ISDA Year in Review

LETTER FROM THE EXECUTIVE DIRECTOR

BOARD OF DIRECTORS ISDA ACTIVITIES INDUSTRY INFRASTRUCTURE COMMITTEES COLLATERAL DOCUMENTATION OPERATIONS DERIVATIVE USERS COMMITTEE FINANCIAL PRODUCTS MARKUP LANGUAGE PRODUCT COMMITTEES CREDIT DERIVATIVES ENERGY, COMMODITIES & DEVELOPING PRODUCTS EQUITY DERIVATIVES STRUCTURED PRODUCTS	OVERSIGHT & SUPERVISION COMMITTEES INTERNATIONAL ACCOUNTING NORTH AMERICAN ACCOUNTING TAX EUROPEAN REGULATORY NORTH AMERICAN REGULATORY RISK MANAGEMENT REGIONAL COMMITTEES ASIA-PACIFIC CENTRAL & EASTERN EUROPE / ISLAMIC FINANCE CANADA / LATIN AMERICA JAPAN RESEARCH & EDUCATION MEMBERSHIP CONFERENCES RISK MANAGEMENT SEMINARS

LETTER FROM THE EXECUTIVE DIRECTOR

Dear ISDA Member:

The privately negotiated derivatives industry continues to be the most dynamic, innovative and fastest-growing sector of the financial markets – and ISDA continues to play an important, leading role in its growth, evolution and success.

Today, ISDA ranks as the world’s largest global financial trade association, with 780 members headquartered in 54 countries on six continents. Over 100 firms joined ISDA in 2006 alone. Our members include the world’s major financial institutions, as well as many businesses, investment firms, governmental entities and other end users who rely on OTC derivatives to manage the financial market risks inherent to their core economic activities. ISDA’s mission is to foster the prudent and efficient development of our business, and our accomplishments and activities during 2006 speak to the energy and focus we bring to this work. In the following pages, I’m pleased to highlight for you key developments over the past year.

Credit Derivatives
As ISDA’s Mid-Year Market Survey highlighted, credit derivatives represent the fastest growing segment of the OTC derivatives industry, with notional outstanding growing in just six months by 52% to $26.0 trillion at June 30th.

In 2006, ISDA reinforced its commitment to improving operational efficiencies within the credit derivatives arena. More than 260 of the world’s major derivatives dealers and organizations have signed on to ISDA’s Novation Protocol II. Improvements introduced by the 2005 Novation Protocol and the current protocol have been instrumental in significantly reducing the backlog of outstanding credit derivatives confirmations, which decreased 94% from September 2005.

Along with the Protocol, our highly successful CDS protocols, created for the Calpine, Dana and Dura bankruptcies, effectively facilitate cash settlement of credit derivatives and continue the important work of streamlining operational efficiencies. The 2006 Dura Protocol is our first protocol to permit the cash settlement of single-name, index, tranche and other credit derivatives transactions. Previous ad hoc protocols only enabled cash settlement of index trades.

Additionally, ISDA published a series of credit derivative templates, including one detailing a recovery lock credit default swap that permits market participants to take a view on where debt of a defaulting Reference Entity will trade.

To increase efficiency, reduce risk and support the growth of the synthetic asset backed securities industry, ISDA undertook a number of initiatives. We published two revised versions of the CDS on ABS Cash or Physical template originally published in 2005, adding a variant to permit an alternative total return swap valuation mechanic.

We also published a CDS on CDO template to facilitate trading in cash flow CDOs. We anticipate developing a Standard Terms Supplement approach for CMBS, RMBS, CDO and other asset categories in order for confirmations to be more streamlined in their execution through DTCC and other services.

As leveraged loans are estimated to be one-third of the U.S. syndicated loan market, we anticipate that our Syndicated Secured Loan Only CDS template will contribute to greater liquidity in this product. The template is designed to permit investors to take short or long credit positions or a combination of those strategies.

Documentation and Netting
In addition to our work in credit derivatives, we had another productive year in the area of documentation, publishing a number of important documents relating to other sectors of the privately negotiated derivatives industry.

To accommodate the rapid growth of derivatives transactions linked to interests in various types of pooled investment vehicles, such as hedge funds and mutual funds, ISDA published the 2006 ISDA Fund Derivatives Definitions. And to facilitate the documentation of inflation derivatives transactions under the ISDA Master Agreement, we published the 2006 ISDA Inflation Derivatives Definitions, which were translated into French for educational purposes.

While ISDA generally seeks to establish one global approach on certain key provisions, regional trading and hedging strategies must also be considered. In the U.S., ISDA revised the 2004 Americas Interdealer Master Equity Derivatives Confirmation Agreement to include forward starting variance swaps. In Europe, we continued to work on the 2006 European Variance Swap Master Confirmation Agreement for use among various types of counterparties that are not solely in the interdealer market.

In the energy area, we published two new versions of the EU Emissions Allowance Transaction document intended for use in privately negotiated, physically settled transactions in European Union emissions allowances. These two documents are part of our effort to harmonize documentation approaches with other associations.

In 2006, ISDA also completed the Convertible Asset Swap Transaction template and the Convertible Asset Option Transaction template for use in interdealer convertible asset swap and option transactions.

During the year, the Association continued to expand the number of jurisdictions in which legal opinions on the enforceability of netting provisions of the ISDA Master Agreements are obtained. This year, we published new netting opinions for Malta and Slovakia. In addition, the Association recently commissioned new netting opinions for Israel and Anguilla. In addition, we published a revised original collateral opinion for Taiwan and are also finalizing a new Hungarian collateral opinion.

Operations & Technology
The results of this year’s Operations Benchmarking Survey were of particular interest because of increased attention to operational issues from the industry and policy makers.

Confirmation backlogs, as mentioned, decreased significantly for credit derivatives, reflecting the increased industry and regulatory attention. Given the current focus on credit default swap backlogs, next year’s results should reflect further improvement.

The September 2006 Federal Reserve Bank of New York meeting expanded the industry focus to equity derivatives. ISDA has been at the center of providing solutions to the issues addressed at that meeting.

We continued enhancements to our FpML standard this year, publishing a Trial Recommendation for version 4.2. This new version includes enhancements in several asset classes, including buy-side specific requirements. ISDA expanded the coverage of credit derivatives by adding CDS baskets and support for index tranches. The most significant addition is in the area of business processes with the introduction of Cash Flow Matching coverage.

To facilitate the use and adoption of FpML 4, we also published the 2006 Edition User’s Guide, which provides guidance about how FpML may be used to address the application needs of derivative market participants.

In June, ISDA and SWIFT announced a collaboration to increase operational efficiency in the rapidly growing privately negotiated derivatives market. This partnership will leverage the benefits of the Financial products Markup Language (FpML) standard and the SWIFT network by transporting FpML messaging over SWIFTNet. The collaboration will further expand the use of FpML, particularly by end-users of derivatives.

Derivatives Users Committee
The ISDA Derivatives Users Committee was formed in 2006. The mission of the committee is to provide a forum for non-dealer firms, represented by the ISDA subscriber membership category that are active in privately negotiated derivatives as clients, investment managers or managed funds.

The Derivatives Users Committee is a means to provide input and stay updated on the work done in various other groups and to identify and deal with user-specific issues where appropriate.

Collateral
The use of collateral in privately negotiated derivatives transactions and related margined activities continued to grow significantly in 2006. ISDA’s Margin Survey estimated that the amount of collateral in circulation was $1.33 trillion, which highlighted a 10% increase over the collateral reported in 2005. Respondents to the Margin Survey reported over 109,733 collateral agreements in place, compared with 70,892 in the 2005 Survey.

In the area of collateral law reform, ISDA submitted comments to the European Commission regarding the current evaluation of the implementation of the EU Collateral Directive. Our remarks focused on the widening of the scope of eligible counterparties, the types of eligible collateral and the expansion of the benefits of closeout netting.

ISDA has been involved in the drafting process of the Hague Securities Convention since its onset. The Convention provides conflict of law rules regarding the law applicable to intermediated securities held as collateral. In the meantime, both Switzerland and the US have signed this Convention. The EU and its member states plus Japan and Latin American countries are currently discussing when to sign this Convention as well. The US is expected to proceed to ratification by the Senate in 2007.

Risk Management
In 2006, ISDA participated in extensive discussions with various trade associations on risk management practices. For example, ISDA, the British Bankers’ Association and the London Investment Banking Association jointly submitted comments to the UK FSA on the consultation paper and draft rulebook implementing the Capital Requirements Directive in the UK. The FSA adopted a copy-out approach to reduce the scope for divergence of interpretation between the UK regulations and the Directive and to encourage consistency of implementation across EU jurisdictions. We also published a joint trade association report on concentration risk and the management of large exposures.

ISDA continued its work with the Basel Committee’s Accord Implementation Group on the roll out of the Internal Ratings-Based “use test,” designed to support banks and supervisors in their interpretation of the Basel II framework.

We also teamed up with the International Association of Credit Portfolio Managers to publish a credit capital model study that advises regulators to consider an internal models-based approach for the calculation of regulatory capital.

Public Policy
Throughout the year, ISDA was involved in a broad range of public policy issues that affect privately negotiated 7 derivatives. Our actions continued to strengthen our mission to encourage the prudent and efficient development of the OTC derivatives business.

ISDA engaged in a detailed critique of recent UK FSA proposals on Best Execution requirements, particularly as they pertain to dealer markets. Working with other interested trade associations, we submitted a thorough response to a discussion paper that sought to open a debate on the best implementation of the high-level requirements contained in Article 21 of the Market in Financial Instruments Directive. The MiFID is due to take effect in November 2007. ISDA also attended a FSA workshop designed primarily to allow firms to give evidence of why they oppose the benchmarking proposals for dealer markets contained in another FSA discussion paper.

ISDA believes that when there is no market failure, a “best-price” mechanism such as benchmarking will not only prove to be expensive, but will potentially have adverse effects on liquidity in the risk management markets that are essential to the financial markets and the wider economy.

Accounting
ISDA expressed its concerns to the International Accounting Standards Board (IASB) about possible delays to the Fair Value Measurement project and the possibility for divergence between U.S. GAAP and IAS 39. The IASB recently announced that there would be no new major standards effective before 2009, which reverses IASB’s 2005 decision.

In addition, the U.S. Financial Accounting Standard’s Board (FASB) published FAS 157, which addresses how companies could measure fair value under U.S. GAAP. Progress has also been made in Europe on the issue of “equivalency” of non-EU GAAPs under the new Transparency and Prospectus Directives.

In 2006, ISDA and the Bond Market Association (TBMA, now SIFMA) commented on the Government Accounting Standards Board’s (GASB’s) preliminary views on accounting and disclosure of derivatives and hedging activities by governmental entities. We highlighted the importance of issuing standards that improve the usefulness of financial reports, as well as the need to balance costs with the benefits of new standards.

Emerging Markets
During the year, ISDA utilized the 2006 Model Netting Act in a number of jurisdictions to encourage insolvency law reform. The new Act incorporates many of the recent improvements in insolvency law from various jurisdictions globally, including the United States.

The Act is designed to be a legislative aid to assist jurisdictions interested in developing their own revised insolvency laws, such as Anguilla, Argentina, Costa Rica, Chile, the Marshall Islands, Mauritius, Peru and Russia. In addition to these efforts, our Central & Eastern Europe Committee met in late September to discuss the legal landscape for OTC derivatives transactions in Kazakhstan. ISDA and the International Islamic Financial Market also signed a memorandum of understanding as a basis for developing a master agreement to document privately negotiated Shariah compliant derivatives transactions.

Asia-Pacific
As the transaction volumes in the privately negotiated derivatives market in China continue to increase, ISDA remains committed to working with public policymakers and market practitioners to further encourage the efficient development of the business in the region. We published a Chinese/English language glossary of commonly used terms in the collateral market to assist dialogue and educational efforts with new counterparties based in the region. ISDA also met with several Chinese regulatory authorities this year.

A meeting with the People’s Bank of China focused primarily on strengthening the support for close-out netting. At a meeting with representatives of the China Banking Regulatory Commission and the Chinese Securities Regulatory Commission, we discussed the possible impact of the new bankruptcy legislation in China.

To better address the specific needs and market practices of the Asia-Pacific region, ISDA’s Asia (ex-Japan) Variance Working Group is in the process of drafting the 2006 AEJ Master Variance Swap Confirmation Agreement to supplement the 2005 AEJ Interdealer Master Equity Derivatives Confirmation Agreement.

ISDA provided input to Malaysian authorities on how to remedy some of the constraints on closeout netting caused by the Malaysia Deposit Insurance Corporations Act 2005 and the Pengurusan Danaharta Nasional Berhad Act 1998.

In India, legislation was enacted that will strengthen certain aspects related to the enforceability of close-out netting.

Japan
Following months of dialogue with the Financial Services Agency of Japan (JFSA) about Japan’s Basel II Implementation Plan, the JFSA published the official guidelines for Basel II implementation. In 2006, we also published the Japan Interdealer Master Variance Swap Confirmation Agreement, which facilitates the trading of Japanese index variances. Currently ISDA is engaged in reviewing regulations under the Japanese Financial Instruments and Exchange Law.

Conferences
2006 was another impressive year for ISDA conferences. Our Annual General Meeting in Singapore, which featured key public policy and industry figures from Asia-Pacific and around the globe, was well attended. We hope to have the same turnout at our 2007 AGM in Boston, Massachusetts in April. In addition, ISDA continued to enjoy a strong turnout at our 2006 Regional Member Conferences in London, New York, Sydney and Tokyo. In all, we held 82 conferences, symposiums and training courses throughout 2006 on subjects that ranged from risk management and new types and uses of derivatives to the latest developments across the industry.

New staff
Throughout 2006, we added new members to our team. Their leadership and expertise has strengthened ISDA’s mission to encourage the prudent and efficient development of our business. At our AGM in March, we welcomed Gregory Zerzan as our new Counsel and Head of Global Public Policy. Mr. Zerzan, who now also chairs ISDA’s U.S. Regulatory Committee, is based in our Washington D.C. office and directs ISDA’s public policy strategies and initiatives on a global basis.

Later in the year, David Geen joined ISDA as European General Counsel. Mr. Geen, who will be based in our London office, will play a key role in a wide range of ISDA’s global legal and documentation activities.

Looking Ahead
ISDA’s growth reflects the strong dynamics of the privately negotiated derivatives business and our impact in encouraging the prudent and efficient development of that business. As we move into 2007, we have plans to deliver even more for the industry, building on our established expertise and our global presence.

We thank you for your support and dedication throughout the year and we encourage all of our members to maintain the same level of involvement as we continue to work to fulfill our mission in the year ahead.

Sincerely,

Robert Pickel
Executive Director and Chief Executive Officer

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ISDA BOARD OF DIRECTORS

Officers
Jonathan P. Moulds, Chairman President Europe, the Middle East, Africa (EMEA) and Asia Bank of America	Michele Faissola, Vice Chairman Managing Director & Global Head of Rates, Global Markets Division Deutsche Bank
Kaushik Amin, Secretary Global Head of Interest Rate Products Lehman Brothers Inc.	Diane Genova, Treasurer Managing Director & Co-General Counsel Investment Bank J.P. Morgan Chase & Company
Directors
Michael Bass Global Head, Rate Derivatives Standard Chartered Bank	Eric Litvack Managing Director, Global coo Volatility Trading Société Générale
Douglas Bongartz-Renaud Principle Advisor - Market Risk Global Risk Management - Risk Advisory Services ABN Amro Bank N.V.	Grant Lovett Managing Director, Co-head of US Investment Grade Credit Sales & Trading UBS Investment Bank
James de Castro Managing Director Merrill Lynch	Robert Pickel Executive Director and Chief Executive Officer ISDA
Thibaut de Roux Global Head of Structured Rate & Equity Products HSBC Bank plc	Riccardo Rebonato Global Head of Market Risk, CM; Head of Quantitative Research, GBM Royal Bank of Scotland
Benoit de Vitry Global Head of Commodities Emerging Markets Rates & Quantitative Analytics Barclays Capital	Thomas Riggs Managing Director Goldman Sachs
Giovanni Gorno Tempini Head of Finance & Treasury Banca Intesa S.p.A.	Hideyuki Sagou General Manager, Structured Products Division, Global Markets Business Unit Mitsubishi UFJ Securities Co., Ltd.
Hidetaka Hara Deputy Managing Director, Global Markets Planning Department Nomura Securities Co., Ltd.	Eraj Shirvani Managing Director, Head of European and Pacific Credit Sales & Trading Credit Suisse
Frédéric Janbon Global Head of Fixed Income BNP Paribas	Kenneth Tremain Managing Director, Head of North American Interest Rate Derivative Trading & Government Bond Trading Citigroup
Robert Lawson Global Business Leader, Finance & Energy Risk Management BP Plc	David Warren Managing Director Morgan Stanley

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ISDA ACTIVITIES 2006 - 2007

The past year has been significant for ISDA’s growth and development. The association has grown in terms of its reach, its focus, its membership and its staff, and has plans for even greater expansion in the coming year.

All this of course is against the backdrop of continuing growth in the industry itself. Credit derivatives increased by 109 percent to $26.0 trillion from mid-year 2005 to mid-year 2006. Equity derivatives grew 32 percent in that time to $6.4 trillion. And the annual growth rate for interest rate derivatives, the most mature of the OTC derivative product sets, was 25 percent to mid-2006. Outstanding notional volumes in that sector now total over $250 trillion.

At its Annual General Meeting in Boston this year the Association will announce year-end figures for 2006. There is no question that these will continue to demonstrate strong growth, as new products, new applications and new participants come to market.

None of this could take place without the firm foundations ISDA has laid down for the privately negotiated derivatives industry. In the fields of documentation, risk management and public policy, ISDA prepared the landscape for the prudent and efficient development of this most innovative product set.

And while it is perhaps for its foundation work that ISDA is best known, it is the Association’s ability to meet the demands of that growth which places ISDA at the forefront of the industry’s next phase of development. Defining standards for credit derivatives trading, ISDA meets new products head-on; CDS on ABS, CDS on CDOs, CDS on loans and a whole array of variations on these products, while also taking on responsibility for CDX and LCDX index documentation. In facilitating new settlement arrangements for this fastest growing of derivatives sectors, ISDA is helping pioneer new territories for credit derivative products.

ISDA is also helping mature product areas stay current with the publication of its 2006 ISDA Definitions, which revise and update standard reference terms for interest rate and currency swap transactions. The industry benchmark swap rate service, ISDAFIX, continues to expand its range of currencies and will broaden its availability via a greater number of data vendors this year.

In the operations space, we are pleased to have played a major part in effecting real change to business processes and facilitating significant improvements across the operational landscape. The effect of the Novation Protocol on confirmations work-in-hand has been enormous.

ISDA noted improvements of more than 80 percent in credit derivatives confirmation processing in the past year. Increasing automation, based on FpML, the ISDA-sponsored communications standard, will greatly assist ongoing improvements across an ever wider range of derivative product areas. ISDA will continue to provide the operational forum for identifying and prioritizing areas of focus for its members.

In recent months, ISDA has expanded its mandate into the structured products arena, focusing on market practice issues arising from embedding derivatives into other instruments.

The Association is also in the vanguard of efforts to create Sharia-compliant derivatives. Inflation, emissions, coal and property are just some of the newer product areas ISDA has been instrumental in helping develop. A new Derivative Users Committee facilitates greater involvement of ISDA’s growing buy-side membership.

In 2006 alone, the Association gained 100 new members. Greater representation among investment managers and expanding regional representation are among the key factors for that increase.

ISDA sees some of the most significant growth potential in Asia in the coming years and is committed to leveraging its presence in the region. AGM 2006 took place in Singapore, representing an increased rotation through Asia for the location of the industry’s most significant annual event, alongside North America and Europe. ISDA’s conference schedule has grown to over 100 conferences a year, helping membership, regulators and the media stay abreast of industry developments.

Individually, any of these achievements would be noteworthy. Collectively, they amount to a remarkable roster of accomplishments for a lean organization that is growing in size and scope. ISDA has a long and successful history in creating a sound legal framework in which the privately negotiated derivatives industry may thrive. It is set to have a long and successful future in furthering the prudent and efficient development of the industry.

2006 was ISDA’s 21st year. The Association has come of age with the industry it represents.

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COLLATERAL

ISDA’s Collateral Committee focuses on issues relevant to collateral managers. Currently, one of the main projects is in the context of the regulatory evaluation of collateral management practices that FSA, SEC and others have embarked on a thematic review of collateral practices. Their focus is on reuse of collateral, issues around portfolio margining and valuations.

Another focus of the Committee’s work is portfolio reconciliation and its effect on collateral management. Operational and credit risk resulting from increased volumes of collateral calls need to be addressed.

Collateral & Financial Law Reform: ISDA’s Collateral & Financial Law Reform Group monitors developments in collateral and financial law reform on a global, regional and national level. On the global level, ISDA participates in projects underway at UNIDROIT, UNCITRAL and the Hague Conference on Private International Law.

ISDA suggested the inclusion of a chapter on special provisions with respect to collateral transactions of the UNIDROIT Convention on Substantive Rules Regarding Intermediated Securities. This chapter aims at ensuring the equal treatment of title transfer collateral arrangements and security interest. It also ensures the operability of a close-out netting provision in collateral arrangements.

ISDA also contributes to the UNCITRAL projects on insolvency and secured transactions (Legislative Guide on Secured Transactions). This project covers conflict of law issues affecting secured transactions as well as security interests in bank accounts used as collateral in financial transactions. The Hague Securities Convention (outlining conflict of law rules for intermediated securities) and the Hague Choice of Courts Convention are also on ISDA’s agenda. The latter instrument becomes especially relevant in the context of the current review of the EU Regulation on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (Brussels Regulation). The issue of forum shopping in light of the rules set out for exclusive jurisdiction clauses is relevant to derivatives transactions as well.

On the European level, ISDA continues to comment on the proposal by the European Commission to convert the 1980 Rome Convention on the Law Applicable to Contractual Obligations into an EU regulation (Rome 1 Regulation). The Brussels Regulation review, the proposal for a Rome Regulation and the European Commission’s project on a single European contract law (Green Paper on the Review of the Consumer Acquis, or existing law) will continue in 2007.

Since 2004, ISDA has been suggesting to the European Commission to consider drafting an EU legal instrument to harmonize the legal regime for close-out netting across the EU. In its submissions to the Commission on its evaluation of the implementation of the EU Collateral Directive ISDA provided country-specific observations on most EU member states’ implementation and also made several suggestions to revise the directive, e.g. in respect of the scope of counterparties covered by the directive to include non-financial entities, including special purpose vehicles, commodity trading firms and so forth.

Another suggestion made was to broaden the scope of collateral assets eligible for collateral arrangements. The definition of “under control by the collateral taker” needs elaboration in several EU jurisdictions. The fourth major point of ISDA’s response to the European Commission was with regards to including substantive provisions on close-out netting. This idea stems from ISDA’s experiences from its various legislative projects in several “old” EU and EU accession countries.

The Commission’s evaluation report acknowledges the inconsistencies regarding netting/set-off across several EU legal instruments and recognizes the possibility of improving the existing acquis in this regard. For the rest of 2007, ISDA will provide more detailed proposals and keep reiterating this message to the various EU entities concerned.

Staff Contacts:
Peter Werner (pwerner@isda.org)

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DOCUMENTATION

The Association continues to develop a wide range of standardized documentation for commodities, credit, equity, foreign exchange and interest rates, as well as new product areas.

In the credit derivatives area, documentation to facilitate single name U.S. trades on loan credit default swaps was published, as well as documentation supporting LCDX, or the U.S. index of 100 names which commences trading in April 2007.

In Europe, a template to facilitate single name loan credit default swaps is progressing. In addition, the Association continued its work in the credit derivatives on asset backed securities space by updating its library of templates and publishing a separate form for credit derivatives on collateralized debt obligations. Ultimately, an ISDA Structured Credit Derivatives Definitions booklet will be published.

The Association is handling the CDX index documentation work, and in addition to updating various CDX Standard Terms Supplements for various indices, documentation for the new tranche ABX and Hybrix products were developed.

With respect to equity derivatives, a wide range of documentation initiatives was undertaken, including the publication of the 2007 Asia excluding Japan Master Variance Swap Confirmation Agreement and a revised 2005 Asia excluding Japan Inter-dealer Master Equity Derivatives Confirmation Agreement for Index Options and Share Options.

In Japan, the 2006 Japan Master Variance Swap Confirmation Agreement was published, as well as the Share Variance Swap Confirmation, to be used in conjunction with the 2006 Japan Inter-dealer Master Variance Swap Confirmation Agreement.

In Europe, the 2007 European Variance Swap Master Confirmation Agreement was published. This form facilitates index and share variance swap transactions with respect to Share Variance Swap Transactions with an Exchange in a Specified Country, on a share issued by an Issuer that is not a fund or similar collective investment scheme or an Index Variance Swap Transaction with a Related Exchange in a Specified Country.

The 2006 ISDA Fund Derivatives Definitions, a streamlined version of the 2002 ISDA Equity Derivatives Definitions, were published to facilitate transactions linked to interests in various types of pooled investment vehicles, such as hedge funds and mutual funds.

The Association also published the 2006 ISDA Definitions, which updated the 2000 ISDA Definitions and Annex thereto. These Definitions, similar to the 2000 ISDA Definitions, are included in many OTC derivative transactions and offer the basic framework for interest rate and currency derivative transactions.

In the commodities derivatives area, ISDA is nearing completion of an updated version of the Commodity Reference Prices included in the 2005 ISDA Commodity Definitions. Members agreed that adding new commodities, as well as periodically updating the existing Commodity Reference Prices, required the Annex to the 2005 Definitions to be updated from time to time.

In addition, the Association published an Annex to the ISDA Master Agreement and a confirmation template to facilitate the purchase, sale or exchange of an emissions product on a spot, forward or option basis.

The emissions documentation for EU emissions allowance transactions was also updated and options and forwards are now covered. Lastly, a template to facilitate physical coal trading is nearing publication.

The Association is also nearing publication of the 2007 ISDA Property Derivatives Definitions, a Shariah compliant Master Agreement and accompanying transaction templates, a series of riders to the ISDA Master Agreement Schedule to facilitate covered bond transactions and a jurisdiction- specific Schedule for European asset managers.

Legal Opinions: We continued to expand the number of jurisdictions where we obtain legal opinions on the enforceability of netting and collateral provisions of the ISDA Master Agreement, adding new collateral opinions for Bahamas, Hungary and Taiwan. ISDA also published a new netting opinion for Anguilla and is commissioning a new netting opinion for Israel.

Staff Contacts:
Kimberly Summe (ksumme@isda.org)
David Geen (dgeen@isda.org)
Katherine Darras (kdarras@isda.org)

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OPERATIONS

Operations continues to be one of ISDA’s busiest and highest profile areas of activity. At the strategic level, ISDA played a lead role in working with the grouping of major firms that have been making commitments to regulators in connection with reducing backlogs of outstanding confirmations and other matters.

In the course of 2006, the industry made strong progress in improving credit derivatives processing, significantly assisted by an extensive range of ISDA initiatives in operations and documentation. This resulted in a dramatic reduction in backlogs of outstanding confirmations by over 80% on average since September, 2005.

The ISDA Novation Protocol played a key role in effecting this reduction and continues to prove its effectiveness in having removed a major potential source of outstanding confirmations. Along with a series of ad hoc protocols to facilitate cash settlement of credit derivatives, this continues the important work to streamline operational efficiencies that began with the publication of ISDA’s Operations Strategic Plan in December 2003 and its Operations Implementation Plan in March 2004.

The regulators had sought an account of what the issues were felt to be in the various asset classes following up on the work done and success achieved in the credit asset class. ISDA polled its members and collated a report for the firms, which the firms presented to and discussed with the regulators.

In the field of equities the firms committed in November 2006 to reduce levels of outstanding confirmations and to improve levels of confirmations automation. To facilitate these aims, it was recognized that the array of ISDA equity Master Confirmations Agreements needed to be expanded significantly; ISDA polled its members as to perceived priorities, and delivered published documents on time at the end of January. Further deliveries were due at the end of March 2007.

This process has been eased by firms’ timely turnaround of comments on drafts. ISDA will continue to work with the firms as they make, and seek to deliver upon, regulatory commitments around confirmations.

The Operations Working Groups have also been busy. The Interest Rates Products Operations Working Group has been an important stakeholder in the 2006 Definitions project. It has also been responsible for defining the terms of the Settlement and Mark to Market matrices.

At a more granular level, the Group facilitated market agreement around Cash Settlement Payment Dates to the effect that these would be calibrated from the Trade rather than Effective Date of transactions going forward. It is also driving the implementation of the 2006 Definitions in the market, whilst another emergent work stream concerns changing the standards in respect of swaption Expiration Date rolls.

The Equity Operations Working Group has worked on statistics, and continues to be a forum for driving the uptake of automation and standardization of terms.

A newly-formed Commodities Operations Working Group met for the first time on March 22. ISDA continues to gather brief monthly Operations metrics, although it is likely that over time, this effort will be rolled into the statistics that firms provide on a monthly basis to regulators. On a geographical basis, levels of engagement in ISDA Operations work continue to increase in Asia-Pacific, with several successful meetings being held there.

2006 saw the active participation of locally based members in Asia Pacific Operations Committees. Under the strong recommendations of the two committees, ISDA organized the first ever operations training in both Singapore and Hong Kong in March 2007.

Staff Contacts:
Julian Day (jday@isda.org);
Karel Engelen (kengelen@isda.org)

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DERIVATIVE USERS

The growing prominence and importance of investment managers, managed funds and other non-dealer firms in the derivatives market precipitated the advent of the Derivative Users Committee as an additional channel to express views within the ISDA structure on derivatives matters.

The committee provides a forum for firms active in privately negotiated derivatives as clients, investment managers or managed funds, to discuss OTC derivatives operations processing, documentation, risk management and market practices. Provide a buy-side voice to ISDA initiatives in automation and straight-through processing and help further development of OTC derivatives through education and training. Unlike other ISDA committees, participation in this committee is limited to users of derivatives with an invitation of dealer representatives on a case-by-case basis. The committee meets every other month. The initial focus was on credit derivatives but the scope has broadened out to cover other asset classes as well. In the first set of meetings particular interest was on the discussions around dispute resolution, which is part of a separate working group.

The group was active and has provided feedback on the preparations for the meeting organized by the New York Fed between a group of 16 (now 18) major dealers and a group of international regulators, in September 2006. The committee has also been a means to stay updated on operations developments e.g. the plans and evolutions of the Data Warehouse. The committee will be the primary channel within ISDA for buy-side firms to stay updated and discuss OTC derivatives related matters from a user point of view. Participation through the committee will focus the user view on particular issues and give the user community a stronger voice in discussions of importance to them.

Staff Contacts:
Karel Engelen (kengelen@isda.org)

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FINANCIAL PRODUCTS MARKUP LANGUAGE

Financial products Markup Language is the business information exchange standard for electronic dealing and processing of financial derivatives instruments.

In 2006, focus was on the development of version 4.2 with coverage of several new asset classes and the start of the work on 4.3. The main additions in version 4.2 are increased product coverage for the different asset classes e.g. relative swaps and inflation swaps, non deliverable settlement provisions and asset swaps; and additional business process and messaging coverage, including support for allocations, accounts and multiple party roles. Version 4.2 was published as a Trial Recommendation in December 2006 and will likely become a Recommendation in the first half of 2007. The initial work for version 4.3 includes coverage of new products and business processes including CDS on ABS and Loan CDS and the portfolio reconciliation business process. 4.3 will also include at a later stage the work of two new working groups covering repo and securities lending and commodity derivatives. In addition, further work on equities and CDS is planned, with an important focus on options through the options task force.

One of the focus areas in 2006 has been and continues to be the use and adoption of FpML by investment managers, custodians and other representatives from the traditional buy-side. In collaboration with Swift, FpML focused on coverage of a typical business process between investment managers and custodians like trade notification.

The coverage of buy-side specific business processes in FpML together with the commitment from Swift to transport FpML over SwiftNet is an important step towards automation of derivatives processing and handling for the buy-side. The active participation of buy side firms in the further development of the standard is a very positive development.

A new version of the FpML Editor/Viewer will be made available with the release of the Recommendation for version 4.2. Collaboration with other standards and technical standard setting bodies and will continue in 2007. The standards groups ISDA interacts with include ISO 20022 (Unifi) and WG 4; FIX protocol, ISITC, and the Data Standards Working Group.

A first working draft of Version 5.0, a major version with non-backward compatible changes is expected for the second half of 2007. Items considered include the use of multiple name spaces, changes in the use of type substitution and different ways to express an object e.g. for pre-trade and post trade purposes. See also Asia Pacific section.

Staff Contacts:
Karel Engelen (kengelen@isda.org)

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CREDIT DERIVATIVES

The committee is a forum in which to address issues affecting the business and practice of credit derivatives trading. Taking in the views of dealers, end-user/hedgers and portfolio managers, the committee aims to find consensus on the most efficient, effective and appropriate means of conducting OTC credit derivatives transactions.

In the 2006 mid-year market survey ISDA reported a 52% growth in notional amount of credit default swaps to $26 trillion. The continued growth has been made possible by further innovation in the market and introduction of new products, e.g. the development of credit derivatives on asset backed securities and loan-only CDS. The creation of the necessary ISDA documentation is one of the cornerstones for a successful development of these products.

In 2006 we witnessed as well the growing participation in the market of an expanding group of buy-side firms like traditional Money Managers. Operationally a lot of progress has been made in automating the post trade lifecycle. The development of an industry data warehouse for credit trades, managed by DTCC - a development that started in 2006 and will continue into 2008 - will drastically change the operational landscape for credit derivatives.

Work on the development of a long-term solution to provide cash settlement for CDS trades, with the possibility of retaining the physical settlement option, further progressed. The experience of the three credit events in 2006, Calpine, Dana and Dura, for which ISDA organized separate protocols and auctions, has been instrumental for the further development of the current off-the-shelf solution, which eventually will become a permanent part of the ISDA credit Derivatives Definitions. Each of the aforementioned settlement protocols was successful and played a central role in allowing the market to settle the credit event.

Documentation projects completed in the last 12 months include: Additional Provisions for Secured Deliverable Obligations Characteristic and Additional Provisions for Reference Entities with Delivery Restrictions; Loan-only CDS documentation; CDS on ABS, CDS on MBS and CDS on CDO documentation; a Recovery Lock Credit Derivative template and updated market practice standards reflected in the most recent version of the Physical Settlement Matrix.

The regulatory focus on the Credit Derivatives market continued in 2006. Throughout the year the major dealers met with a group of regulators, led by the New York FED and the UK FSA. In the summer of 2006 the group reported a dramatic reduction in backlogs of outstanding confirmations over 30 days by over 80% on average since September 30, 2005 and in September the major dealers additionally reported an overall reduction of outstanding confirmations by 70%.

The 2005 ISDA Novation protocol played a key role in effecting this reduction and continues to prove its effectiveness. The ISDA Novation Protocol II (NPII) assures the same efficiencies for new entrants in the credit market.

Also, in December 2006, working closely with securities and loan-focused organizations, ISDA reaffirmed its membership’s commitment to the maintenance of effective Chinese walls in the credit markets. This built on earlier, fuller statements of the relevant considerations in this area, in 2003 (for the US) and 2005 (EU). Further work on this subject is envisaged for 2007.

In the fall of 2006 ISDA and CDS Index Co agreed to bring the development of CDX index documentation and the related operational work under ISDA.

Staff Contacts:
Karel Engelen (kengelen@isda.org);
Richard Metcalfe (rmetcalfe@isda.org)

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ENERGY, COMMODITIES & DEVELOPING PRODUCTS

The Energy, Commodities and Developing Products Committee supports initiatives to improve trading practices in the commodity markets, and promotes sound legal and risk management practices in its documentation efforts in cooperation with other ISDA committees.

The Committee’s agenda for 2007 is focused on meeting the documentation and policy needs of its members as we witness the continuing evolution of the commodity markets, as new commodities are traded, as financial innovation continues and as capital continues to flow into the sector.

The Committee, together with the combined efforts of ISDA’s Documentation Committee, intends to continue to offer market participants alternative ways to manage physical and financial commodity risks more efficiently under new commodity-specific documentation and to open up the sector to new and different investors by encouraging broader market participation.

The Committee is already focused on meeting the changing needs of commodity market participants by considering a number of diverse documentation projects including: confirmation templates for transactions on commodity indices and commodity baskets; an annex to the ISDA Master Agreement for physical refined products and/or crude oil; and developing terms for trading carbon emissions reductions in the EU and renewable energy credits in the US. The ISDA Global Physical Coal Annex publishes in April. In December 2006, ISDA published a US Emissions Allowance Transaction Annex to the ISDA Master Agreement together with a confirmation template, in response to member demand for standardized terms for trading emissions in the US.

The new documentation covers purchases, sales or exchanges of emissions products on a spot or forward basis, as well as options to purchase, sell or exchange an emissions product. Emissions products currently covered by the new annex include Carbon Financial Instruments traded on the Chicago.

Climate Exchange; emissions of nitrogen oxide; emissions of sulfur dioxide and any emissions allowance or credit created under a U.S. state cap-and-trade program. The flexible structure of the annex is designed to facilitate updates as new emissions products, such as renewable energy credits mentioned earlier, gain liquidity in the market.

On a related topic, in September 2006, ISDA published Version 3 of the ISDA EU Emissions Transaction Document, which, among other things, adds provisions for financially and physically settled options and forwards.

ISDA published the first Supplement to Sub-Annex A to the 2005 ISDA Commodity Definitions on May 12, 2006. This Supplement includes a new Commodity Reference Price for the NYMEX’s reformulated gasoline blendstock for oxygen blending futures contract (“RBOB”).

In a simultaneously issued Best Practices Statement, ISDA, in consultation with energy market participants, recommended that parties to over-the-counter derivatives transactions affected by the NYMEX’s discontinuation of its New York Harbor Unleaded Gasoline (HU) futures contract, should replace references to the HU futures contract (discontinued in January 2007) with references to RBOB.

The Committee’s most recent policy issue relates to the closing of US exchanges on Tuesday, January 2, 2007 in observance of a national day of mourning for former US President Gerald Ford. ISDA Guidance was issued as a supplement to guidance produced by ISDA on December 29, 2006, to specifically address OTC commodity derivative transactions that were affected by the unscheduled holiday. After consultation with commodity market participants (including NYMEX and Platts), ISDA recommended that January 2 should be treated as a Commodity Business Day for the purposes of calculating the Floating Price of NYMEX or COMEX-based commodity derivative transactions.

The guidance recommended that parties use the official settlement price for the relevant commodity futures contract published by the NYMEX on January 2 (which ISDA understood to be the rolled forward official settlement price for certain commodities on December 29, 2006).

With respect to commodity derivative transactions that reference other Price Sources that did not publish or report official prices or index levels, ISDA recommended that January 2 should not be treated as a Commodity Business Day and therefore, should not be included for purposes of calculating the Floating Price of such transactions.

Staff Contacts:
Johanna Schwab (jschwab@isda.org);
Peter Werner (pwerner@isda.org)

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EQUITY DERIVATIVES

The committee focuses on facilitating and addressing issues, ranging from documentation to market practice, related to the prudent development of the range of equity derivatives transactions.

The focus for 2006-2007 has been on share and index variance documentation globally. The first project that was completed was the 2006 Japan Interdealer Master Variance Swap Confirmation Agreement which published first an index variance swap template in June, 2006, then published a share variance annex in December, 2006. Both annexes are with respect to an underlying Japanese index or share.

As part of the continuing variance initiative, a joint European/ US group worked to converge market disruption treatment and other items in variance documentation in those markets, the goal being, where possible, treatment should be the same unless there is distinct local market reason to diverge. The treatment of events agreed in Europe and the United States was ultimately debated and a decision as to how to treat it was largely implemented in the Asia Ex Japan documentation as well.

As a culmination of the variance work, the 2007 Americas Master Variance Swap Confirmation Agreement was published at the end of January, 2007. The 2007 AEJ Master Variance Swap Confirmation Agreement was published February 12, 2007, which facilitates documentation of index and share variance swap transactions with respect to an underlying index or share in Australia, Hong Kong, India, Indonesia, Korea, Malaysia, New Zealand, Singapore, Taiwan and Thailand.

Lastly, the 2007 European Variance Swap Master Confirmation Agreement was published in March of 2007. This template is designed to document index and share variance swap transactions with respect to Covered Transactions.

Covered Transactions are defined in the agreement as a Share Variance Swap Transaction with an Exchange in a Specified Country and on a share (excluding American Depository Receipts and Global Depository Receipts) issued by an Issuer that is not a fund or similar collective investment scheme; or an Index Variance Swap Transaction with a Related Exchange in a Specified Country. Specified Countries are defined as Austria, Belgium, Denmark, Finland, France, Germany, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland or the United Kingdom.

Current but as yet unpublished documentation initiatives include a European swap and option Master Confirmation Agreement, which is due to be published in second quarter of 2007.

In non-documentation related areas, ISDA continued to monitor disclosure-related issues, with particular regard to cash-settled derivatives in takeover situations. ISDA urged further consideration on the part of the UK Takeover Panel before drawing conclusions on the effectiveness of its new (November 2005) regime; and advised the UK FSA not to extend the regime beyond takeovers, given that such a step was of doubtful merit even where takeovers were concerned, and of none where they were not. Also, ISDA held market discussions in June on the changes to the Hang Seng Index compilation methodology (a summary is available on our website) and provided guidance regarding US Exchange Closings on January 2, 2007 in observance of a national day of mourning for former U.S. President Gerald Ford.

Staff Contacts:
Katherine Darras (kdarras@isda.org)
Richard Metcalfe (rmetcalfe@isda.org)

STRUCTURED PRODUCTS

The Structured Products Committee was created early 2007, focusing on market practice and related issues of embedded derivatives.

Reflecting the hybrid nature of such instruments, the Committee mainly proceeds by means of joint work with securities- focused trade associations. Market practice issues relate notably to the interface between wholesale product markets and retail distribution, which may raise varying supervisory issues, depending on the jurisdiction or jurisdictions involved. The Committee and its predecessor working group (itself based on informal contact among members) has in practice focused on generating a set of principles relating to the provider-distributor interface and responding to a UK FSA discussion paper (DP06/4) on the same topic.

Staff Contacts:
Richard Metcalfe (rmetcalfe@isda.org)

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INTERNATIONAL ACCOUNTING

The Accounting Committee discusses and examines current market practices as well as developments arising from accounting standard setters and the international harmonization of accounting standards. The Committee works with international accounting standard setters. The Committee has considered a wide range of issues including hedge accounting, disclosure practices, fair value measurement, and international harmonization.

In 2007 Zhang Weiguo, a senior Chinese regulator is to join the IASB. Zhang Weiguo is currently chief accountant of the stock market regulator, the China Securities Regulatory Commission, and will take up his new role on the Board in July 2007. Approximately 1,200 companies listed in Shanghai and Shenzhen are preparing to switch to IFRS-based standards from January 1 next year.

In 2006 ISDA submitted an industry response to the IASB’s Discussion Paper on Measurement Bases for Financial Accounting. The discussion paper reviews the criteria for valuation, the possible bases for measurement on initial recognition, market vs. entity specific measurement objectives, value affecting properties and market sources, reliability, and includes an analysis of alternative methods.

Also in the past year the IASB announced that there will be no new major standards to be effective before 2009 (presumably including no new US fair value measurement standard). This is consistent with the objective to have a stable platform for IFRS for four years, although the IASB may still publish new standards, earlier adoption would only be voluntary.

Conceptual Framework project ISDA members also submitted comments on the joint IASB FASB paper on the Conceptual Framework for Financial Reporting. The Boards are looking to finalize their preliminary views on the objectives of financial reporting and the qualitative characteristics of “decision-useful” information. ISDA supports the idea of a joint Conceptual Framework and considers it a key development for future “principles-based” standard setting.

Fair Value Measurement: During 2006 the IASB decided to delay a key convergence project on fair value measurement by issuing a Discussion Paper on the US standard (SFAS 157) rather than an Exposure Draft. This puts back the issuance of a new IFRS on fair value guidance until at the earliest the beginning of 2009. The IASB is anxious not to be seen to by-pass its own due process, while concerns remain on the conceptual reasons for changing to an ‘exit price objective’ of fair value.

ISDA members recently discussed the implications of this, with significant concerns raised over the possibility of having different fair values in the US, EU and elsewhere, with the resulting consequences for reconciliation work and gap analysis. ISDA wrote to the IASB to express concerns about possible delays to the project and the possibility for further divergence between US GAAP and IFRS.

The IASB went ahead in publishing the Discussion Paper in November 2006, setting out its preliminary views on providing consistency in the measurement of fair value, when already prescribed under existing IFRS. ISDA’s European Committee, together with members from North America are in the process of compiling industry comments on the paper. The comment deadline is April 2, 2007. Also as part of this work ISDA is organizing a workshop on the adoption and implementation of SFAS 157 and fair value measurement under IFRS in Boston, Massachusetts on Tuesday April 17, prior to ISDA’s AGM. Leading accounting experts will discuss with invited members the key provisions and practical challenges of the new fair value measurement regime.

Accounting in Europe: In Europe in 2006 the lack of a decision on equivalency of non-EU GAAPs was a big concern. Two new Directives on transparency and covering prospectuses risked introducing new and very onerous reconciliation requirements for non-EU GAAP filers active in Europe’s capital markets from January 2007 onwards. ISDA was actively engaged in the debate with the relevant authorities and was pleased with the EU Commission‘s decision to make the necessary amendments to the Directives to postpone the equivalency decision for a further two years. This allows both the Commission and the SEC in the US to progress their work on the road map for convergence in 2009.

New International Technical Accounting Group: ISDA set up a new technical accounting group primarily to focus on the implementation and application of IFRS. The International Financial Instruments Technical Accounting Group or InFITAG meets once a month to discuss topical issues related to applying IFRS in practice.

Staff Contacts:
Ed Duncan (eduncan@isda.org)

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