ISDA International Swaps and Derivatives Association, Inc. EMU GUIDEBOOK DISCLAIMER This Guide does not purport and should not be considered to be a guide to or explanation of all relevant issues or considerations in connection with EMU. Parties should therefore consult with their legal advisers and any other adviser they deem appropriate prior to using this Guide. ISDA assumes no responsibility for any use to which any documentation or any definition or provision contained therein may be put. Copyright © April 1998 by International Swaps and Derivatives Association, Inc. All rights reserved. EMU GUIDEBOOK ISDA CONTENTS Foreword - European Monetary Institute Section I Introduction Page 5 Section II Financial Markets Overview Page 11 1. Money Markets and Derivatives 2. Bond Markets and Derivatives 3. Foreign Exchange Markets and Derivatives 4. Equity Markets and Derivatives Section III Legal and Documentation Page 21 1. Legal Framework 2. Documentation 3. ISDA EMU Protocol Section IV Accounting, Tax and Capital Page 37 1. Tax and Accounting 2. Risk Management and Capital Section V Operations Page 43 1. Introduction 2. Interest Rate Products and Basic Principles 3. Bond, Equity and Foreign Exchange Derivatives 4. The Conversion Weekend and Beyond Glossary Page 65 References Page 71 Annexes A. European Regulations - 235 & 109 l(4) Annex A B. Commission Q&A on European Regulations Annex B C. NY Legislation Annex C D. Joint Statement on Harmonised Market Conventions Annex D E. Impact of EMU on Price Sources - Legal Issues Annex E F. Impact of EMU on Price Sources - Overview Annex F G. Outline of Euro Libor by the British Bankers’ Association Annex G H. Outline of Euribor by the Banking Federation of the EU Annex H I. Bond Redenomination: Overview by Monetary Committee Annex I J. Tax Issues: Inland Revenue Q&A Annex J EMU Guidebook ISDA FOREWORD Efficient and integrated financial markets conditions for the single monetary policy play a crucial role in the work of the to be followed by the ESCB. European Monetary Institute. The set of monetary policy instruments which the While it has been the policy of both the EMI is in the process of developing for the EMI and the EU NCBs to emphasise that future European System of Central Banks the organisation of the future single (ESCB) is in conformity with the market money, bond and foreign exchange principles enshrined in the Treaty. The markets should be the initiative and ESCB will mainly use open market responsibility of the financial industry operations to implement the single itself, the progress of the preparations has monetary policy and will rely on market been closely monitored. To this end, the forces for an efficient allocation of EMI has initiated a dialogue between the liquidity, thus ensuring the prompt EU-wide banking and financial associations transmission of monetary policy signals and the central bank community on issues and uniform monetary conditions concerning the changeover to the single throughout the euro area. The dynamics currency. It has acted as a forum for the of the scenario for the changeover to the mutual exchange of information and views euro, as developed by the EMI, was and encouraged the individual associations motivated by the considerable scope given to establish harmonised market to market forces and competition in this conventions. complex and unprecedented process. ISDA has made an invaluable contribution The EMI has long been aware that to the dialogue with the EMI, and its markets' preparations for the changeover activities have been instrumental in to the euro will need to be supported by increasing market participants' awareness the provision of timely information on the of the need for adequate preparations for ESCB’s monetary policy instruments and EMU. The commitment of ISDA to procedures. It has, therefore, released a ensuring timely preparations for EMU has number of reports containing a significant been a source of considerable relief and amount of technical information, including encouragement for us, as we have been the specification of the operational grateful over recent years to know that framework of the single monetary policy in our extraordinarily heavy burden of work January 1997 and the General has been shared with professionals Documentation on the ESCB's monetary genuinely interested in making the policy instruments and procedures in financial markets' changeover to the euro September 1997.1 Any outstanding issues a success story. will be decided by the ECB, which will complete and finalise the terms and Frankfurt, March 1998 H. K. Scheller 1 Since January 1998 these documents have Secretary General, been available on the EMI’s Web site European (www.ecb.int), together with further Monetary Institute information dedicated to the changeover to the single currency, which provide 200 hyperlinks to the Web sites of other public and private institutions offering technical information on the changeover to the euro. 3 EMU Guidebook ISDA Section I INTRODUCTION 5 EMU Guidebook ISDA INTRODUCTION The introduction of the single currency in I am proud of the Association's Europe will have profound implications for considerable achievements over the past the financial markets, none more so than two years in these areas. We have led the trading in privately negotiated derivative successful effort to adopt legislation transactions. Indeed, the flexibility of ensuring continuity of contracts in both derivatives and their application to an the European Union and New York. We array of underlying risks means that the have succeeded in establishing common changes unleashed by the euro in the market conventions for the euro. We have money, foreign exchange, bond and equity achieved significant progress in resolving markets are all relevant to derivatives. the problems raised by disappearing price The implications of the euro for trading, sources. We have clarified tax settlement, documentation, operations, implications of EMU. We have also accounting, tax, capital and risk provided a mechanism for members to management in all these markets need to address the impact of EMU on outstanding be considered. This presents the transactions and have published practitioner with the need for information comprehensive guidelines for the from an number of public and private operations implications of EMU. sources in order to get a clear picture of the changeover process. Organisation of this Guidebook All of this work is either described or This book is designed to address this reproduced in this guidebook – along with need, by providing ISDA members and the many other areas of ISDA's EMU other market participants with a activities. comprehensive guide to the impact of EMU on derivatives businesses and with copies This guidebook is organised as follows: of the key reference documents that are • In the following section, ISDA provides needed to plan for the changeover. a market-by-market overview of the impact of EMU, summarising the key ISDA’s Role in Preparing for EMU transition issues and implications for This guide represents the culmination of derivatives. This is designed as a two years of work by ISDA members, staff high-level overview and refers the and consultants to address the reader to relevant documents or implications of EMU for derivatives. From source material (much of which is an early stage, ISDA has taken an active reproduced) in order to look into any role in preparing for the euro, forming a particular question in further detail. number of key task forces (see Figure 1) and focusing on the practical implications • ISDA then looks at a number of over- of the new single currency for our arching issues relating to EMU: the industry. This work has been guided by a legal, accounting, tax and risk desire to promote legal certainty for the management implications. This new currency, to ensure a parallel includes a user-friendly summary of transition for the cash and derivatives the main provisions of the EU markets, and to provide ISDA members regulations on the legal status of the with early, authoritative information about euro. the mechanics of the changeover. • Section V of the book reproduces the full text of ISDA's guidance on the 7 ISDA EMU Guidebook implications of EMU for derivatives with many member state national central back office operations. This reflects banks and governments, the European the consensus of the Association's EMU Commission and the European Monetary Operations Task Force, following Institute. We would like to take the lengthy discussion and consultation, opportunity to thank these organisations and provides an outline of the common for the assistance they have provided and, approach market participants expect to in particular, the EMI for kindly providing a take on numerous detailed operational foreword to this book. Also, thanks are issues. due to the many other market associations with whom we have co-operated on EMU • The annexes to this book reproduce issues. key EMU source material that market participants need to prepare for the Finally, I would like to note the important transition, including copies of relevant contributions made by ISDA's staff and EU and New York legislation and consultants to our EMU work. In information on price sources, bond particular, special thanks go to Jeffrey redenomination, harmonised market Golden, Edward Murray, Richard Tredgett conventions and other matters. and the other members of the Allen & Overy team and to Angela Papesch and, in • Lastly, the guidebook includes a user- particular, Matthew Elderfield of ISDA's friendly glossary and a reference to European Office. other important EMU sources. While our work on EMU is continuing, I These achievements were only possible believe that this guide provides an because of the major contribution made excellent reference for ISDA members and by ISDA members. I am therefore very other market participants, as each of you grateful to all those individuals who prepare for a single currency for Europe.