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S E C U R I T I E S A N D D E R I VAT I V E S U P D AT E 08 NOV 2018

Initial Margin Implementation

under EMIR and the ISDA
2018 Credit Support Deed (for
IM)

ISDA publishes revised versions of their credit support

agreements for initial margin under English and New York law.
The new versions build on the 2016 template but now cover a
wider range of margin rule regimes. They also include greater
optionality in various areas, including treatment of non-
regulatory independent amounts, procedure for withdrawal of
collateral on a default of the secured party and custodian events.
In this briefing we look at the English law version of the 2018
Credit Support Deed for Initial Margin (IM).

Overview g h

Introduction

The International Securities and Derivatives Association ("ISDA") recently published the 2018 Credit Support Deed
for Initial Margin (IM) (the "2018 IM CSD"), which is designed to facilitate the exchange of initial margin between
relevant counterparties under applicable margin rules as they are phased in over the next two years.

The 2018 IM CSD is closely based on the ISDA 2016 Phase One IM Credit Support Deed (the "2016 IM CSD"),
which had been developed to assist parties subject to the first phase of initial margin requirement implementation
on 1 September 2016 and was also used by parties on the second and third phases of implementation (see
"Implementation Timeline" below).

In this briefing, we give an overview of the key initial margin requirements under the European Market
Infrastructure Regulation (EU) 648/2012 ("EMIR") and the regulatory technical standards contained in Commission
Delegated Regulation (EU) 2016/2251 (the "EMIR Margin Rules") as well as some of the main features of the 2018
IM CSD. We also highlight some key points for parties to consider as they plan for the next phases of initial margin
implementation.

Background

What is initial margin?

Initial margin is, in essence, a volatility buffer – it is defined under the Margin Rules to be the collateral collected by
one party to cover its current and potential future exposure in the interval between the last collection of margin and
(i) the liquidation of positions or hedging of market risk following a default of the other party or (ii) the hedging of
that exposure.

General requirement to collect initial margin

EMIR introduced the requirement that parties to a non-cleared OTC derivative contracts ensure the timely,
accurate and appropriately segregated exchange of collateral between the parties to non-cleared OTC derivative
contracts. Further specifications specific to initial margin are set out in the EMIR Margin Rules including,
requirements for collateral agreements, collateral eligibility criteria, collateral concentration limits, calculation
methodologies, segregation requirements and phase-in thresholds.

The phase-in thresholds, which must be exceeded by both parties in order for the initial margin requirements under
the EMIR Margin Rules to apply, are calculated by reference to the outstanding aggregate average notional amount
of all non-centrally cleared OTC derivatives of that party's group of companies measured at the last business day of
March, April and May in the relevant year ("IM Notional Amount Threshold").

Implementation timeline

Requirements applicable to exchange of initial margin

The principal requirements under the EMIR Margin Rules applicable to the exchange of initial margin are:

the collateral agreement must cover certain prescribed matters, including segregation arrangements (which are
subject to an independent legal review);

initial margin is to be valued daily using prescribed calculation and valuation methods;

the collection of initial margin is to be done on a same-day basis without offsetting of initial margin amount
between the counterparties;

collateral constituting initial margin must meet the eligibility criteria in respect of permitted asset type and
comply with specified concentration limits;

collateral collected as initial margin must be segregated from the collecting party's other proprietary assets or
those of the custodian, as applicable;

collateral collected as initial margin must be available to the posting party in a timely manner following the
default of the collecting party;

cash collateral collected as initial margin must be held at a third party account bank that is an EU credit
institution or the equivalent thereof in a third country whose supervisory and regulatory regime is recognised as
equivalent and may be reinvested by the account bank where the account bank cannot hold such cash collateral
on a segregated basis;

where a third party holds the collateral collected as initial margin, the collateral holding structure must allow
access to the collateral; and

the collateral taker cannot rehypothecate, re-pledge or other reuse the collateral except where reinvested.

Exemptions to the obligation to collect initial margin

Parties to certain OTC derivative contracts are exempt from, or are out of scope of, the requirement to collect initial
margin. The main exemptions other than the IM Notional Amount Threshold referred to above are as follows:

foreign exchange forwards, foreign exchange swaps and currency swaps are excluded from the obligation to
collect initial margin;

interest rate or currency hedges in respect of covered bonds where certain structural features are complied with;

where the amount due from that counterparty would be equal to or less than EUR500,000 (or its equivalent in
another currency);

where the counterparties are unconnected and the amount of initial margin required to be collected from all
parties in the posting group is equal to or less than €50,000,000 (or its equivalent in another currency) and where
parties are part of the same group, the threshold is €10,000,000 (or its equivalent in another currency);

intra-group transactions where there is (a) no practical or legal impediment to the transfer of capital or payment
of liabilities between the counterparties and (b) the risk management procedures of the counterparties are
adequate and consistent with the complexity of the transaction, and the competent authority has determined
that to be the case or it has been notified and does not disagree;

certain non-cleared OTC derivatives transactions entered into by central counterparties; and

where the netting set exclusively consists of options under which the premiums are paid up front.

ISDA 2018 Credit Support Deed For Initial Margin (IM)

The 2018 IM CSD takes on board some of the experiences that parties have had in negotiating the 2016 IM CSD in
phases 1 to 3 of the implementation of initial margin requirements and provides more flexibility through a larger
number of elective provisions to account for the broader range of counterparties that will be subject to phases 4 and
5.

We discuss some of the key features of the 2018 IM CSD and their interaction with the initial margin requirements
under the EMIR Margin Rules in this section 3.

Required contents of Collateral Agreement under EMIR Margin Rules

As mentioned above, the EMIR Margin Rules require the documentation regulating the collection of collateral to
contain as a minimum the following:

the levels and type of collateral required;

the segregation arrangements;

the netting set to which the exchange of collateral refers;

the procedures for notification, confirmation and adjustment of margin calls;

the procedures for settlement of margin calls for each type of eligible collateral;

the procedures, methods, timeframes and allocation of responsibilities for the calculation of margin and the
valuation of collateral;

the events that are considered to be default or termination events; and

the law applicable to the non-centrally cleared OTC derivative.

The 2018 IM CSD has been developed through an ISDA working group with a view to enabling parties to comply
with these requirements. The 2018 IM CSD, like the 2016 IM CSD, also contains provisions designed to comply with
the principal margin requirements of, among other regimes, the EMIR Margin Rules, including daily valuation, same-
day delivery and timing of posting of undisputed amounts. We do not discuss those provisions in significant detail
below.

As mentioned above, parties are obligated to perform an independent legal review of the collateral exchange
arrangements and the segregation arrangements contained therein to ensure their enforceability and compliance
with the EMIR Margin Rules. ISDA has published collateral opinions covering the enforceability of the rights of the
collateral provider and the collateral taker respectively under English law, among others, and the 2016 IM CSD. We
expect that ISDA will revise those opinions to cover the 2018 IM CSD.

Covered Transactions

The scope of transactions that are included in the determination of the Margin Amount (IM) under the 2018 IM CSD
is limited to each Covered Transaction, which is defined as an outstanding transaction which is subject to initial
margin collection or delivery requirements under the Regime(s) elected by each party (or the relevant party if the
2018 IM CSD is specified as being one-way). Under the 2016 IM CSD, Covered Transactions also included
"Additional Types" of transaction under Regimes not yet in effect but this has been removed from the 2018 IM CSD
as the Regimes in most significant jurisdictions for derivatives trading are now in effect.

Parties may also elect to exclude any Covered Transaction from the scope of transactions under any other credit
support annex, credit support deed or collateral transfer arrangement. This exclusion was automatic under the
2016 IM CSD but the change to make it elective recognises that parties may have existing initial margin
arrangements in place that they wish to preserve, for example, because they are more stringent that the Margin
Amount (IM) that would be calculated under the 2018 IM CSD.

Margin Amount (IM)

Delivery Amounts and Return Amounts under the 2018 IM CSD are determined by reference to the Credit Support
Amount (IM), and how that amount is determined depends on the Margin Approach the parties elect. There are
three Margin Approaches:

1. the Distinct Margin Flow (IM) Approach, which represents a standard formulation, where the Credit Support
Amount (IM) is Margin Amount (IM) minus Chargor's Threshold;

2. the Allocated Margin Flow (IM/IA) Approach, which also uses the standard formulation to determine the Credit
Support Amount (IM) but provides for the Chargor's posting obligation with respect to the sum of all Independent
Amounts determined under other collateral agreements (the "Margin Amount (IA)") to be reduced by the Credit
Support Amount (IM); and

3. the Greater of Margin Flow (IM/IA) Approach, where the Credit Support Amount (IM) is the greater of (i) Margin
Amount (IM) minus Chargor's Threshold and (ii) the Margin Amount (IA).

The Margin Approach that parties will want to apply will therefore depend in large part on what existing collateral
arrangements they have in place under which they collect Independent Amounts and to what extent those
arrangements already contemplate the parties collecting regulatory required initial margin under a separate
agreement, such as the 2018 IM CSD.

The Margin Amount (IM) is defined with respect to a Chargor's posting obligation as the amount of initial margin
required under a Regime in respect of the Covered Transactions (IM) determined using the Method, being ISDA
SIMMTM or, if SIMM Exception is specified with respect to such Chargor, such other calculation methodology
specified by such party. If more than one Regime applies, the Margin Amount (IM) is the greatest amount
determined under each applicable Regime.

Security Interest

Each party as Chargor creates security by way of first fixed charge over the collateral and the collateral account and
by way of assignment of all rights in the collateral. The 2018 IM CSD also contains:
(a) a negative pledge which restricts the Chargor from creating or allowing to subsist any other security interest
over or dispose of any right in the collateral, the collateral account or the assigned rights; and
(b) a prohibition on the Chargor selling, pledging, rehypothecating, assigning or investing the collateral or registering
the collateral in the name of the Secured Party or the custodian in line with the EMIR Margin Rule requirement.

The 2018 IM CSD provides for the collateral to be released from the security interest and transferred by the
custodian to the Chargor only following instructions from the Secured Party, following delivery of a Chargor Access
Notice under the Control Agreement or otherwise as agreed by the parties. A Chargor Access Notice can only be
delivered upon the occurrence of a Chargor Rights Event, which is the designation of an Early Termination Date as a
result of an Event of Default or a specified Termination Event with respect to the Secured Party.

If Chargor Full Discharge Condition is specified as applicable, a Chargor Rights Event will not occur until the Chargor
has delivered a calculation statement under Section 6(d) of the ISDA Master Agreement and no Early Termination
Amount is or remains payable by the Chargor or such amount is payable by the Chargor but will be satisfied in full by
delivery of Posted Collateral (IM) to the Secured Party. The Chargor Full Discharge Condition applies as standard
under the 2016 IM CSD and the ability to elect not to apply it is new to the 2018 IM CSD. This allows parties to take
a view as to whether the EMIR Margin Rules requirement to return collateral in a timely manner should be
construed as requiring a return where the Chargor still owes secured obligations, notwithstanding that that could
make the analysis more complex as to whether or not the Secured Party has sufficient "control" over the collateral to
establish a fixed charge. Parties can also elect to apply the Cooling-off Period Condition, which applies an additional
two business day period before the Chargor Rights Event occurs.

Transfers of Collateral

The provisions of the 2018 IM CSD relating to the calculation, transfer and substitution of collateral are largely
unchanged from the 2016 IM CSD and consist principally of provisions:

1. providing conditions precedent to the delivery and return of collateral, being no Events of Default, Potential
Events of Default or specified Termination Events having occurred and continuing;

2. specifying the means of transfer of collateral (i.e., book-entry, wire transfer or other means);

3. legislating for the same-day transfer of collateral in line with the EMIR Margin Rules, subject to notification being
made by agreed cut-off times, and requiring the Secured Party to instruct the custodian prior to the custodian's
cut-off times for same-day transfers;

4. on the timing of calculations made by the Calculation Agent and the information the Calculation Agent may use in
performing those calculations;

5. permitting substitutions of collateral to be effected, subject to consent of the Secured Party (if consent is elected
as applicable) and subject to the Secured Party having received the substitute collateral prior to being obligated
to instruct the Custodian to return the collateral being substituted; and

6. addressing ineligible collateral, which upon notice is valued at zero from the specified Ineligibility Date and the
Chargor has five Local Business Days to replace it prior to the Secured Party being able to designate an Event of
Default or treat the circumstance as a Potential Event of Default.

Relationship with Custodian

There are a number of provisions in the 2018 IM CSD, like the 2016 IM CSD, which reflect the introduction of a third
party custodian into initial margin collateral arrangements. These provisions cover matters such as instructions to
the custodian to deliver or return collateral, dealings with the collateral accounts, notification mechanics and cut-off
times to effect transfers of collateral.

In particular, Paragraph 6 of the 2018 IM CSD requires each party as Chargor and as Secured Party together with
the custodian to enter into a control agreement that regulates the mechanics of giving instructions to the custodian,
interest and dividend payments and voting rights. Paragraph 6 also allocates liability for the acts and omissions of
the custodian to the Chargor and provides that such acts or omissions are treated as acts or omissions of the
Chargor for the purposes of defaults under Paragraph 7 of the 2018 IM CSD. The parties can, however, specify
certain acts or omissions of the custodian as constituting a Custodian Event, which entitles the Chargor to identify a
replacement custodian within a prescribed time frame or, failing that, to terminate the related ISDA Master
Agreement pursuant to an Additional Termination Event.

The parties can also elect whether or not:

1. the control agreement is a Credit Support Document (which is particularly relevant to the Event of Default under
Section 5(a)(iii) (Credit Support Default) of the ISDA Master Agreement);

2. the provisions of the 2018 IM CSD prevail over the control agreement; and

3. they agree to certain actions and determinations that are performed in accordance with the control agreement
being recognised as satisfying equivalent obligations under the 2018 IM CSD, including with respect to
substitutions, custodian valuations, service of demands, instructions to the custodian and return or delivery in
lieu obligations of the Secured Party.

Defaults and enforcement

While a Custodian Event, if applicable, will not constitute an event of default under the ISDA Master Agreement,
Paragraph 7 of the 2018 IM CSD amends Section 5(a)(iii) (Credit Support Default) of the ISDA Master Agreement to
include:

1. failure of collateral delivery by the Chargor (with a grace period of 2 days);

2. failure of the Secured Party to instruct the custodian to return collateral to the Chargor (with a grace period of 2
days); and

3. a failure to perform any obligation under the 2018 IM CSD other than those in (a) and (b) (with a grace period of
30 days).

The 2018 IM CSD gives the Secured Party a range of rights and remedies following a Chargor default that are typical
for English law security agreements, including a right of appropriation (to the extent the 2018 IM CSD constitutes a
"security financial collateral agreement" under the Financial Collateral Arrangements (No.2) Regulations 2003), a
security power of attorney and a right to appoint a receiver.

Key Points To Consider

Parties that will be subject to phases 4 and 5 of implementation of the initial margin requirements and phase 1 to 3
parties that need to negotiate margin-rule compliant documentation with phase 4 and 5 counterparties will need to
consider:

1. the impact of Brexit on their trading relationships and identifying the group entities that will be involved in
implementing the contractual negotiations;

2. whether they wish, or will be required by their counterparties, to adhere to one of the electronic platforms
through which initial margin negotiations can be undertaken (several of which provide free access for buy-side
parties);

3. which custodian they will use for initial margin purposes and the steps required to get their custodial
arrangements in place;

4. where the 2018 IM CSD is used, their preferred elective positions thereunder; and

5. whether their custodian relationship and documentation may necessitate a "transfer-only" version of the 2018
IM CSD – for example where parties wish to apply the governing law of the ISDA to the mechanical and operative
aspects of their collateral relationship and a different governing law to the grant of security over the custody
account and collateral therein.

Key Contacts

We bring together lawyers of the highest calibre with

the technical knowledge, industry experience and
regional know-how to provide the incisive advice our
clients need.

Jonathan Haines Kerion Ball

PARTNER PARTNER
LONDON LONDON

+44 20 7859 1396 +44 20 7859 1529

x y x y

James Coiley James Knight

PARTNER PARTNER
LONDON LONDON

+44 20 7859 3079 +44 20 7859 1991

x y x y

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