GMRA Mechanics: Key Provisions, Market Standards and Relevant Legal Issues Paul Landless and Emir Nurmansyah 22 November 2012 Indonesian GMRA Annex

GMRA Mechanics: Key Provisions, Market Standards and Relevant Legal Issues

Paul Landless and Emir Nurmansyah

22 November 2012

Indonesian GMRA Annex

Introduction


• Part A: Framework & Transaction Initiation• Part B: Margin & Income Payments• Part C: Events of Default & Close-out• Part D: Boilerplates

GMRA Mechanics: Key Provisions, Market Standards and Relevant Legal Issues 222 November 2012

Part A: Framework & Transaction Initiation


Introduction to GMRA Master Agreement

What are Master Agreements?• Standard contractual terms apply

Why are they used?• Formalities• Transactions agreed orally over

telephone• Uncertainty• Entire agreement clauses


Common Architecture

• Documentation Architecture• Master Agreement produced by trade association• GMRA Annex (Annex I)• Customised Annexes for particular markets or

products• Confirmations

• Forms a single agreement• No cherry picking• Forms the basis for close-out netting


The Repo Master Agreement

• Standard form principal agreement is Global Master Repurchase Agreement (GMRA) • Framework agreement used to carry out any number of

individual repo transactions

• Documentation issued by SIFMA and ICMA


Annexes to the GMRA

The GMRA is designed for use in particular situations where:• UK regulatory requirements and UK tax• Issuer of the transferred securities may pay the

coupon gross• Seller and Buyer act as principals

• Agency Annex The GMRA may be adapted for use in other

situations (e.g. buy/sell-back transactions)GMRA Mechanics: Key Provisions, Market Standards and Relevant Legal Issues 722 November 2012

Examples of GMRA Annexes


The Confirmation

• Commercial terms of an individual transaction or "trade"

• Standard form in Annex II


Details of the Confirmations• Date of the relevant GMRA• Date of the transaction• Type and nominal value of the

securities transferred• Identifying numbers for the

securities• Name of the buyer and the seller

and bank account details• Purchase date• Additional terms may also be

incorporated

• Purchase price• Currency of the contract• Repurchase date (or, if the repo

is terminable on demand, a statement to this effect)

• Repo rate• Sell-back price (if the transaction

is a sell/buy-back)• Agency transaction; if so, name of

party acting as agent and as principal


Negotiating a GMRA Annex• Buy/Sell-Back Annex

applicable?• Net-paying Securities to be

covered under the agreement?• Agency Transactions

permitted?• Base Currency• Designated Offices• Pricing Source• Spot Rates

• Delivery of Confirmations• Interest Rate on Cash Margin• Interest Payment Intervals• Delivery Period for Margin

Calls• Delivery and payment

condition precedent applicable?

• Event of default for fails on a per trade basis applicable?

• Addresses for communication• Agent for service of process


GMRA Annex – Key Provisions, Market Standards and Relevant

Legal Issues


Overview - Terms under GMRA Annex (1)

• Standard Terms common to all transactions, e.g.:• Representations and Warranties • Events of Default

• Other matters to be agreed between the parties, e.g.:• Base Currency for the Transactions• Each Party's Address for Service• Name of any Process Agent

• Supplemental Provisions


Overview - Terms under GMRA Annex (2)


Parties to the GMRA• Each party enters individual transactions

though designated offices and authorised individuals• Designated offices• Authorised individuals

• Regulatory authority


• Paragraph 1• Buyer on one transaction, Seller on

another• Buy/sell-back transactions between the

parties

GMRA Mechanics: Key Provisions, Market Standards and Relevant Legal Issues 16

Applicability

22 November 2012

Initiation; Confirmation; Termination

• Paragraph 3• (a): A transaction may be entered into orally or in writing

at the initiation of either the seller or the buyer• (b): Obligation to deliver written confirmation• (c): Purchase Date• (d)&(e):Termination

• “On demand” transactions• (f): Transfer of Equivalent Securities against

payment of the Repurchase Price (Paragraph 2(pp))• Pricing Rate (Paragraph 2(jj))


Part B: Margin Maintenance & Income Payments


Margin maintenance (1)

• Paragraph 4• Concepts:• (1) Exposure

• Party with “Net Exposure” in respect of other party may require other party to make Margin Transfer equal to Net Exposure

• Net Exposure determined with reference to Transaction Exposure

• Transaction Exposure = diff between Repurchase Price x Margin Ratio and market value of equivalent securities


Margin maintenance – Example 1

• On Purchase Date:

• Exposure

- Purchased Securities: $100 - Cash: $100

- Exposure = 0 - Exposure: 0


Buyer SellerPurchase Price: $100

Purchased Securities: $100 market value

Buyer Seller


• Exposure mid-way through transaction

- Purchased Securities: ↑ $150 - Repurchase Price: ↑ $120- Exposure = 0 - Exposure: $30

• Margin call

- Purchased Securities: $150 - Repurchase Price: $120- Exposure = 0 - Cash (Cash Margin): $30

- Exposure: 0


Buyer Seller

Buyer $30 Cash Margin Seller

Margin maintenance (2)

• (2) Initial Margin• Fixed proportion or ratio of collateralisation for one

party

• (3) Haircut• Discount to actual market value of a security• Purchased Securities or Margin Securities (for 2011

GMRA)



• Initial Margin (GMRA 1995 & 2000):• 10% in favour of Buyer:

OR• 10% in favour of Seller:






Margin maintenance (3) – Margin Call

Maintenance of Margin

(1)Margin Call (Paras 4(a)-(h))

• Paragraph 4(a)-(b): Margin calls / Margin call notices• Paragraph 4(c): Net Exposure (Exposure, Haircuts

and Initial Margin)• Paragraph 4(d): Composition of margin transfers• Paragraph 4(e)&(f): Cash Margin• Paragraph 4(g): Delivery period for margin• Paragraph 4(h)&(i): Alternative methods of margining


Margin Maintenance (4) - Repricing & Adjustment

• Parties can agree that Net Exposure may instead be eliminated by repricing (Para 4(j)), adjustment (Para 4(k)) or a combination:

(2) Repricing (Paragraph 4(j))• Repurchase Date under original transaction deemed to

occur• Parties deemed to enter into a new transaction• Net sum is payable (diff between Repurchase Price under

original transaction and Purchase Price under new transaction which is based on market value of securities on Repricing Date)

(3) Adjustment (Paragraph 4(k))• Similar to repricing• Net amount of securities delivered on Adjustment Date


Income Payments• Paragraph 5• Purpose – economic nature vs legal relationship• “Manufactured income payments”• Buyer to credit the seller's account with income on the

securities during the term of the repo• “Income” on securities provided as margin / collateral• Voting rights and corporate actions?Relevant Legal Issues• Recharacterisation issues• Power of attorney required?


Payment and Transfer (1)• Paragraph 6• Payment and transfers (Para 6(a))

• Method for transferring securities

• Gross-up (Para 6(b))• Gross-up unless otherwise agreed• Para 11 – Tax Events

• Delivery versus payment (Para 6(c) & (d))• May waive simultaneous transfer/payment but must be on same day

• Outright title transfer (Para 6(e)&(f))• Absolute title transfer of title to all securities and money• Indonesia Annex: paragraph 6

• Formalities for the transfer of Indonesian securities / bonds?GMRA Mechanics: Key Provisions, Market Standards and Relevant Legal Issues 2722 November 2012

Payment and Transfer (2)• Time of the essence (Para 6(g))

• Close-out provisions and EODs • Settlement netting provisions (Paragraph 6(h) & (i))

• Settlement netting vs close-out netting• Cash payments• Deliver of Securities

• Paragraph 6(j): Suspension of obligations• Optional • No Potential EOD• Currently the subject of litigation in English courts

• Indonesian legal position?

• Recharacterisation-related issues re transfer of “Margin Securities”?


Contractual Currency

• Paragraph 7• Contractual Currency (Para 7(a))

• Base Currency (Paragraph 2(d))

• Indonesian rupiah FX Issues• Foreign exchange restrictions• Reporting obligations


Substitution

• Paragraph 8• Seller’s right to substitute equivalent securities for the

securities transferred• Equivalent Margin Securities /Equivalent Securities (Paragraphs 2(r)&(s))

• Buyer’s consent required (Para 8(a))• Buyer re-transfers the original securities back to Seller (or an

agreed portion of them) (Para 8(b) & (d))• Seller transfers the substitute securities (Para 8(b) & (d))• At least market value as at the date of the re-transfer (Para

8(a) & (d))• Timing of valuation


Part C: Events of Default & Close-out


Representations and Warranties (1)

• Paragraph 9(a) – (h)• Breach or representations and warranties an EOD• The representations and warranties are repeated on

• The date on which any transaction is entered into• On each day on which the securities are transferred

• Due authorisation (Para 9(a))• Acting as principal (Para 9(b))• Governmental and regulatory authorisations (Para 9(d))


Representations and Warranties (2)

• No breach of law, constitution or agreement (Para 9(e))• Non-reliance and acceptance of risks (Para 9(g))• Ability to transfer securities free of encumbrances (Para

9(h))

• Indonesia Annex• No events of default• No litigation or arbitration• Capacity• Portfolio management purpose


Events of Default (1)

• Paragraph 10(a)• Events of Default and Close-out Netting• Events of Default following service of Default

Notice • Exception: Act of Insolvency (Paragraph 2(a))

• Revocation of business license?

• 2011 GMRA changes to Default Notice

• Grace Periods?• Business Day (Paragraph 2(e))

• “Mini close-out” provisions (Para 10(g) & (h))


Events of Default (2)Events of Default (Para 10(a))

• Failure to pay Purchase Price or Repurchase Price (Para 10(a)(i))

• Failure to deliver securities (optional) (Para 10(a)(ii))

• Failure to comply with margin maintenance provisions (Para 10(a)(iv))

• Failure to pay manufactured payments (Para 10(a)(iii))


Events of Default (3)• Act of Insolvency (Para 10(a)(vi))• Indonesia Annex:

Business licence revocation: liquidation Bankruptcy and Suspension of Tagment Consent, approval and acquiescence of above

• Business licence revocation: new 10(a)(xi) • Breach of representations in any material respect (Para

10(a)(vii))• Regulatory action against party (Para 10(a)(ix))• “Sweep up” clause – breach of any other obligations –

30 day grace period (Para 10(a)(x))


“Mini close-out” Provisions

• “Mini close-out” (Paras 10(g) and (h)) Failure by Seller to deliver securities on Purchase Date (Para

10(g)) Failure by Buyer to deliver securities on Repurchase Date

(Para 10(h))• Termination of transaction

• Determination default market value of securities and repurchase price

• Set-off

• Timing

• Indonesia Annex: Articles 1425 – 1435 of Code


Consequences for counterparty upon Event of Default

• Default Notice• Notification of EOD or Potential EOD • Required for all events except presentation of

winding up petition or appointment of a liquidator• Practical difficulties of serving notice• Special default notice procedure


What happens on a default? – what will you seek to recover?

• Value of positions

• Recovery of expenses

• Your hedging costs

• No liability for consequential loss


Close-out netting – Example (1)

Transaction 1• Purchase Date:

• 3 months later:

- Purchased Securities: ↓$90 - Repurchase Price: ↑$110


Party A Party BPurchase Price: $100

Purchased Securities: $100

Party A Party B


Transaction 2• Purchase Date:

• 3 months later:

- Purchased Securities: ↑$120 - Repurchase Price: ↑$105


Party B Party APurchase Price: $100


Party B Party A


Event of Default occurs:• Step 1: Acceleration of obligations


Party A Party BRepurchase Price: $110


Party B Party APurchased Securities:

$120

Repurchase Price: $105

T1

T2


• Step 2: Conversion of delivery obligations into cash obligations


Party A Party BRepurchase Price: $110

DMV: $90

Party B Party ADMV: $120

Repurchase Price: $105

T1

T2


• Step 3: Netting

• Single net close-out balance


Party A Party B

$15Party B Party A

T1

T2

$20

Party AT1 + T2 Party B$35

What happens on a default? – close-out netting

• Paragraphs 10(b)-(f) & (i)-(k)• Repurchase Date accelerated• Cash margin repayable and equivalent margin

securities deliverable• Non-defaulting party establishes “Default Market

Value” of securities, the amount of cash margin to be transferred and the repurchase prices payable

• Amounts set off to produce single net amount payable by one party to the other• Limits on rights to set-off & net? • Preferential Transfers under Indonesian Bankruptcy Law?• Automatic Early Termination?


Part D: Boilerplates & Other General Provisions


Tax Event• Paragraph 11• Material adverse effect on that transaction• Action by tax authority or change in fiscal or regulatory regime• Affected party may give notice to terminate

• The notice must specify a date for close-out (at least 30 days after the date of notice)

• Other party may serve counter-notice to prevent such termination• The counter-notice will constitute the other party's agreement to

indemnify the first party against the adverse effect• If no counter-notice, termination will go ahead and the first party will

indemnify the other party against any reasonable legal and other professional expenses incurred by the other party

• Stamp Duty Issues?• Sale of Indonesian shares or bonds


Interest

• Paragraph 12• Interest is payable on late payments• The rate of interest is the greater of the repo

rate specified in the confirmation and LIBOR• 2011 GMRA: “Applicable Rate”


Governing law

• Paragraph 17• Indonesia Annex

• Arbitration Clause: Annex I election• BAPMI / BANI / SIAC / other• Waiver of immunity


Buy/Sell back vs Repo: Key differences

GMRA Mechanics: Key Provisions, Market Standards and Relevant Legal Issues50

Buy/Sellback vs Repo: Key differences

Buy / sellback RepoDocumentation • Simple: structured as two

separate transactions (spot purchase and forward sale) not under a master agreement

• More complex: sale and repurchase structured as one transaction under a master agreement

Close-out netting • Not available due to absence of master agreement

• All transactions under a master agreement can be terminated if an Event of Default occurs under any one transaction

• If Party A defaults on any one transaction, Party B must wait for other transactions with Party A to mature

22 November 2012



Buy/Sellback vs Repo: Key differences (2)

Buy / sellback Repo

Margining • Typically not margined • Securities regularly valued or marked-to-market and margin called for accordingly

• Documentation provides for non-compliance and release of excess margin

Insolvency Risk • Risk that a party becomes insolvent after initial purchase but before forward sale

• Reduced exposure due to operation of close-out netting

• Solvent party could be unsecured creditor as regards all sums owing to it from the insolvent party

• Solvent party will be unsecured creditor only as regards the net balance owing to it from the insolvent party

22 November 2012



52


Buy / sellback Repo

Insolvency Risk • “Cherry picking” a possibility in some jurisdictions

Accounting treatment

• Treated as outright sale • Seller retains securities on its balance sheet

• Securities leave Seller’s balance sheet

• Coupon accrues for benefit of the Seller

• Securities appear on Buyer’s balance sheet

• Coupon accrues for benefit of the Seller

22 November 2012



53


Buy / sellback Repo

Regulatory capital treatment

• Increased requirement based on gross exposure to counterparty due to lack of close-out netting and margin

• Reduced requirement based on net exposure to counterparty as obligations can be netted and/or margined

Distributions • Buyer keeps income when distributed

• Buyer promptly pays equivalent sum to Seller (“manufactured dividend”)

• Accounted for in sellback price paid at maturity

• Convention only – no contractual obligation on Buyer to pay distributions to Seller

22 November 2012

Questions?


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Documents

GMRA Mechanics: Key Provisions, Market Standards and Relevant Legal Issues Paul Landless and Emir Nurmansyah 22 November 2012 Indonesian GMRA Annex