Governing Documents

New York City Municipal Water Finance Authority (“NYW”)
Derivative Policy
(as amended on October 3, 2002 and February 24, 2003)

This policy will govern the use by NYW of financial derivative products, such as swaps, swaptions, caps, floors and collars (“derivatives”). The failure by the NYW to comply with any provision of this policy will not invalidate or impair any derivative agreement.

The Conditions Under Which Derivatives May Be Entered Into

Purposes

Derivatives may be used for the following purposes only:

1. To achieve significant savings as compared to a product available in the bond market. Significant savings shall be calculated after adjusting for (a) applicable fees, including takedown, remarketing fees, credit enhancement and legal fees, and (b) options that may be available. Examples may include synthetic fixed rate debt and synthetic variable rate debt. Alternatively, significant savings are deemed to occur if the use of derivatives helps to achieve diversification of a particular bond offering.
2. To enhance investment returns within prudent risk guidelines.
3. To prudently hedge risk in the context of a particular financing or the overall asset/liability management of NYW. Examples may include buying interest rate caps and entering into delayed start swaps.
4. To incur variable rate exposure within prudent guidelines, such as selling interest rate caps or entering into a swap in which NYW’s payment obligation is floating rate.
5. To achieve more flexibility in meeting overall financial objectives than can be achieved in conventional markets. An example may include a swaption with an up front payment.

Legality

NYW must receive an opinion from a nationally recognized law firm that the agreement relating to the derivative is a legal, valid and binding obligation of NYW and entering into the transaction complies with applicable law. In addition, NYW must receive an opinion acceptable to NYW as to the counterparty from a counsel acceptable to NYW.

No Speculation

Derivatives shall not be used for purposes outside of prudent risks that are appropriate for NYW to take.

Methods of Soliciting and Procuring Derivatives

In general, NYW should procure derivatives by competitive bidding. NYW shall determine which parties and the number of parties it will allow to participate in a competitive transaction. NYW may allow one or more bidders in addition to the winning bidder to participate in the transaction if NYW deems such participation to be in its best interests.

Notwithstanding the above, NYW may procure derivatives by negotiated methods in the following situations:

1. NYW may enter into a derivatives transaction on a negotiated basis if NYW makes a determination that due to the size or complexity of a particular derivative transaction, a negotiated transaction would result in the most favorable pricing. In this situation, NYW should attempt to price the derivative based upon an agreed-to methodology relying on available pricing screens to obtain inputs to a mathematical model. If appropriate, NYW should use a financial advisory firm to assist in the price negotiations.
   
2. NYW may enter into a derivatives transaction on a negotiated basis if it determines, in light of the facts and circumstances, that doing so will promote its interests by encouraging and rewarding innovation or the substantial commitment of time and resources by a counterparty.

Regardless of the method of procurement, NYW shall obtain an independent finding that the terms and conditions of any derivative entered into reflect a fair market value of such derivative as of the date of its execution.

Form and Content of Derivatives

To the extent possible, the derivatives entered into by NYW shall contain the terms and conditions set forth in the International Swap and Derivatives Association, Inc. (“ISDA”) Master Agreement, including any schedules and confirmation. The schedule should be modified to reflect specific legal requirements and business terms desired by NYW. If possible, NYW should attempt to negotiate the master agreement and schedule with qualified counterparties to facilitate the use of derivatives in situations in which their use is desirable.

NYW shall consider including provisions that permit NYW to assign its rights and obligations under the derivative agreement and to optionally terminate the agreement at its market value at any time.

Events of Default

Events of default of a counterparty shall include the following:

1. Failure to make payments when due
2. Material breach of representations and warranties
3. Failure to comply with downgrade provisions
4. Failure to comply with any other provisions of the agreement after a specified notice period

An event of default by the counterparty shall lead to termination of the agreement with the termination payment being calculated on the side of the bid-offered spread which is most beneficial to NYW.

Aspects of Risk Exposure Associated with Such Contracts

Before entering into a derivative, NYW shall evaluate all the risks inherent in the transaction. These risks to be evaluated should include counterparty risk, termination risk, rollover risk, basis risk, tax event risk and amortization risk.

NYW shall endeavor to diversify its exposure to counterparties. To that end, before entering into a transaction, it should determine its exposure to the relevant counterparty or counterparties and determine how the proposed transaction would affect the exposure. The exposure should not be measured solely in terms of notional amount, but rather how changes in interest rates would affect NYW's exposure ("Value at Risk"). The Value at Risk should be based on all outstanding derivative transactions by NYW. NYW may also elect to take into account the exposure of the City and any related entities to a particular counterparty.

Counterparty Credit Standards

Many derivative products create for NYW a continuing exposure to the creditworthiness of financial institutions that serve as NYW's counterparties on derivative transactions. To protect its interests in the event of a credit problem, NYW will take a three-tiered approach:

1. Use of highly rated and experienced counterparties: Standards of creditworthiness, as measured by the credit ratings, will determine eligible counterparties. Differing standards may be employed depending on the term, size and interest-rate sensitivity of a transaction, types of counterparty, and potential for impact on NYW's credit ratings. In addition, eligible counterparties should have demonstrated experience in successfully executing derivative transactions.
   
2. Collateralization on downgrade: If a counterparty's credit rating is downgraded below a specified threshold, NYW will require that its exposure to the counterparty be collateralized as per an ISDA Credit Support Annex.
   
3. Termination: If a counterparty's credit is downgraded below a second (lower) threshold, NYW may exercise a right to terminate the transaction prior to its scheduled termination date. NYW will seek to require, whenever possible, that terminations triggered by a counterparty credit downgrade will occur on the side of the bid-offered spread which is most beneficial to NYW, and which would allow NYW to go back into the market to replace the downgraded party with another suitable counterparty at no out-of-pocket cost to NYW.

In evaluating a particular transaction involving the use of derivatives, NYW shall review long-term implications associated with entering into derivatives, including costs of borrowing, historical interest rate trends, variable rate capacity, credit enhancement capacity, opportunities to refund related debt obligations and other similar considerations.

Methods to be Used to Reflect Such Contracts in NYW's Financial Statements

NYW shall reflect the use of derivatives on its financial statements in accordance with generally accepted accounting principles.

Monitoring and Reporting

NYW shall issue a report to the NYW Board of Directors at least once per year and as requested by the NYW Board of Directors. Such report shall include the following:

1. A summary of key terms of the agreements, including notional amounts, interest rates, maturity and method of procurement.
2. The marked to market value of each agreement.
3. The full name, description and credit ratings of each counterparty or the applicable guarantor.
4. The amounts that were required to be paid and received, and any amounts that were actually paid and received.
5. Listing of any credit enhancement, liquidity facility or reserves and accounting of all costs and expenses associated with the credit enhancement, liquidity facility or reserves.
6. The aggregate marked to market value for each counterparty and relative exposure compared to other counterparties.
7. A calculation of NYW's Value at Risk for each counterparty.
8. Discussion of other risks associated with each transaction.