Sample Swap Agreement
This is an example of swap agreement. This document is useful for creating swap agreement.
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Municipal Debt Advisory Commission Sample Interest Rate Swap Policy (Adopted February 5, 2004) Introduction The purpose of the Swap Policy is to establish guidelines for the execution and management of the District’s swap (interest rate exchange) program. This Swap Policy confirms the commitment of the Board, management, staff, advisors, and other decision makers to adhere to sound financial and risk management practices, including achieving the lowest possible cost of capital within prudent risk parameters. It is expected that this Policy will be reviewed at least annually and updated as necessary. Philosophy Regarding Use of Swaps Interest rate swaps can be appropriate interest rate management tools. Properly used, swaps can increase the District's financial flexibility and provide opportunities for interest rate savings, enhanced investment yields, or reduced risks. Swaps should be integrated into the District's overall debt and investment management policy. Swaps will not be used for speculation. For policy purposes, speculation means taking additional risks, unrelated to the District’s business, in an effort to increase returns. The District will follow rules simliar to those they would use on any significant investment. Swaps may be used when they achieve a specific objective consistent with the District’s overall financial policy. Swaps may be used, for example, to lock-in a current market fixed rate or create additional variable rate exposure. Swaps may be used to produce interest rate savings or alter the pattern of debt service payments. Swaps may be used to cap, limit, or hedge variable rate payments. Reasons to use Interest Rate Swaps and Swaptions include, but are not limited to: • Reducing interest expense; • Hedging and actively managing interest rate, tax, basis, and other risks; • Optimizing capital structure (e.g., achieve targeted debt allocation); • Achieving appropriate asset/liability match; and • Enhancing investment returns. Permitted Instruments The District may use the following financial products after identifying the specific financial objective to be realized and assessing the attendant risks: • Interest Rate Swaps -- Immediate or forward starting floating-to-fixed rate swaps may be used to capture current market fixed interest rates or eliminate variable rate exposure. Fixed-to-floating rate swaps may be used to create additional variable interest rate exposure. • Interest Rate Caps -- Financial contracts (caps, collars, floors) may be used to limit or bound exposure to interest rate volatility. • Options on Swaps –- Sales or purchases of options may be used to commence or cancel interest rate swaps. Options can range from simple (e.g., European or American) to exotic (e.g., knock- outs). • Basis Swaps -- Floating-to-floating rate swaps may be used to manage basis or tax risk and change the basis on which variable cash flows are determined. • Rate Locks –- These are often based on interest rate swaps and may be used to hedge an upcoming fixed rate bond issue. Page 1 of 5 • Structured Notes -- Fixed income securities may be used to offer investors a tailored risk/reward pay-off. The District may execute hedging agreements to return to a fixed or variable rate. • Total Return Swaps – These may be used to manage credit and market risk of securities. • Other financial products – May be used at the discretion of the Board. The District should use interest rate exchange (swap) financial products to produce a result not otherwise available in the cash market (lack of advance refunding/non-callable debt) or provide a higher level of savings, lower level of risk, greater flexibility, or other direct benefits related to the debt obligation with which the swap product is associated. The District may not use interest rate exchange financial products that (i) create extraordinary leverage or financial risk; (ii) lack adequate liquidity to terminate at market; or (iii) provide insufficient price transparency to allow reasonable valuation. Swap Risk Analysis The District shall evaluate all derivative financial products with respect to the unique risks with which they are associated. A specific determination must be made that the expected benefits exceed the identified risks by an adequate margin over those available in the traditional cash market, if any. • The District shall evaluate the potential risk involved for each transaction by examining all of the factors listed below; such evaluation shall also include an analysis of the impact of the risk attendant to the proposed swap transaction on the District’s overall financial assets and liabilities. The District shall examine:Market or interest rate risk - Does the transaction hedge or create interest rate volatility? By how much? • Tax Risk - Is the transaction subject to a future change in federal income tax policy? • Termination Risk - Under what circumstances might the transaction be terminated? What is the probable range of values? How would a possible termination payment be funded? • Risk of Uncommitted Funding (Put Risk) - Does the transaction entail the risk of future refinancing needs? • Legal Risk - Is the District authorized by its governing law to enter into the transaction and has it received the required authorization, if any, from its governing body or authority? • Counterparty Risk - What is the creditworthiness of the counterparty? • Rating Risk - Is the proposed transaction consistent with current ratings of the District’s financial obligations? • Basis Risk - Do the anticipated payments the District will receive match the payments it makes? If not, is the basis risk justified by the expected benefits? • Subsequent Business Conditions - Does the transaction or its benefits depend upon the continuation, or realization, of specific industry business conditions? Risk Limits Value at Risk. This District shall measure, monitor, and limit its market risk on interest rate swaps. The District will calculate the effect of a 1% unfavorable change in interest rates on its swap program at least quarterly. The aggregate Value at Risk of the District’s swaps will be limited to ___% of total [investments/debt] or $___ million. Other limits. Swap terms may not exceed the term of the debt obligation associated with the swap (interest rate exchange) agreement. The total notional amount of the swap agreement must not exceed the total par amount of the debt obligation association with the swap agreement. Financial Advisor, Swap Procurement and Execution The District will retain an independent financial advisory firm (FA) to assist it on all matters related to procuring, reaching or pricing an Agreement. Page 2 of 5 The District will solicit and procure an Agreement by competitive bid when feasible. Only parties conforming to the minimum credit standards outlined in this Policy are allowed to participate in a competitive transaction. The District may procure an Agreement by negotiated methods if it is determines that due to the size or complexity of a particular Agreement, competitive bidding is undesirable, impractical or impossible and a negotiated transaction would result in the most favorable terms. The District should attempt to price the Agreement based upon an agreed-to methodology relying on available pricing data to obtain inputs to a mathematical model. The District will use a FA to assist in price negotiations and the determination of the method of procurement. Regardless of the method of procurement, the District shall obtain a finding from the FA that the terms and conditions of the Agreement reflect a fair market value of such Agreement as of the date of its execution. All services related to swap transactions will be procured in a manner consistent with the District’s standing practices for procuring investment banking and other similar services, so as to provide the District with the highest level of service at the best available terms and pricing. The [Director of Finance/Chief Financial Officer] may execute interest rate swap agreements and other documents related to such transactions and may execute the documents related to similar transactions, if such documents result in a transaction consistent with this Policy. This authorization will extend to future termination or modifications of the initial documents provided such terminations or modifications do not result in a structure that exceeds the Risk Limits set forth in this Policy and is otherwise consistent with this Policy (see Active Management, below). The District must obtain specific approval from its governing body or authority to undertake a transaction that does not meet the requirements of this Policy or is an unusually complex transaction. Swap Counterparties Policy The District shall execute credit-sensitive derivative transactions only with counterparties with strong credit ratings. While the District may have a flexible credit standard, it will attempt to do business with counterparties rated in the “AA” category or above as of the transaction date. For lower-rated (below “AA” category) counterparties, the District shall seek credit enhancement in the form of: • Collateral; • Guarantees; or • Termination events (e.g. below investment grade). If (i) the rating of the counterparty is below the “AA” category or the counterparty’s rating is downgraded below the “AA” category while the swap agreement is in effect, or if (ii) the counterparty’s payment obligations are not guaranteed by another entity or if the entity that guarantees the counterparty’s payment obligations, if so secured, is rated below the “AA” category, then: • The obligations of the Counterparty will be 102% collateralized by cash or Treasuries or Agencies; and • The cash or obligations will be deposited with the District or with an agent of the District; and • The collateral obligations will be valued daily. The District will structure swap agreements to limit losses due to non-performance of its swap counterparties. Page 3 of 5 The District will establish and review counterparty exposure limits. (Not to exceed amounts for a given counterparty) Swap Documentation The District will use standard ISDA swap documentation, including the Schedule to the Master Agreement as well as a Credit Support Annex (if insurance is not available or cost-effective). The District swap documentation should include the following terms: • Key provisions, including those related to early termination (such as rating downgrade) and collateral requirements should be the same for both counterparties. • The specified indebtedness related to credit events in the Master Agreement should be narrowly drafted. • Eligible collateral should be limited to Treasuries, Agencies, and cash. • Collateral amount thresholds should be set on a sliding scale based on credit ratings of the counterparty or guarantors. • Termination value should be determined by "market quotation" methodology. • For counterparties below the “AA” category, use a credit support annex to document swap termination value collateralization procedures. Active Management The District will seek to maximize the benefits it accrues and minimize the risks it bears by actively managing its swap program. This will entail continuous monitoring of market conditions (such as current interest rates, credit ratings or the parties to a transaction and other relevant factors), in conjunction with the swap counterparty and the District’s advisors, for emergent opportunities and risks. Active management may entail modifications of existing transactions including: • Early termination of an agreement; • Shortening or lengthening the term of an agreement; • Sale or purchase of options; and • Application of basis swaps. Each proposed modification must be consistent with this Swap Policy and the District’s risk tolerance and should be expected to further the goals of the swap program as stated in this swap management and debt management plan. The Director of Finance should have delegated authority sufficient to provide flexibility to actively manage existing transactions without board approvals. Such delegated authority should include, but is not necessarily limited to, the authority to execute modifications to documents or to exercise actions permitted under the documents related to a transaction. Reporting and Disclosure The District shall provide its governing body or executive with [quarterly/monthly] reports on the status of its swap transactions. These reports will include market values, cash flows, value at risk and other performance measures, as well as evaluations of each transaction’s performance relative to benchmarks or goals set forth for the transaction or the District’s general financial benchmarks or goals. The reports will also note all material changes to swap agreements or new swap agreements entered into by the District since the last report. The District shall monitor and require compliance with this Swap Policy as well as then-current accounting practices and federal, state, and local regulations and requirements Page 4 of 5 Rating Agencies The District will seek Rating agency review to determine materiality of any swap transaction on the credit quality of the District as of part of it’s overall rating agency strategy. Swap Management Plan The District will prepare and maintain a swap management plan as part of it overall debt management plan. Managing derivatives requires an ongoing commitment from the District’s senior management. All senior management – not just the Director of Finance – shall become familiar with the risks and rewards of the derivatives being considered. Therefore, to help ensure understanding and knowledge of a swap transaction, the District’s Debt Management Plan will contain a discussion of the details of the swap, it’s risks, rewards, and exit strategies. The following will be addressed in the Plan: • Why the swap makes sense for the District. • The swap counterparty’s rating and it’s implications for the District. • Has the District’s governing body reviewed and understood cash flow projections detailing costs and benefis of the swap? • Discussion of senior management’s awareness of basis risk, rollover risk, termination risk, and counterparty risk. • The methods for handling basis risk, rollover risk, termination risk, and counterparty risk. • Events that may trigger an early termination under the the swap documents. • Assessment of the possibility of involuntary termination due to an Event of Default or Event of Termination. • On a best efforts basis, determine how much an involuntary or voluntary termination would cost and how it would be paid. • In the event of early termination, discuss how variable rate exposure will be rehedged. • Identity of key personnel and/or positions involved in monitoring the terms of the swap and counterparty creditworthiness. 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