days 15 days

ISSUES TO NEGOTIATE
• Credit Support (what is the collateral?)
• Specified Entities
• Cross Default / Cross Acceleration
• Additional Termination Events
• Credit Event Upon Merger

SPECIFIED ENTITY
• Third parties which are subject to certain provisions of
the Agreement
o Default under Specified Transactions
o Cross Default
o Bankruptcy Default
o Credit Event upon Merger
o Absence of Litigation Representation
• Bank perspective: as broad as possible (“all Affiliates”)
• Borrower perspective: no more restrictive than loan
agreement

AFFILIATES
• Standard definition of "Affiliate" includes:
o Subsidiaries: any entity controlled, directly or indirectly, by a
party
o Parent companies: any entity that controls, directly or indirectly,
the party
o Sister companies: any entity directly or indirectly under common
control with the party.
• “Control” means ownership of a majority of the voting power of the
entity or person.
• Some banks like to name “All affiliates” as Specified Entities
• Borrowers should consider potential consequences (for example,
should a bankruptcy of a sister company trigger an ATE?)

CROSS DEFAULT
• Event of Default if a party defaults on third party
obligation for borrowed money in excess of a threshold
amount
• Negotiation Points
- Change to cross-acceleration
- Exception for administrative errors
- Expansion to include other financial obligations
- Threshold amount
- Specified Entity (will be subject to the cross default
provision)

ADDITIONAL TERMINATION EVENTS
• If an ATE occurs, a party may have the right to terminate
• Examples:
- Optional early termination at election of borrower
- A default under the loan documents
- The loan is prepaid and the loan documents are
terminated
- The lender no longer has commitments under the
loan agreement (could result from sale of loan)

ADDITIONAL TERMINATION
EVENTS (cont.)
Additional Examples:
- Decline of credit ratings
- Financial covenants
- Granting of a lien in favor of other creditors that does
not secure the swap on a pari passu basis
- Partial termination if amortizing loan is partially repaid

CREDIT EVENT UPON MERGER
1992 CEUM
May apply to a party if:
• Merger
• Transfer of substantially
all its assets
2002 CEUM
May apply to a party if:
• Merger or consolidation
• Any substantial part of its assets
comprising the business as of the
agreement date
• Reorganization or reincorporation
• Acquisition of control by another
person or group
• Substantial change in capital
structure (issuance of debt,
convertible securities or preferred
stock)
Note: CEUM also requires a deterioration of credit following the triggering
event.

TERMINATION
• Under 1992 Master Agreement, parties elect either “Market Quotation” or
“Loss”
- Market Quotation: based on (i) average of two middle bids
obtained from 4 reference market makers or (ii) the middle
bid of 3 bids so obtained
- Loss: cost of unwinding hedges related to the terminated
transactions (more subjective determination)
• 2002 Master Agreement adopts single damages measurement defined as
the “Close-out Amount”
- Requires a good faith determination, using commercially reasonable
procedures, of the losses or gains that are or would be realized in
providing for the economic equivalent of the material terms of and
option rights of the parties under the terminated transactions

REGULATION
OVERVIEW OF SWAPS REGULATION:
THE DODD-FRANK ACT
• In 2010 President Obama signed into law the Dodd-
Frank Wall Street Reform and Consumer Protection
Act of 2010 – known as the Dodd-Frank Act.
• Designed to curtail systemic risk in the banking and
financial system.
• Cornerstone of this legislation is regulation of the
swaps market – Title VII.

REGULATION (cont.)
THE DODD-FRANK ACT
Main areas of interest rate swaps regulation under
Title VII:
• Clearing and exchange trading (“trade
execution”).
• Data reporting.
• Margin rules for uncleared swaps.
• Rules for swap dealers (and MSPs).
• Eligible contract participant (ECP) requirement.

REGULATION (cont.)
THE DODD-FRANK ACT
Key Dodd-Frank Swap Terminology:
• ECP = Eligible contract participant
• NSBS = Non-security-based swap (“swap”)
• SBS = Security-based swap
• SD = Swap dealer
• MSP = Major swap participant
• SBSD = Security-based swap dealer
• MSBSP = Major security-based swap participant
• SEF = Swap execution facility
• DCM = Designated contract market
• DCO = Derivatives clearing organization
• SDR = Swap data repository

REGULATION (cont.)
THE DODD-FRANK ACT
• Title VII mechanics:
• The CFTC regulates non-security-based swaps
(known simply as “swaps”).
• The SEC regulates security-based swaps (SBS).
• Interest rate swaps are non-security-based swaps
(“swaps”) under Title VII and are therefore generally
regulated under CFTC rulemaking.
• For details on swaps vs. SBS under Title VII, see http://us.practicallaw.com/3-502-
8950?q=3-502-8950#a477834: Types of Swaps under Title VII.

REGULATION (cont.)
DODD-FRANK ACT: SWAP CLEARING
• Under Section 723(a)(3) of the Dodd-Frank Act,
which added new Section 2(h) to the Commodity
Exchange Act (CEA), all swaps for which a
Clearing Determination has been issued by the
CFTC must be cleared by a CFTC-registered
Derivatives Clearing Organization (DCO) –
CME, ICE, LCH, etc.
• If a trade is req'd to be cleared and may not be
cleared or is rejected for clearing, it is void ab
initio and unlawful to enter into.

REGULATION (cont.)
What is “Clearing”?
• Non-cleared transactions are bilateral – that is,
entered into by two parties.
• In a cleared trade, the clearinghouse inserts
itself into the middle of the transaction,
“guarantying” the performance of both parties.
• Eliminates counterparty risk.
• BUT: does not eliminate systemic risk
(performance only guaranteed to the extent of
clearinghouse resources).

What is “Clearing”?
REGULATION (cont.)
Cleared Swap
Bilateral Swap

REGULATION (cont.)
On November 28, 2012, the CFTC issued its first
and only final Clearing Determination to date. It
covers many common types of:
• Credit default swaps (CDS).
• Interest rate swaps (IRS).
This includes most plain vanilla fixed-for-floating
US dollar IRS, as are entered into in connection
with real estate and other commercial lending
transactions.

REGULATION (cont.)
Specification Fixed-to-Floating Interest Rate Swap Class
1. Currency US Dollar (USD) Euro (EUR) Sterling (GBP) Yen (JPY) US Dollar (USD)
2. Floating Rate Indexes LIBOR EURIBOR LIBOR LIBOR LIBOR
3. Stated Termination
Date Range
28 days to 50
years
28 days to 50
years
28 days to 50
years
28 days to 30
years
28 days to 50
years
4. Optionality No No No No No
5. Dual Currencies No No No No No
6. Conditional Notional
Amounts
No No No No No
CFTC Interest Rate Swap Clearing Determination

REGULATION (cont.)
• These transactions, therefore, must be cleared
through a registered DCO unless an exception or
exemption is available (more on this to come...).
• Furthermore: Under the mandatory Title VII trade-
execution requirement set out in Section 2(h)(8) of
the CEA, all swaps that are approved for clearing
must be entered into on a registered DCM or SEF,
unless no registered exchange accepts the swap for
trading (7 U.S.C.A. § 2(h)(8)).

REGULATION (cont.)
Commercial End-User Clearing Exception: Section
2(h)(7)(A) of the CEA, as amended by Section 723(h)(7)(A)
of the Dodd-Frank Act and Part 50 of CFTC Regulations.
Available for swaps where at least one party to the
transaction:
• Is either:
– Not a "financial entity"; or
– An exempt financial entity; and
• Is using the swap to "hedge or mitigate commercial risk."
• Notifies the CFTC how it generally meets its financial obligations associated with
entering into uncleared swaps.

REGULATION (cont.)
“Financial Entity” Definition: Section 2(h)(7)(C)(i) of the
CEA provides a definition of “financial entity” that includes
the following types of entities:
• Swap dealers and security-based swap dealers;
• Major swap participants and major security-based swap
participants;
• Commodity pools;
• Private funds, as defined in Section 202(a) of the
Investment Advisers Act of 1940;
• Employee benefit plans as defined under ERISA; OR….

REGULATION (cont.)
“Financial Entity” Definition (cont’d):
• (VIII) a person predominantly engaged in activities
that are in the business of banking, or in activities
that are financial in nature, as defined in section
1843(k) of Title 12.
• Small bank exclusion ($10B) – CTFC Regulation
50.50(d).
– BUT: not applicable where bank not hedging
commercial risk.

REGULATION (cont.)
Hedge or mitigate commercial risk:
Under CFTC Regulation 50.50(c), a swap is used to hedge or mitigate
commercial risk if the swap is:
• Not used for a purpose that is in the nature of speculation, investing,
or trading;
• Not used to hedge or mitigate the risk of another swap or SBS
position, unless that other position itself is used to hedge or mitigate
commercial risk; and
• Economically appropriate to the reduction of risks in the conduct and
management of a commercial enterprise, where the risks arise from
any fluctuation in interest, currency, or foreign exchange rate
exposures arising from a person’s current or anticipated assets or
liabilities.

REGULATION (cont.)
Making the election and reporting obligations for
the Clearing Exception
The parties to the swap elect to make use of the exception by having the
reporting party report the following information to a swap data repository (SDR),
or if no SDR is available, to the CFTC:
• Notice of election to use the end-user exception.
• The identity of the counterparty that is eligible to elect the end-user
exception.
There is no prescribed form for this notice – for onboarding, see:
• DTCC: DDR-Onboarding@dtcc.com
• ABA: regreformtracker.aba.com/2013/08/swaps-end-user-reporting.html
Note that Under CFTC Regulation 23.505, documentation must be furnished to SDs and MSPs by non-financial entity
swap counterparties claiming the exception from the mandatory swap clearing requirement sufficient to provide a
reasonable basis on which to believe that its counterparty meets the statutory conditions required for an exception from
the clearing requirement.

REGULATION (cont.)
Making the election and reporting obligations for
the Clearing Exception (cont’d)
The following information must be provided to the CFTC either in an annual filing by the
electing counterparty or on a swap-by-swap basis by the reporting counterparty:
• Whether the electing counterparty is either:
– a financial entity acting as an affiliate of a non-financial entity; or
– a small financial institution.
• Whether the swap for which the exception is being elected is being used to hedge or
mitigate commercial risk.
• Information regarding how the electing counterparty generally meets its financial
obligations associated with entering into uncleared swaps.
• If the electing counterparty is an SEC filer, whether its board of directors has
approved generally the decision to enter into swaps that are excepted from Title VII
clearing and exchange-trading requirements.

REGULATION (cont.)
THE DODD-FRANK ACT: DATA REPORTING
Overview: Data Reporting for Interest Rate Swaps
CFTC Dodd-Frank swap data reporting rules:
• Part 43: Real-time public data reporting. Reporting of swap data
is required only at the inception of the swap. Data fields in Appendix
A of the final rules. Data must be reported as soon as
technologically practicable upon the creation of the swap.
• Part 45: “SDR” swap data reporting and recordkeeping. Data
reporting under Part 45 is regulatory reporting. This data is not
publicly disseminated but is submitted to the CFTC.
• Part 46: Historical swap data reporting and recordkeeping. For
swaps entered into before enactment date of Dodd-Frank Act or
compliance date for SDR rules.

REGULATION (cont.)
Reporting Party
The Reporting Party is the party to the swap that is
responsible for reporting data electronically to a registered
Swap Data Repository (SDR):
• The data that must be reported under CFTC swap data
reporting rules – Parts 43, 45 and 46.
• The required information regarding the election of the
commercial end-user clearing exception.
• Note that the reporting party is also usually the party
responsible for recordkeeping under Part 45 rules.

REGULATION (cont.)
CFTC Reporting Hierarchy:
Which is the Reporting Party?
• If one of the parties to the swap is a swap dealer or MSP, the SD/MSP is responsible
for fulfilling the parties' reporting obligations.
• If one of the parties to the swap is a swap dealer and the other is an MSP, the SD is
responsible for fulfilling the parties' reporting obligations.
• If neither of the parties to the swap is a swap dealer or MSP, but one party is a
"financial entity" as defined under CEA Section 2(h)(7), the financial entity is
responsible for fulfilling the parties' reporting obligations.
• If both parties are swap dealers, both parties are MSPs or both parties are non-
SD/MSP counterparties, then the parties must designate among themselves which of
them is to be the reporting party unless only one of the parties is a US person, in
which case the US person is to be the reporting party.
• DCO reports for cleared swaps.
Hierarchy applicable for all CFTC swap data reporting rules.

REGULATION (cont.)
CFTC Swap Data Reporting: Part 45
Under Part 45 of the CFTC’s regulations (“SDR”
rules), reporting of swap data is required:
• At the inception of the swap (Creation Data).
• During the life of the swap until expiration or
termination (Continuation Data).

REGULATION (cont.)
Creation Data
For swaps that are not executed on a SEF or DCM nor cleared through a DCO, under the final SDR rules, the
reporting party to a swap entered into with a US person must submit to an SDR that accepts data for that
asset class of swap the following creation data and reports
• Confirmation data. The swap transaction confirmation terms that the reporting counterparty has
recorded.
• Minimum PET data. The minimum primary asset-class specific economic terms (interest rate, FX, credit,
equity and other commodity), which may or may not be contained in the transaction confirmation. These
reports may be found for each asset class in Appendix 1 to the final SDR rules. (Note: Not aligned with
Part 43 reports.)
• Internal identifiers. The internal counterparty identifier, internal transaction identifier and the internal
master agreement identifier used by the automated systems of the reporting party.
• USI. The unique swap identifier (USI) for the swap.
• LEI. The counterparty's legal entity identifier (LEI). You will need LEI to enter into a swap. Parties may
apply for an LEI at the Global Markets Entity Identifier (GMEI) Utility at https://www.gmeiutility.org.
For “off-facility” swaps not subject to mandatory clearing, this data must be submitted no later than 30 minutes
after execution for credit, equity, foreign exchange, and interest rate swaps, if the non-reporting
counterparty is a non-SD/MSP counterparty that is not a financial entity

REGULATION (cont.)
Continuation Data: Life-cycle approach.
The life-cycle approach calls for reporting life-cycle events, meaning
any event resulting in a change to data previously reported in
connection with the swap
This includes:
• Assignment, transfer, conveyance, or novation.
• Partial or full termination of the swap.
• Change in the cash flows originally reported.
• Amendment.
• Exchange or extinguishing of rights or obligations under the swap.
• Corporate events.

REGULATION (cont.)
Continuation Data: Life-cycle approach
Under CFTC Regulation 45.4(c), if the reporting counterparty is a
non-SD/MSP counterparty:
- Life-cycle event data must be reported no later than the end
of the first business day following the date of any life-cycle
event.
- Except that: life-cycle event data relating to a corporate event
of the non-reporting counterparty must be reported no later
than the end of the second business day following such event.

REGULATION (cont.)
Continuation Data: “Corporate Event”
• The term "corporate event" is not defined in the final SDR data reporting rules, nor in
the CEA or CFTC regulations.
• Because there is no definition, the provision leaves it up to the party to determine
whether an even should be reported.
• Implied in the rules that this relates to M&A activity, such as a merger or succession
event involving a party to the swap.
– This activity has implications for legal entity identifiers (LEIs) and other data. May
impact entity status (swap dealer, financial entity, etc.), as well as jurisdiction (US
person) and other factors.
• A party need not disclose material non-public information in undertaking this
obligation.
• “Counterparties should use due diligence to ensure that the non-reporting counterparty notifies the
reporting counterparty promptly of the non-reporting counterparty’s corporate events affecting any
primary economic term of the swap.” (see Amendment to Covered Agreement – Section 4.03)

REGULATION (cont.)
CFTC Data Reporting: Duties of Non-Reporting Party
The non-reporting party still has reporting responsibilities:
• Clearing exception: Reporting requirements in
connection with election of the clearing exception.
• Creation data: Under Part 45, the non-reporting
counterparty must provide any required information in
the PET report (LEI, etc.).
• Continuation data: Under Part 45, the non-reporting
counterparty must timely provide information and data to
the reporting counterparty on any “corporate event” that
occurs with respect to itself.

REGULATION (cont.)
THE DODD-FRANK ACT: NON-CLEARED MARGIN
Q: Which rules apply?
- Bank margin rules?
- CFTC margin rules?
These rules only apply to swap dealers and MSPs.
A: Unless one of the parties to a swap is a SD, MSP, SBSD
or MSBSP, parties may continue to negotiate their
collateral arrangements using the ISDA Credit Support
Annex (CSA), without regulatory interference.
• Even with a swap dealer or MSP counterparty: Both
rules include non-financial end-user exclusions.

REGULATION (cont.)
THE DODD-FRANK ACT: ECP REQUIREMENT
• Section 723(a)(2) of the Dodd-Frank Act
amended CEA section 2(e) to provide that “it
shall be unlawful for any person other than an
'eligible contract participant' to enter into a swap
unless the swap is entered into on, or subject to
the rules of, a board of trade designated as a
contract market [DCM] under Section 5 of the
CEA.“
– Swaps conducted on a DCM are subject to a host of protective rules and
regulations making it less necessary, from the perspective of swap regulators, for
the parties to have high net worth.

REGULATION (cont.)
• Both parties must be ECP when the swap is
entered into (if swap is “off-facility”).
– NOT an ongoing obligation.
• Parties must represent to one another that they
are ECPs
– See Amendment to Covered Agreement – Section
3.02
• When entering into a swap with a swap dealer (or MSP),
this is covered by the ISDA Dodd-Frank Protocol
Questionnaire – incorporated into the ISDA Master by
reference.

REGULATION (cont.)
• “Swap” Definition: Section 721(a) of the Dodd-Frank
Act defines the term "swap" by adding Section
1a(47) to the CEA (7 U.S.C. § 1a(47)) – August 2012.
• CFTC No-Action Letter 12-17 clarifies that swap
guarantors and pledgors must be Eligible
Contract Participants.
– In No-Action Letter 12-17, issued on October 12, 2012, the CFTC
clarified its view that the definition of the term "swap" included any
guaranty of a swap and pledges of assets used to secure swap
obligations.
– As a result, each guarantor and pledgor must be ECP at execution
or it may not provide credit support for a swap.

REGULATION (cont.)
Consequences of ECP Failure:
• The guaranties made under or in connection with a loan
agreement are unenforceable to the extent the
guaranteed obligations include swap obligations
guaranteed by, or supported by pledge of assets by,
non-ECP borrower subsidiaries (or other parties).
• This is the case even where the direct swap
counterparties are ECPs.
• Further, because loan guaranties are rarely severable,
there is a risk that the entire loan guaranty could be
rendered unenforceable.

REGULATION (cont.)
ECP Definition: CEA section 1a(18)
• Swap dealers, MSPs, SBSDs, MSBSPs.
• Corporations, partnerships, proprietorships, organizations, trusts, or other entities with more than $10 million in assets, or any entity
guaranteed by such entity.
• Individuals with aggregate amounts of more than $10 million invested on a discretionary basis (or $5 million if hedging).
• Entities with a net worth of at least $1 million that are hedging commercial risk.
• Financial institutions.
• Insurance companies.
• Investment companies subject to regulation under the Investment Company act of 1940 (and similar foreign entities subject to similar
foreign regulation).
• Commodity pools with more than $5 million in assets under management (AUM).
• Employee benefit plans subject to ERISA with total assets exceeding $5 million or whose investment decisions are made by a registered
commodity pool advisor (CPO) or commodity trading advisor (CTA) subject to regulation under the Investment Advisers Act of 1940, or by
a financial institution or insurance company.
• Governmental entities (including the US, a state or a foreign government).
• Brokers and dealers subject to regulation under the Securities Exchange act of 1934 (Exchange Act) and similarly regulated foreign
entities. If the broker or dealer is an individual it must have discretionary investments of greater than $10 million.
• Futures commission merchants (FCMs) and similarly regulated foreign entities, except that if the FCM is an individual it must have
discretionary investments of greater than $10 million.
• Any entity that:
– is owned entirely by ECPs;
– where the entity and its owners have an aggregate of at least $1 million in net worth;
– is entering into an interest rate, FX or commodity derivative to hedge a commercial risk.

REGULATION (cont.)
ECP Definition: CEA section 1a(18)
The ECP definition provides several alternatives for meeting the
test. Only one prong of the definition must be met for a party to
qualify as an ECP.
The alternative most likely to be relevant for loan parties in
secured lending transactions found in CEA section 1a(18)(v)(III):
• "(v) a corporation, partnership, proprietorship, organization, trust, or other
entity — (III) that: (aa) has a net worth exceeding $1,000,000; and (bb)
enters into an agreement, contract, or transaction in connection with the
conduct of the entity's business or to manage the risk associated with an
asset or liability owned or incurred or reasonably likely to be owned or
incurred by the entity in the conduct of the entity's business[.]" (7 U.S.C. §
1a(18)(v)).

REGULATION (cont.)
ECP solutions: Keepwell cure
• ECP definition 1a(18)(v)(II):
– "(v) a corporation, partnership, proprietorship,
organization, trust, or other entity — (I) that has total
assets exceeding $10,000,000; [or] (II) the obligations of
which under an agreement, contract, or transaction are
guaranteed or otherwise supported by a letter of credit or
keepwell, support, or other agreement by an entity
described in subclause (I), …;

REGULATION (cont.)
ECP solutions: Carve out
• Carve-out language: Carves out obligations under the
borrower's (or any other party's) swaps from the basket of
guaranteed obligations under the loan documents.
– LSTA market advisory (Feb. 2013): recommended that the
defined term or terms used in the guaranty or security agreement
to identify the obligations guaranteed or secured (typically terms
like "Obligations" or "Guaranteed Obligations" and "Secured
Obligations") specifically exclude all “Excluded Swap
Obligations.” Definition of that term provided. (Sample language
in materials.)
– ISDA also has published similar carve-out language to
address the ECP issue, as well as keepwell language.

SECURING SWAPS
• Credit Agreement Issues:
– Swaps Permitted?
– Swaps Secured?
• Mortgage Issues:
– Swaps Secured?
– Priority
– Mortgage/Recording Tax
– Title Insurance Endorsement (ALTA 29)

SECURING SWAPS (cont.)
ALTA 29:
• 1. The insurance provided by this endorsement is subject to the
exclusions in Section 3 of this endorsement, the Exclusions from Coverage
in the Policy, the Exceptions from Coverage contained in Schedule B, and
the Conditions. As used in this endorsement:
– a. The “Date of Endorsement” is _____________________; and
– b. “Swap Obligation” means a monetary obligation under the interest rate
exchange agreement dated ________________, between _________________
and the Insured existing at Date of Endorsement and secured by the
Insurance Mortgage. The Swap Obligation is included as a part of the
Indebtedness.
• 2. The Company insures against loss or damage sustained by the
Insured by reason of the invalidity, unenforceability or lack of priority of the
lien of the Insured Mortgage as security for the repayment of the Swap
Obligation at Date of Endorsement.

SECURING SWAPS (cont.)
• Other Issues
– Hedge Pledge
– Payoffs
– Legal Opinion Qualification:
“We express no opinion regarding the enforceability
of any guaranty to the extent such guaranty would
result in or require a party to guarantee a swap
obligation and such party is not an eligible contract
participant under the Commodity Exchange Act”

Interest Rate Swaps for Borrower’s Counsel

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