York City Municipal Water Finance Authority (“NYW”)
(as amended on October 3, 2002, February 24, 2003 and May 10, 2013)
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
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) other 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 so as to lower the cost of the bonds not subject to the derivatives.
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 and diversification in meeting overall financial objectives than can be achieved in conventional markets. An example may include a swaption with an up front payment.
6. To manage NYW’s counterparty credit risk.
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.
Derivatives shall not be used for purposes outside of those enumerated above and shall only entail 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, in consultation with its Swap Advisor, 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:
- NYW may enter into a derivatives transaction on a negotiated basis if NYW makes a determination, in consultation with its Swap Advisor, 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 and its Swap Advisor should attempt to price the derivative based upon an agreed-to methodology relying on available pricing screens to obtain inputs to a mathematical model.
- 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.
Use and Selection of Swap Advisor
NYW will utilize a swap advisor (“Swap Advisor”) to assist with the evaluation and execution of swap transactions, as well as with the ongoing monitoring and valuation of its derivatives portfolio. The Swap Advisor will meet all the necessary registration, qualification and other requirements required under applicable law, rules and regulations. In addition, the Swap Advisor selection criteria may be changed from time to time to enable NYW to make any necessary representations related to its Swap Advisor. NYW will periodically update its derivatives policy to reflect any changes and additions to such rules and regulations affecting the requirements related to swap advisors and will periodically evaluate the performance and services provided by its Swap Advisor.
The Swap Advisor shall qualify as a Qualified Independent Representative (“QIR”) under rules and regulations of the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”) promulgated pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), as set forth below:
- The principals and/or senior staff of the Swap Advisor providing services to NYW will have sufficient knowledge to evaluate derivative transactions and risks;
- Principals and/or senior staff will have prior derivatives experience at major swap dealer(s) or comparable experience at financial or swap advisory firms;
- The Swap Advisor will have all required industry and regulatory registrations and licenses and will not be subject to any statutory disqualification related to such registrations or licenses;
- The Swap Advisor will be independent of a swap dealer or major swap participant (each as defined in the Dodd-Frank Act) For purposes hereof, “independent” means that (i) the Swap Advisor shall not be and, for a period of at least one year prior to engagement by NYW, shall not have been associated with any swap dealer or major swap participant, (ii) there is no principal relationship between the Swap Advisor and a swap dealer or major swap participant, (iii) the Swap Advisor is not directly or indirectly, through one or more persons, controlled by, in control of, or under common control with a swap dealer or major swap participant and (iv) the Swap Advisor was not referred, recommended or introduced to NYW by a swap dealer or major swap participant within one year of NYW’s engagement of the Swap Advisor;
- In the event that NYW is planning to execute a new derivatives transaction, the Swap Advisor will disclose to NYW any potential conflicts of interest. This includes any compensation the Swap Advisor has received from a potential counterparty in the preceding 12 months and any business relationships the Swap Advisor has with any potential counterparty. Further, the Swap Advisor shall not receive any compensation from a counterparty related to a NYW derivative without prior written consent of NYW.
- The Swap Advisor will have models and access to historic and live market data necessary to price derivative transactions in real-time, perform historic and prospective risk analyses, and provide portfolio reporting and monitoring, independently of dealers, consultants and counterparties; and
- The Swap Advisor shall be subject to restrictions on certain political contributions imposed by the CFTC, the SEC, or a self-regulatory organization that is subject to the jurisdiction of the CFTC or the SEC.
Obligations of the Swap Advisor
NYW and its Swap Advisor shall enter into a written contract pursuant to which the Swap Advisor shall (i) undertake a fiduciary duty to act in the best interests of NYW, (ii) agree to make appropriate and timely disclosures to NYW of all material conflicts of interest that could reasonably affect the judgment or decision making of the Swap Advisor with respect to its obligations to NYW, (iii) agree to develop and comply with written policies and procedures reasonably designed to manage and mitigate such material conflicts of interest and (iv) evaluate, consistent with any guidelines provided by NYW, fair pricing and appropriateness of the derivatives transaction and provide a written opinion that the terms and conditions of any derivative transaction entered into reflect a fair market value as of the date of its execution. The contract between NYW and its Swap Advisor shall also contain such terms and conditions as the Swap Advisor and NYW shall mutually agree upon.
Form and Content of Derivatives
To the extent possible, the over-the-counter 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, as these may be updated from time to time to reflect then-current legal requirements and best practices. The schedule should be modified to reflect specific legal requirements and business terms desired by NYW. When possible, NYW should attempt to negotiate the Master Agreement, Schedule and Credit Support Annex with qualified counterparties in advance of a potential transaction 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 and Termination Events
Events of default and termination events shall include the following:
1. Failure to make payments when due
2. Material breach of representations and warranties
3. Failure to comply with provisions related to credit ratings and ratings downgrades
4. Failure to comply with any other provisions of the agreement after a specified notice period
An event of default or termination event shall permit NYW to terminate 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 Derivative Contracts
Before entering into a derivative, NYW shall evaluate, with the assistance of its Swap Advisor, all the risks inherent in the transaction. These risks to be evaluated should include counterparty risk, termination risk, rollover risk, basis risk, and tax event risk.
NYW shall endeavor to diversify its exposure to counterparties. To that end, before entering into a derivative 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, through the use of sensitivity analysis showing reasonable worst-case scenarios. The analysis should be based on all outstanding derivative transactions of NYW. NYW may also elect to take into account the exposure of the City and any related entities to a particular counterparty. NYW should also take into account investment, credit, liquidity and other exposures to potential counterparties in evaluating risks.
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:
- 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.
- 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.
- Termination: If a counterparty's credit is downgraded below a specified 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.
NYW will, with its Swap Advisor, monitor counterparty ratings and net mark-to-market derivatives values so that if and when collateral posting requirements may be reasonably expected to be triggered, it can establish a collateral account with its Bond Trustee or other appropriate party, enter into necessary collateral agreements and establish procedures for collateral monitoring, management and reporting.
In evaluating a particular transaction involving the use of derivatives, NYW shall review, with the assistance of its Swap Advisor, 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
No less than quarterly, NYW shall request the Swap Advisor to determine, or shall determine internally, the information identified in numbers 2, 3, 6 and 7 below. 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:
- A summary of key terms of the agreements, including notional amounts, interest rates, maturity and method of procurement.
- The marked to market value of each agreement.
- The full name, description and credit ratings of each counterparty or the applicable guarantor.
- The amounts that were required to be paid and received, and any amounts that were actually paid and received.
- 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.
- The aggregate marked to market value for each counterparty and relative exposure compared to other counterparties.
- A sensitivity analysis showing reasonable worst-case exposure for each transaction and aggregated by counterparty, when applicable.
- Discussion of other risks associated with each transaction.
Derivatives Policy Updates
NYW intends to comply with all applicable regulatory requirements concerning derivatives as these may be promulgated from time to time by the CFTC, the SEC or other regulatory body with jurisdiction over NYW derivatives. NYW will periodically review and update this Derivatives Policy to reflect any changes or additions to relevant rules and regulations.