ISDA PRESS REPORT - TUESDAY, NOVEMBER 28, 2000

* Uneven Progress
* German Derivatives Legislation: A Need For Change Now
* Rate Derivatives Is Top Performer
* Capital Concerns
* Enron To Expand Weather Derivatives Cover

Uneven Progress
Asia Risk - November 2000
By Quentin Hills

The derivatives markets across Asia continue to develop in terms of maturity
and complexity.  However, as has been the case over the past five years,
this development has been neither homogeneous or consistent. Before
considering the future landscape, it is worth reviewing the various phases
of the market during the last few years.

During the early to mid 1990s, the main activity comprised currency and
interest rate transactions in the major currencies. The market was dominated
by a handful of foreign financial institutions, while local currency
business was limited and activity was for the most part evenly distributed
throughout the region. The regulatory environment was mixed and generally
not well defined or comprehensive.  Increasingly during this period, the
transactions became more speculative (in line with global trends)and the
inevitable occurred in the first quarter of 1994. As interest rates quickly
reversed (de, rose) in February 1994, there were several well-publicised
losses both in the region and globally. There were quick and adverse
consequences on the derivatives markets.

Activity abruptly slowed, speculative transactions ceased and financial
institutions that had been active pulled back - at least temporarily.
Globally, the focus turned towards discipline and control and there was a
flurry of new derivatives guidelines and regulations. Asian regulators
responded with new guidelines, which largely followed international
practice. During this period the industry, represented by the International
Swaps and Derivatives Association and regulators from all countries,
developed strong relationships.  These relationships continue to this day
and result in increasing industry comments during the drafting of new
regulations.

As derivatives markets began to recover, players returned and new entrants
emerged, local currency markets developed strongly and end-users focused on
risk management processes.  Nevertheless, despite the lack of highly
leveraged    structures, companies throughout the region continued to fund
long-term local currency investments with shorter term foreign currency
("cheaper") liabilities, both in the cash markets and synthetic derivatives.
When the Asian Crisis struck, the impact was severe and the toll heavy.
Apart from deals being unwound, activity ceased and liquidity disappeared.

Since the crisis, derivatives markets have recovered with a marked increase
in activity (although not to pre-crisis levels), the return of market makers
and the introduction of new products, such as credit derivatives.

Going forward, the market seems poised to resume strong growth as Asia
emerges from this difficult period.

Breadth and depth of participants

A consequence of the crisis was a sharp and significant fall in counterparty
creditworthiness across the region and the withdrawal of many market makers.
This was particularly acute during the height of the crisis, but is
reversing as foreign banks once again become more active and local banks
build their derivatives capabilities. Corporate credit quality is slowly
improving and a recent trend has been the increasing use of derivatives by
financial institutions - particularly local banks and fund managers. This is
expected to continue as more active portfolio management leads to a focus on
yield enhancement and credit risk management.

Additionally, there has been an ongoing mend among end-users of markedly
improved understanding and use of derivatives in risk management. Also
noticeable is the broader application of new products. For example, local
financial institutions are using credit derivatives to manage balance sheet
risk strategically, both for liabilities and assets. This reflects the
efficiencies available through the correct use of derivatives and increasing
sophistication of end-users.

Domestic bond markets

The emergence of domestic bond markets is having a positive impact on market
development, both directly and indirectly. There is a direct impact where
bond issues are swapped into a different currency (in the case of foreign
issuers accessing a market), or interest rate (where issuers wish to alter
the interest rate basis).  Additionally, the increased availability of
instruments in the market and greater demand for product from investors is
leading to new local currency products, such as options on domestic interest
rates and securities.

Regulatory convergence

Finally, derivatives regulation in the region has generally been somewhat
mixed, with some countries adopting a prescriptive approach and others a
risk-based approach. Prior to the Asian Crisis, there was a trend towards
convergence and harmonization with respect to regulation. During the crisis,
however, new  regulatory initiatives were put on hold as countries managed
larger and more pressing issues.

The response to the economic turmoil elicited different responses concerning
currency convertibility. Naturally, where currency controls were imposed
either in part or in full, there was a direct adverse impact on the local
derivatives market. However, in those countries where the response has been
to keep markets open, or even to restructure the local financial markets,
derivatives usage has rebounded quickly. This in turn requires further
regulatory consideration, which has generally been in line with
international standards. Going forward, it is reasonable to expect a mend
towards regulatory harmonization and increasing adoption of international
regulatory standards.

The derivatives markets in Asia have undergone dramatic changes over the
last few years. The markets themselves are far from homogeneous and
significant progress has been made from a low base. There has been continual
progress as the number of users increases, more products become available
and regulations put in place to allow healthy market development.
Development has not been uniform across the region, nor has it been
consistent over time as evidenced by the setbacks brought about by the Asian
Crisis. Nevertheless, the derivatives markets in Asia will continue to
develop and mature as end-users grow in number and sophistication, while the
range of products continues to expand.

German Derivatives Legislation: A Need For Change Now
Derivatives Week - November 26, 2000

In a global economy it is essential that each country establish a
transparent and efficient regulatory system for financial products. To
ensure market stability, governments must also instill a high degree of
confidence m the legal system. In   relation to over-the-counter derivatives
transactions, these goals have not yet been fully achieved in Germany. But
with the forthcoming Fourth Financial Markets Enhancement Act
(4.Finanzmarktf~rderungsgesetz) there might be light at the end of the
tunnel. In this context, it makes sense to look at a much-needed change in
the legal regulation of the so called Borsentermingeschaft.

ENFORCEABILITY
Generally, a party to a derivatives contract under German law could attempt
to challenge the validity of the agreement by raising a statutory defense:
the gaming or betting defense (sec. 762 of the Civil Code, Burgerliches
Gesetzbuch), the margin defense (sec. 764 of the Civil Code), or the futures
defense (sec. 52 of the Exchange Act, Borsengesetz).  However, there are two
ways to possibly avoid the threat of such defenses: (i) the contract in
question could qualify as a hedging transaction, or (ii) as a so called
exchange traded futures agreement (Borsentermingeschaft).

HEDGING
Under the hedging exception, a derivatives transaction is valid,
enforceable, and not subject to the gaming, betting or margin defense either
if it constitutes a hedge for both parties or if the transaction is a hedge
for one party and if this party believes, without negligence, that the
transaction constitutes a hedge for the other party as well. The term hedge
in this context covers micro-hedging strategies. Whether this exception is
also true with respect to macro-hedging strategies is not entirely dear.
Modern legal authors tend not to use the term "hedging exception" anymore,
but more broadly refer to economically justified transactions.

BORSENTERMINGESCHAFTE
According to the Exchange Act (sec. 53 pare. 1) Borsentermingeschafte are
binding on both parties if each
party is a merchant, and is either registered or not subject to registration
because he/it is a foreign resident or a public law  entity, or a
professional (defined as a person who, at the time of the transaction or
prior thereto, traded in futures commercially or professionally, or is
permanently admitted to engage in exchange-trading).

If only one party qualifies under the relevant provision of the Exchange
Act, a futures transaction is enforceable only if one party is subject to
statutory banking or exchange supervision, be it in Germany or abroad, and
informs the other party in writing of the risks inherent in the derivatives
transactions in question
(standardized information papers which, pursuant to German Supreme Court
(Bundesterichtshof ) case law, satisfy the requirements under the Exchange
Act and were created by the industry federations of the German banks). This
technique of entering a valid agreement is commonly referred to as the
"information model" and is subject to strict and ongoing form requirements.

In addition, the transaction in question must qualify as a
Borsentermingeschaft. Unfortunately, this term has never been statutorily
defined, but is intended to cover new types of transactions and has, thus,
to be interpreted in a broad sense.  Moreover, the Exchange Act was amended
in 1989 to extend the privilege of its sec. 53 to transactions with a
similar financial purpose as exchange-traded futures transactions.
Therefore, today most types of financial, commodity, energy and credit
derivatives, whether stock exchange traded or OTC products, are generally
eligible for falling under sec. 53 of the Exchange Act. Despite the vast
amount of case law (almost exclusively in the context of warrants) on this
matter, there is still some uncertainty as to whether certain OTC
derivatives qualify as Borsenter7ningeschdffe within the meaning of this
provision.

RELIEF: THE FOURTH FINANCIAL MARKETS ENHANCEMENT ACT
It is, however, widely expected-or at least hoped - that the forthcoming
Fourth Financial Markets  Enhancement Act will include the introduction of a
statutory definition of Borsentermingeschafte.
A legislative initiative to define Borsentermingeschafte in concrete terms
would be helpful, not least because the German Supreme Court seems in its
more recent judgments to have entirely given up the attempt to bring such
transactions within its own traditional definition attempts and now lays
emphasis only on the financial purpose necessary for qualification as a
Borsentermingeschafte.

The term also requires clarification in light of recent amendments to the
Securities Trading Act (Wertpapierhandelsgesetz) and the Banking Act
(Kreditwesengesetz), implementing into German law the EC Investment Services
Directive (ISD) and the EC Capital Adequacy Directive (CAD), which
introduced the distinguishable supervisory law term "derivative," narrowly
defined, into the two acts.

The term "Borsentermingeschaft" is not used internationally - it is specific
to Germany. Its conceptual scope is controvasial3 and the continuous
development of new types of transactions requires a provision which is as
comprehensive as possible. For this reason, it makes sense to find a legal
definition which includes existing derivatives and can accommodate new
developments.

Moreover, the essential point of a derivative is the dependence of its price
upon the development of its underlying(s). Securities,  money-market
instruments, currencies, units of account, interest rates or other yields as
well as commodities, power, and precious metals may all be assets underlying
derivatives transactions as defined in, for example, the Securities Trading
Act and the Banking Act. In addition, the inclusion of other underlyings
such as credit events, weather developments, traffic flows and environmental
emissions would be desirable in order to ensure that here too validity
defenses are essentially eliminated.

A broad definition of a Borsentermingeschafte would remedy the existing lack
of public confidence in the law - especially with regard to future
developments-and thus would enhance the status of Finanzplatz Deutschland.
The German banking associations and the International Swaps and Derivatives
Association should be supported by all market participants in air attempts
to convince the German legislator to make a broad definition of
Borsentermingeschafte a reality as soon as possible.

Rate Derivatives Is Top Performer
Australian Financial Review - November 28, 2000
By Bill McConnell

An explosion in the use of interest rate derivatives, particularly forward
rate agreements and swaps has been the standout feature of Australian
financial markets this year alongside strong growth in non-government debt
securities.

However, a slump in foreign exchange transactions resulted in an overall
decline in total financial markets turnover.

The Australian Financial Markets Association, in conjunction with the
Securities Industry Research Centre of Asia-Pacific  released the results of
its annual report on trading in  Australian financial instruments yesterday.
The report detailed statistical results of Australian over-the-counter, and
exchange traded market activity.

Traded contracts in Australian financial instruments totaled $38.3 trillion
with the bulk of trading taking place on over-the-counter markets which
contributed 72 per cent of total market turnover.

The two markets to show substantial declines in trading activity were
foreign exchange and options on futures, with yearly volumes down 16.7 per
cent in FX markets and 26.1 per cent in SFE traded options. The fall in
activity in currency trading the first since 1994-95 led to an overall
decline in market turnover of 1.5 per cent.

The total turnover on the Australian Stock Exchange options and direct
equities was $466 billion, or a little over 1 percent of total market
volume. But the meager contribution provided by equity markets masked an
impressive 28 per cent increase on volumes from levels last year, and a 14
per cent increase in exchange traded options.

Market capitalisation in the Australian sharemarket also increased by 20 per
cent to $682 billion.

The report identified not only a growth in share trading, but also a
changing investor profile.

``This growth in investor participation in the market does not mean larger
volumes. It also means there is a growing number of more experienced
investors, seeking a broader range of investment products. In addition, the
growth in superannuation funds in Australia is placing greater demand on
investment                  products. The challenge for exchanges is to meet
these growing demands.''

But the top performer in Australian financial markets this year was interest
rate derivatives . Use of forward rate agreements more than doubled during
the year to $1 trillion making it the fastest growing market segment for the
year.  Non-government debt securities, repurchase agreements and swaps
experienced growth in turnover between 36 and 50 percent.

Swap turnover has increased every year since data was first collected in
1992-93.

``Turnover in swap markets has increased each year for four years, and that
has been happening irrelevant of economic circumstances,'' said Mr. Gordon
Axford, chairman of the Swaps Committee.

``This has been a function of greater use of capital markets, and an
increased borrowing requirement by the corporate sector requiring the use of
swaps to hedge exposure.''

Mr. Ken Farrow, chief executive officer of AFMA, said it had been ``an
astonishing turnaround'' by interest rate markets after FRA markets appeared
to be in decline in 1994.

``The interest rate market was more volatile this year than last and that
means there was greater underlying customer demand for interest rate
hedging,'' said Mr. Farrow.

Trading in government debt securities fell for the fourth consecutive year,
and while the traded volumes fell by only 1.1 per cent, the trend suggests a
creeping supply gap between government and corporate markets.

``Corporate issuance has really come into its own,'' said Mr. Phil Coates,
AFMA debt capital markets committee chairman.

``The market has advanced considerably. People are very much in tune with
what is on offer and we have seen the expansion of the corporate floating
rate note market.''

But Mr. Brad Scott, vice-president, head of fixed income credit research at
Salomon Smith Barney, said while the corporate bond market was of equal size
to the semi-government sector, the liquidity of the government bond market
still far outstripped the corporate market by a factor of more than three.

``As funds inflow continues to outstrip demand, deal sizes particularly in
the triple B land will need to continue to increase to attract offshore
demand and encourage broad-based turnover growth.

``Similarly, greater issue diversity and liquidity provided by global credit
markets will continue to attract more interest from funds who have money to
place and can't wait for the market to grow.''

KEY POINTS

* Australian financial markets' turnover was $38.3 trillion for the
year.
* Turnover in forward rate agreements increased by 101 percent, the
fastest growing market segment.
* Foreign exchange trading fell 16.7 per cent, the first fall since
1994.
* Trading in government debt securities fell for the fourth
consecutive year, down 1 per cent.

Capital Concerns
Risk - November 2000
By Oliver Bennett

There are plenty of people who believed it would or should - never happen.
But early next year, regulators are expected to announce a tier one capital
charge for operational risk.  Bankers who have worked closely with the Basle
Committee on Banking Supervision say it is likely to recommend three
different options for banking supervisors: basic indicators (that is, a
single proxy for the entire bank, such as trading volumes); a business line
approach using Committee-imposed capital ratio; or thirdly, internal
measurement using a bank's own loss data within a supervisory specified
framework. The implication is that further and more detailed work on the
internal measurement approach may result an the development of appropriate
models and a fourth regulatory option, based on internal modelling.

There has been intense criticism from banks about an operational risk
capital charge through industry groups such as the International Swaps and
Derivatives Association (ISDA) and the British Bankers Association (BBA).
However, the Committee's consistent position on a capital charge for "other
risks" is encouraging initiatives to develop methodologies and coiled data
related to managing operational risk. Standardisation is some way off,
although there is growing industry agreement on a core operational risk
definition, the collection and sharing of internal loss data and the
importance of qualitative criteria.

The proposal took banks by surprise the absence of a standard methodology
led to fears of an arbitrary operational risk charge, supplementary to
existing capital charges for credit and market risk, based on size and
volume. Allen Wheat, chief executive officer and chairman of Credit Suisse
First Boston, speaking at Risk's annual European congress in Paris last
April, described the proposal for an operational risk capital charge as "the
dopiest thing I've ever seen".  Other leading banks like JP Morgan also
expressed concern that an operational risk capital charge was premature when
the industry had not come to an agreement on how important the issue was, or
how to measure it.  A rule-of-thumb measurement would not accurately reflect
different levels of risk in various banks and could result in overcharging
some banks for risk and undercharging others. Similarly, operational risk
capital charges could penalise banks competing against non-banking
organisations not subject to the charge.

The principal message to regulators is that larger banks with good
operational risk measurement and management should achieve lower capital
charges. However, without a standardised methodology, proposed operational
risk capital charge criteria need to be progressive, flexible and include a
risk-based option. Joseph Sabitini, managing director in the corporate risk
management group at JP Morgan in New York, recognises that a new regulatory
framework for operational risk must accommodate banks at all levels of
sophistication in terms of risk measurement and management, but that it also
includes a risk-based option for "those with the appropriate capability".
Sabitini, who has been working closely with the Risk Management Group of the
Committee, goes on to say that to avoid the shortcomings of the previous
Accord, the capital rules must also be transparent, uniform and consistency
applied.

A recent report by Meridien Research, the Massachusetts-based technology and
advisory service, concludes that in two to three years only one-third of
financial institutions will have the technology to measure and manage their
operational risks.  The report examines how financial institutions measure
up in a four-stage progression of addressing and implementing an operational
risk management strategy. In  the first stage, firms concentrate on the
identification of key risk Indicators and data collection. Stage two
involves developing metrics and tracking for the identified risks from stage
one. Stages three and four move on to using technology for the measurement
and management of those risks within a firm. The report gods on to say that
most firms are working in stages one and two of the operational risk
management process.

With the regulatory option to focus on specific business lines such as
investment banking, retail banking or asset management, banks are
concentrating on internal definitions and management strategies. But how are
they preparing for a capital charge? For most banks this includes
loss-gathering initiatives, key indicator information, risk assessment and
in some cases calculation However, unlike market risk and credit risk, a
purely quantitative approach to measure operational risk is not the current
focus.  Chris Rachlin, head of group operational risk at Royal Bank of
Scotland (RBS), details the main initiatives his group have been focusing
on: "We have been identifying and implementing tools and techniques to help
our businesses identify, manage and monitor operational risks better. As
part of this we have been collecting data on loss
events. We have also looked at a number of quantification techniques, but
believe their effectiveness will depend on the quality and quantity of the
data available."

The current challenge is to find a way around the lack of data on big loss
experiences. Due to the rarity of these large losses, banks lack extensive
data on operational catastrophes such as Nick Leeson-style fraud or a
complete systems breakdown. According to Tony Peccia, vice-president in the
operational risk management division at CIBC World Markets in Toronto, most
banks would want to be at the internal measurement stage of the proposed
capital charge when implemented - which is dependent on internal data. This
has led to the establishment of a number of operational loss databases - in
particular,
introduction consortia of internal loss data-bases. The two principal
consortia are the Multinational Operational Risk Exchange managed by
NetRisk, and the Global Operational Loss Database (Gold), managed by the
BBA, which both provide a mechanism to share loss data in a secure
environment. The consortium members supply operational loss data, business
and risk characteristics to the managing agents.  The data is sanitised,
secured and scaled then returned to the consortium members As well as
assisting banks to manage their operational risks, the data can be used to
compare their performance against their competitors and highlight vulnerable
areas.  The More consortium has agreed to begin sharing data from November 1
2000 and receive the first batch of scrubbed, anonymous data by the end of
the year.

There are a number of concerns regarding data standards. According to
Richard Metcalfe, ISDA Assistant Director of European Policy: "There is
concern that, while the proposed Basle Committee rules incentivise data
gathering, that is not the only issued if banks record their losses in
general categories when submitting internal data but do not associate losses
with enough contextual information, it we be difficult to understand the
finer gradations of risk later on - or indeed to reclassify the database to
an agreed industry or regulatory
standard. Matt Kimber, a director with Arthur Andersen's financial practice,
welcomes initiatives to collect internal loss data to increase the breadth
of information available.  However, he goes on to say that users of the
information "will have to be mindful of the parameters as to how the
information is "gathered and prepared." Similar criticisms are also levelled
at publicly disclosed external loss databases, where issues of caring and
cleansing must be considered.

Last month, ISDA issued a discussion paper, Operational Risk Regulatory
Approach Discussion, on operational risk capital charges.  The paper
highlights concerns that a purely quantitative approach could enable
institutions with poor operational risk management processes and controls,
but with access to internal loss event data, to achieve a lower capital
charge that institutions with stronger risk management processes but no
access to internal loss event data. The paper also highlights fears over the
method of calculation of operational risk capital for an institution that
has recently experienced serious loss, but
where management has reacted and strengthened the control environment in
that area, and consequently reduced the likelihood of reoccurrence.

The paper, produced with the active support of over 20 ISDA member firms and
facilitated by PriceWaterhouseCoopers, sets out a series of structured and
transparent qualitative assessment criteria - with particular reference to
quantitative criteria - to complement the operational risk data requirements
currency proposed by regulators. The paper argues blat there is strong
support in the industry for a regulatory capital assessment model that
allows institutions managing operational risk to effectively access a more
precise means of Calculating an operational risk capital charge -
institutions should benefit from more sophisticated controls and the
regulatory regime should establish incentives to improve risk management and
controls.  This is consistent with proposed quantative techniques once
internal loss data is
incorporated into the operational risk capital charge calculation, as any
institution with an effective control environment would normally expect to
have a lower loss experience, and thus a lower capital charge.

According to Arthur Andersen's Kimber, there is another option - insurance.
"Insurance and risk transfer will become an important and sophisticated
component in an operational risk manager's tool-box over the next few years.
"There are definitely challenges for insurance providers in offering
operational risk cover, but there has been some recent headway in the last
year or two" In fact, regulators have made it clear that, in principle,
mechanisms such as insurance might be an acceptable way for banks to
mitigate risk and reduce their capital charges. Depending on the stance of
regulators, the Committee might insist that policies that mitigate the
capital charge pay out immediately after any operational disaster, or that
these polices only cover certain classes of operational risk. It may also
stipulate a specified credit rating of the insurance company, or the
percentage of risk that the primary insurer can sell into the wider
insurance market.

Possibly the most well-known operational risk insurance product is Swiss
Re's Financial Institutions Operational Risk Insurance (Fiord). With
Fidelity Investments as the first client for the re-insurance firm's
product, it is designed for the top 400 financial institutions in the world.
FIORI would have covered most of the devastating losses that have hit the
headlines over the last few years - 68% of them according to the insurer's
own analysis.  Lars Schmidt-Ott, head of global banking practice at Swiss Re
New Markets, sees insurance as a good alternative to capital charges.
"Holding Capital on the balance sheet is not good for shareholder value - if
you can keep it off the balance sheet at an efficient price you only pay the
downside premium."

But according to RBS's Rachlin, there are a number of problems with the
insurance option - principally the speed of payment and potential lack of
capacity for meaningful levels of rover from financially secure insurers.
Although some products on the market will provide immediate liquidity to a
bank following a disaster, there may be certain arguments after the event.
Policies with catastrophe levels of cover would also need to be scheduled or
layered, and it is not always possible to secure acceptance for finely
worded polices from differed underwriters.  Rachlin also highlights
reputational issues: "While insurance may cover the short-term financial
impact for some events the longer term reputation impact can be of greater
concern."  Although Schmidt-Ott does not agree that there are any
reputational issues using insurance products, he recognises that it may be
some time before gaining relief from operational risk charges becomes a real
incentive to take out insurance.  "Insurance will play a role as an
instrument for managing operational risk, but not in its current form....we
are waiting for the regulators."

Insurance aside, the Basle Committee's capital charge announcement for
operational risk is not eagerly awaited.  If the regulators make their
announcements in the first quarter of 2001 they probably would not become
effective until at least 2002.  Depending on the flexibility of the
proposals, research into internal modelling approaches to operational risk
is likely to intensify.  Victor Dowd, an associate involved with operational
risk capital charge discussion at the UK's Financial Services Authority
agrees that further and more detailed work on the internal measurement
approach may result in the development of appropriate models.  However, for
the present, he says," modelling is not an option" for the regulators to
consider.

Enron To Expand Weather Derivatives Cover
Derivatives Week - November 27, 2000

Enron Europe is set to start quoting weather derivatives on an additional 15
cities in Europe in the next two weeks. Thor Lien, v.p. and head of weather
risk management-Europe in Oslo, said Enron is adding the cities in the U.K.,
the Netherlands, Germany and France. Enron has since the beginning of the
year been offering weather coverage via its website (www.enrononline.com)
and voice brokers on London, Paris, Oslo and Stockholm, as well as some U.S
and Asian cities.

Lien predicts the European weather derivatives market will double in size to
approximately EURO-8 billion (USD5.1-6.8 billion) (total outstanding
notional) within a year. Fund managers and risk managers are growing more
interested in the product as liquidity and transparency increase. Although
customers will also be able to trade weather derivatives through Enron's
voice brokers, the company is putting the contracts on its web site to
entice players worldwide and increase liquidity, Lien said.



End of ISDA Press Report for Tuesday, November 28, 2000.

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