Asset Swap Task Force

Asset Swap Task Force Introduction Questions around the coverage of asset swaps, total return swaps and related trades within FpML have come up repeatedly. Different working group chairs have asked guidance on the coverage in FpML, does it sit in one or another asset class or should it be one or more asset classes on its own? Users of FpML have questions around the coverage of asset swaps (assetSwapLeg) within EquitySwap. Goldman Sachs submitted a proposal on asset swaps representation in FpML to the task force. Coverage: 2 main product categories for the task force to consider in first instance are Total Return Swaps and Asset Swaps which can be defined in the following way:

Total return swap: An agreement in which one party (total return payer) transfers the total economic performance of a reference obligation to the other party (total return receiver). Total economic performance includes income from interest and fees, gains or losses from market movements, and credit losses; in return for receiving a stream of, typically, Libor based cash flows.

Asset Swap: A swap agreement where one leg mimics the return of the underlying asset. No transfer of asset takes place. (sometimes the sale of the bond is included in the “asset swap construct”)

The group mentioned other products that need further discussion at a later stage they include (incomplete list) - Bond options - Performance Swaps - Bond indexes - Convertible bond options ISDA legal Documentation – confirmation examples A starting point to look at the classification of different products is to look at different confirmation templates and study which part of the ISDA documentation they are build on. Goldman Sachs provided the following set of Total Return Swap examples: Index Swap Share Swap Futures Swap (exchange element) Share Basket Swap All these examples use the 2000 Definitions - Swap Transaction and the 2002 Definitions – Equity Swap Transaction (Share Swap Transaction, Index Swap Transaction, Share Basket Swap Transaction). The return leg is not always an equity (e.g. future swap) but also in this case the Equity Definitions are used (“references to “shares” in such equity Definitions shall be treated as if they were references to ‘futures contract””) 2 ISDA legal projects that have been mentioned in the 2 meetings are: - Convertible Bond underlyers: Documentation for Convertible Asset Swap Transactions done outside of ISDA. ISDA is currently reviewing the document and gauging the interest for it to become an ISDA sponsored document (2000 and ‘97 Government Bond Definitions) - Total Return Swap on debt and convertible debt: new equity working group to be started in the fall of 2005.

The FpML EquitySwap structure Equity Swap support was provided in FpML 4.0 by the EQD working group, using the complex type EquitySwap, with complex child types EquityLeg “A type describing the equity leg of the equity swap” and InterestLeg “A type describing the fixed income leg of the equity swap”

Equity Variance Swap support was introduced in FpML 4.1. Creation of the AssetSwapLeg type preserves backward compatibility, and allows for an EquitySwap to have one to many directional legs of any type. This has the effect of overloading the meaning of EquitySwap complex type. In addition, the choice of AssetSwapLeg is unfortunate as it is representing return swaps.

People familiar with the structure do not see this as a problem anymore however it is confusing for new users, even people familiar with FpML.

Possible actions: - don’t change the structure, document the use, educate the users. - change name of the AssetSwapLeg type (remove asset swap reference) and decide if EquitySwap structure should only be used for Equity underlyers or more generally return type trades – how prescriptive should this be? If we want to use the structure for more general return type trades, should the name EquitySwap be changed to ReturnSwap? - revert back to the 4.0 structure with a choice structure for EquityLeg, InterestLeg and a Variance Leg. - document the use of the structure with examples (irrespective of the solution chosen) The FpML Asset Swap structure Currently no Asset Swap structure exists. Goldman Sachs submitted a proposal based on credit assets and for internal purposes. Based on the proposal and the comments during the review of the proposal, Marc prepared the attached asset swap proposal.

Discussion Meeting on April 20th

FpML EquitySwap Structure: After some discussion the consensus in the group was to keep the return structure within the equitySwap product element, with clarification of the names where possible. A proposal with these changes will be made for discussion at the next meeting. The proposal needs to balance the need for clarification against the impact of changes. Additionally the group agreed that more elaborate documentation through examples should be done.

Actions: - work out proposal - work on the examples

The FpML Asset Swap structure: The discussion in the group if a new product should be created to represent asset swaps versus extending the current interest rate swap stream, was not concluded. Creating a new product gives the benefit of a more structured schema. As an action item we will look at the additional elements that are needed to represent asset swaps and the impact these will have on the current interest rate (optional elements versus changes to the current elements). Based on this the working group will decide at the next meeting.

Actions: - analysis of additional elements for asset swaps (Marc G.)

Meeting on June 9th FpML Equity Swap Structure: - Return Swaps: proposal agreed as circulated (see Annex 1) o Agreed to use the Equity Swap structure to support Return Swaps. o Agreed to change the name of assetSwapLeg to returnLeg. This is the head of the substitution group so instance documents are not affected. The change is backward compatible. o Agreed to implement this change in versions 4.1 and 4.2 Asset Swap structure: - Agreed that asset swap and Condition Precedent Bond are two different things. Condition Precedent Bond ties to the legal condition regarding the placement of the bond. The agreement was to support both within the existing Swap structure. - All information required for supporting asset swaps exists in the current Swap structure. Since within asset swaps there isn’t always a bond reference, a separate AssetSwap type would copy the existing Swap model without adding any value. - Instead of referencing the generic underlying asset component, the group felt that narrowing the scope to bond (and maybe convertible bond in the future) would provide a more accurate definition. The existing underlying asset is too broad for this purpose, allowing coverage of cash and ETF that do not seem appropriate for this structure. - Agreed to make bondReference element optional within additionalTerms for extensibility purpose. Group envisions that internal xml vocabularies will extend the additionaTerms element. Making bondReference required would be a problem for extensions. - Agreed that the Condition Precedent Bond flag shouldn’t be placed in the Bond type since this element would be used in a very specific case. Placing the element within the Bond will overload the type.

Comments from Andrew Parry (JP Morgan) on June 13 Regarding FpML Equity Swap Proposal (see Annex 1): - "ReturnLeg" should be made abstract if this is compatible with implementations by extension being used by substitution. (agreed) - Change attribute "legIdentifier" to be "id" in common with all other use of attribute type "xsd:ID". (impact ?) - Rename "EquitySwapBase" to "ReturnSwapBase". (open)

Regarding FpML Asset Swap Proposal (see Annex 2): - This continues to overload the meaning of Swap instead of creating a derived type by extension. - additionalTerms appears to be a catch all container. - bondReference allows reference to only a single bond. o Multiple bonds are not supported. o Other asset classes are not supported. - I had expected modeling "Asset Swap EXTENDS Swap HAS-A ... ( child elements as required )"

Standards Committee Offsite on June 28 Regarding the FpML Equity Swap Proposal (see Annex1): - Using equitySwap element to represent total return swaps is confusing. - Proposed to create a new returnSwap structure with the same content model as the existing equitySwap but substituting references to “equity” for “return” (element and type names) in version 4.2. - Deprecate the existing equitySwap structure and remove it in the next major version (version 5.0).

Regarding FpML Asset Swap Proposal (see Annex 2): No comments.

Open Questions - where to cover inflation swaps - Does the Asset Swap architecture choice mean that every similar product has to be contained within the swap element? Annex 1

Proposed Changes to Equity Swap

The proposed solution is to change name of the AssetSwapLeg type to ReturnLeg (removing asset swap reference). Technically, the use of substitution group in the leg level will be kept but changing the name of it (returnLeg instead of assetSwapLeg).

Switching back to a choice between the different legs (used in version 4.0) instead of using the substitution group doesn’t improve anything and it would reduce schema validation (all the elements within the choice have to be made optional).

The EquitySwap structure should not only be used for Equity underlyers but more generally return type trades. The names for equity swap (product element and type) will be kept as they currently are. Annex 2

Proposed changes to support Asset Swaps