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Announcement:

Moody's Reviews Bankruptcy Risk of Derivative Product Companies

12 Dec 2008

New York, December 12, 2008 -- Moody's announced today that it is reviewing several issues regarding the operations of derivative product companies ("DPCs"), including the risk of voluntary bankruptcy and, for a subset of DPCs, the role of continuation managers. DPCs are special purpose operating companies typically established and sponsored by investment banks to transact in derivative products such as interest rate swaps. Their Aaa ratings are based on factors such as bankruptcy remoteness from their sponsor, dynamic capital and collateral requirements, insulation from market risk via mirror trades with a sponsor-affiliated entity and adherence to a set of operating guidelines that, among other things, restricts the types of products the DPC may transact in.

In light of the October 5, 2008 bankruptcy filings by Lehman Brothers Derivative Products Inc. ("LBDP") and Lehman Brothers Financial Products Inc. ("LBFP"), two DPCs sponsored by Lehman Brothers, Moody's highlights the risk that well-capitalized DPCs which otherwise merit their Aaa counterparty rating may file for voluntary bankruptcy. As a result of LBDP's and LBFP's bankruptcy filings and persisting uncertainty over the timing of their payments to their counterparties, Moody's downgraded the counterparty ratings of LBDP and LBFP from Aaa to Baa3 with direction uncertain on October 6, 2008, and further to B1 on review for downgrade on October 10, 2008. LBDP's Aaa counterparty rating was initially placed on review for downgrade on September 16, 2008 due to operational risk in administering LBDP's termination as a derivative products company. The bankruptcy filing of Lehman Brothers Holdings Inc. had caused a trigger event for LBDP, which as a termination vehicle required LBDP to unwind its portfolio.

Moody's is engaged in active dialogue with DPCs to assess their susceptibility to voluntary bankruptcy and possible mitigants to that risk. For DPCs whose operating guidelines specify the activation of a contingent manager under certain circumstances, Moody's is also discussing the role of such a contingent manager.

With respect to the risk of voluntary bankruptcy, issues of concern to Moody's include mechanisms to preserve the independence of the board of directors, procedural requirements for filing voluntary bankruptcy, safeguards against the improper removal and replacement of independent directors, and transparency and timely communication of bankruptcy-related board actions to interested parties, including counterparties. Moody's is also interested in whether counterparties have an adequate opportunity to contest an invalidly filed application for voluntary bankruptcy.

In Moody's view, voluntary bankruptcy poses a significant risk that, at the very least, counterparties will not receive payments due to them on a timely basis. In some circumstances, the ability of a DPC to ultimately meet its obligations in full may be compromised by a bankruptcy filing. Although DPCs have existing features that protect their bankruptcy remoteness, the bankruptcy filings of the Lehman DPCs have called into question the sufficiency of those measures. As a result, Moody's will be reviewing the actions undertaken by each DPC to address the risk of voluntary bankruptcy and analyzing their adequacy. Moody's will be issuing a publication on both the potential mitigants to the risk of voluntary bankruptcy and findings with respect to continuation managers, followed by an invitation for comments from market participants.

New York
William May
Managing Director
Structured Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
William Harrington
Senior Vice President
Structured Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Reviews Bankruptcy Risk of Derivative Product Companies
No Related Data.
© 2019 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.

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