NEW DEVELOPMENTS IN ASSET-BACKED

COMMERCIAL PAPER

Jim Croke
Orrick, Herrington & Sutcliffe LLP

Copyright © 2007
All Rights Reserved

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 Biographical Information

James J. Croke, Jr., is a partner in the Structured Finance Department of

Orrick, Herrington & Sutcliffe LLP.

Jim acts as counsel to underwriters and issuers in public offerings and private placements
of funded and synthetic asset-backed securities. His structured finance experience includes
funded and synthetic securitizations of credit card receivables, high-yield bonds, hedge funds,
leveraged and synthetic lease debt, project finance debt, mortgage loans, commercial loans,
equipment leases, government receivables, mortgage warehouse lines of credit, trade receivables
and numerous other assets.

Jim’s practice involves both U.S. offerings and offerings in the Euromarkets as well as
global underwriting facilities involving simultaneous offerings in the United States and
Euromarkets. He has acted as counsel to banks, insurance companies and other sponsors,
commercial paper dealers and placement agents in connection with the establishment of more
than 130 asset-backed commercial paper conduits and structured investment vehicles.

Jim serves annually on the faculty of the Practising Law Institute with respect to its
coverage of “New Developments in Asset Backed Commercial Paper.” Jim has been recognized
as one of the top 25 structured finance lawyers in the world by Euromoney’s Best of the Best
Expert Guide, and as one of the world’s leading structured finance lawyers by the International
Financial Law Review. A frequent author of articles regarding legal and regulatory issues
related to securitization of financial assets, he also participates in numerous professional
seminars and conferences, including as a speaker or moderator regarding ABCP conduits, CDO
transactions, synthetic securitizations, and related legal and regulatory issues.

Education and Background

Law Clerk to the Hon. Dudley B. Bonsal, United States District Court Judge, Southern
District of New York.

J.D., University of Notre Dame Law School.

B.S. in Mathematics, graduated cum laude in three years, University of Kentucky.

Professional Activities

Member, New York and California Bars.

Member, Board of Directors, Asset Securitization Forum

Jim may be contacted at:

Orrick, Herrington & Sutcliffe LLP

666 Fifth Ave.

New York, NY 10103
Tel: (212) 506-5085
Fax: (212) 506-5151
Email: jcroke@orrick.com

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 TABLE OF CONTENTS

Page

I. INTRODUCTION ......................................................................................................... 3
II. ASSET-BACKED COMMERCIAL PAPER OVERVIEW ............................................ 3
III. THE SECURITIES ACT OF 1933................................................................................. 6
A. Securities Act of 1933 - Section 3(a)(3) ......................................................................... 6
B. Securities Act of 1933 - Section 4(2).............................................................................. 7
C. Integration of Section 3(a)(3) and Section 4(2) Placements ............................................ 8
D. Rule 144A...................................................................................................................... 9
E. Regulation S ................................................................................................................ 10
IV. INVESTMENT COMPANY ACT OF 1940 ................................................................ 10
A. Section 3(c)(1) - The Private Investment Company Exemption .................................... 10
B. Rule 3a-7 - The Asset-Backed Security Exemption...................................................... 13
C. Section 3(c)(5) - Commercial Financing And Mortgage Banking Business
Exemption ................................................................................................................... 13
D. Section 3(c)(7) - The Qualified Purchaser Exemption................................................... 14
E. Comparison Between QPs and QIBs ............................................................................ 15
F. No-Action Letter: Foreign Issuers and U.S. Offerings .................................................. 16
G. No-Action Letter: Resale Procedures and Purchaser Status .......................................... 17
H. No-Action Letter: Registration as an Investment Company .......................................... 21
I. Rule 2a-7 ..................................................................................................................... 22
J. Effect of FIN45R on Rule 2a-7 .................................................................................... 26
V. RISK BASED CAPITAL – REVISED BASEL CAPITAL ACCORD ......................... 27
A. Scope of the Securitization Framework ........................................................................ 28
B. Standardized Approach for Securitization Exposures ................................................... 28
C. Internal Ratings-Based Approach for Securitizations.................................................... 31
VI. RISK BASED CAPITAL - U.S. REVISIONS.............................................................. 38
VII. INTERNATIONAL ABCP PROGRAMS .................................................................... 41
A. General ........................................................................................................................ 41
B. The Issuance of Sterling Denominated ABCP .............................................................. 41
VIII. INNOVATIVE FUNDING SOURCE FOR PROJECT FINANCE DEALS ................. 42

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 TABLE OF CONTENTS
(continued)
Page

IX. THE USA PATRIOT ACT AND ABCP PROGRAMS ................................................ 44

Figure 1: Fully Supported Asset Backed Commercial Paper .................................................... 46
Figure 2: Partially Supported Asset Backed Commercial Paper ............................................... 47
Figure 3: Cross-Border Funding Alternatives - Conventional Structure - Japan........................ 48
Figure 4: U.S. Assets -- Off-Shore Issuance of Notes.............................................................. 49
Figure 5: Secondary Market Assets - - U.S. and Offshore Issuance of Notes........................... 50
Table 1Long-term rating category............................................................................................ 51
Table 2 U.S. ABS risk weights when the external assessment represents a long-term
credit rating and/or an inferred rating derived from a long-term assessment ................. 52
Table 3 U.S. ABS risk weights when the external assessment represents a short-term
credit rating and/or an inferred rating derived from a short-term assessment................. 53
Table 4 U.S. Risk Weighting Tables ........................................................................................ 54

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I. INTRODUCTION

This article provides an overview of certain legal issues related to asset-backed

commercial paper (“ABCP”) transactions and some of the significant recent developments in the
regulatory environment affecting ABCP. This article also briefly considers the effect of these
developments on certain legal issues related to international ABCP transactions involving the
U.S.

To put this overview in context, this article commences with a brief introduction to
ABCP conduit structures, including an analysis of the difference between a fully supported and a
partially supported structure.

The assistance of Nikiforos Mathews, an of counsel at Orrick, Herrington & Sutcliffe

LLP, in the preparation of this article is acknowledged with thanks.

The assistance of Christopher Byrne of Ogiers and Anthony Walsh of Matheson Ormsby
Prentice, with respect to preparing and updating sections of this article relating to Jersey and
Irish legal developments, respectively, is acknowledged with thanks as well.

II. ASSET-BACKED COMMERCIAL PAPER OVERVIEW

ABCP is a term typically used to describe a debt security with an original term to
maturity of no longer than 270 days (or, sometimes, 397 days), the payment of which is
supported by cash flows from assets or one or more liquidity or credit support providers, or both.

ABCP programs are often categorized as either fully supported or partially supported
programs.

(A) Fully supported ABCP is issued under a program that provides for an entity other than
the issuer of ABCP to undertake to repay the entire face amount of commercial paper
notes (“Notes”) pursuant to some form of financial guarantee (e.g., a surety bond, letter
of credit, total return swap, third-party guarantee or irrevocable “unconditional” liquidity
facility). The credit rating of the commercial paper is primarily determined by reference
to the credit rating of the institution providing the financial guarantee and not by the cash
flow from the underlying assets.

Please see Figure 1

(B) Partially supported ABCP is issued under a program where repayment of the commercial
paper primarily depends on the cash flow to be realized on a pool of assets, as well as
liquidity and credit enhancement provided by third parties.

Please see Figure 2

A bankruptcy remote special purpose multi-participant commercial paper entity (“SPE”)

is established to issue the commercial paper by the initiative of the “arranger” of the program,
typically a financial institution or operating company that wants to engage in off-balance sheet
asset finance. The SPE is not owned by the arranger nor is it affiliated with the arranger. It is

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typically owned and managed by a third-party engaged in the business of owning and managing
this type of special purpose finance vehicle. The SPE generally does not have any active or
functional employees and the arranger or another party will usually serve as an “administrator”
of the SPE and, as agent for the SPE, assist the SPE in performing its contractual obligations
under the related program documents. The SPE’s single purpose is to issue Notes and to use the
proceeds of such issuance to purchase financial assets or make loans, which may be secured by
financial assets. The Notes are typically assigned credit ratings by one or more rating agencies.
The rating agencies will analyze the ability of the SPE, as the issuer of the Notes, to pay
principal and interest in full on the maturity date of the Notes. In ABCP programs, this analysis
requires an evaluation of the assets (in the case of a partially supported program), the credit
enhancement and liquidity support arrangements (in the case of both a partially supported and a
fully supported program) and the quality and experience of the administrator and other providers
of services to the SPE. If the credit rating of the arranger is not high enough to permit it to
provide credit enhancement or liquidity support to the SPE (to the extent such support is needed
in order to obtain the desired rating on the Notes), the arranger may utilize a cash or otherwise
collateralized structure and/or obtain credit enhancement and liquidity (either directly or through
a confirmation) from a more highly rated third-party bank.

Fully supported ABCP is supported by a third-party support provider which supplies both
liquidity and credit protection for investors in all circumstances relevant to the timely payment in
full of the Notes. Generally, the support provider will provide both the credit enhancement and
the liquidity support for the program by a commitment to make loans to the SPE to pay any and
all maturing Notes or to buy assets or participations in assets from the SPE when the SPE needs
funds to pay maturing Notes.

In partially supported ABCP programs, it is typically not possible to rely solely on the
cash flow from the assets to repay maturing Notes because the payment on the assets and the
maturity of the Notes are usually not matched in terms of timing and amount. In addition,
payments on the assets may be paid to the SPE only once a month, or less frequently, whereas
Notes may mature at various times during that month or other, longer, period. Therefore, a
liquidity facility will provide for the timely repayment of the Notes up to the amount of non-
defaulted assets (i.e., the liquidity banks do not cover the credit default risk of the assets).
Partially supported ABCP programs also generally provide for some pool-specific credit
enhancement such as overcollateralization that protects against the first losses experienced on the
particular pool of assets and program-level credit enhancement that is available to cover losses
experienced on any pool of assets financed by the SPE. Program-level credit enhancement is
usually in the form of a letter of credit, a surety bond, a total return swap, a cash collateral
account, or an irrevocable “unconditional” liquidity facility (e.g., a liquidity facility in which the
banks are required to fund in all meaningful circumstances).

Innovations and Developments in the ABCP Context

In the past few years, ABCP programs have started using various innovative structures
for improved credit enhancement and/or liquidity. For example, ABCP programs sometimes
provide for the issue of subordinated notes as an additional form of credit enhancement. The
SPE issues both Notes and subordinated notes, using the funds from the subordinated notes to
support the SPE’s ability to pay maturing Notes. This type of credit enhancement raises several

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interesting issues. As with any asset-backed subordinated notes, there are questions relating to
the classification of the notes as debt or equity, with the concomitant tax implications. As the
subordinated notes are of a lower credit quality, they are more likely to default and lead to a
claim against the SPE by the holders of those notes, jeopardizing both the SPE’s ability to make
timely payment of the Notes and the bankruptcy remoteness of the SPE.

Innovations to ABCP structures have also been implemented to improve the overall
liquidity of the ABCP programs. Due to (i) the rapid growth of the ABCP market and the related
amount of outstanding ABCP and (ii) rating agency criteria that require adequate liquidity be
available to support the timely payment of ABCP at maturity, arrangers of ABCP programs have
increasingly been looking for alternative sources of liquidity. These “alternative liquidity”
ABCP program structures now in the market include: (i) market value structures in which the
market value of the assets financed by the SPE is continuously monitored and maintained at a
level greater than the face amount of ABCP outstanding (and the SPE may then obtain liquidity,
if required, through the disposition of the assets); (ii) extendable or callable ABCP structures that
provide for an extension of the maturity date of ABCP if, on the related expected maturity date
or call date, the SPE for some reason is not able to access sufficient liquidity through the issue of
additional ABCP (and the SPE may, during the extension period, take one or more steps to
manage its cashflow and assets (including the disposition of such assets) so as to provide for the
timely payment of ABCP, including the “extended” or “uncalled” ABCP) on or before the legal
final maturity date; and (iii) structured liquidity note programs in which the SPE or another
special purpose company issues “liquidity notes” to raise funds that may be used to provide the
SPE with liquidity if the SPE does not have sufficient funds to provide for the timely payment of
ABCP that matures on any day.

Repurchase Agreements in ABCP Programs

In addition to the above referenced innovations, the use of repurchase agreements (both
as liquidity facilities and as forms of asset financing agreements) has become much more typical
in ABCP programs. In part, this is due to 2005 revisions to the U.S. Bankruptcy Code which
now permit bankruptcy-remote financing of certain types of assets under eligible repurchase
agreements. The use of repurchase agreements may introduce market value risk into the ABCP
conduit’s credit analysis/profile. Investors and third parties with exposure to these conduits may
have exposure to some or all of this risk, consistent with the particular transaction structure and
the related rating agency analysis of the program.

If a repurchase agreement provides for full recourse to a highly-rated seller, the ABCP
may be rated based on the obligations of the seller, in which case investors could be isolated
from market value risk associated with the assets. The rating agencies may in this case focus on
the rating of the seller (or guarantor, as applicable) in assigning a rating to the ABCP.

Alternatively, if the repurchase agreement represents a limited recourse obligation of the

seller, under which the purchaser has recourse only to the assets, the ABCP conduit’s ability to
pay the ABCP may be dependent upon the market value of the assets held by the ABCP conduit.
In this case, the analysis of the rating agencies will focus on the market value of the assets, rather
than on the ability of the seller to repurchase asset(s) from the ABCP conduit.

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 It is also possible to structure programs in which repayment of the ABCP is reliant upon a
combination of the seller’s ability to repurchase asset(s) from the ABCP conduit and the market
value of the assets held by the ABCP conduit. Under this hybrid approach, the analysis of the
rating agencies will focus on the market value of the assets held by the ABCP conduit and on the
ability of the seller to perform under the repurchase agreement.

To the extent that the substantive rights of the holders of securities issued in connection
with one of these alternative liquidity structures differs from the rights of holders of more
traditional ABCP, the required legal disclosure used in connection with the offer and sale of such
securities will differ from traditional ABCP disclosure. In the absence of traditional liquidity
support, the rights of holders of the securities to receive full and timely payment may be more
dependent on the legal structure of the financing and the performance (and possibly the market
value) of the financed assets.

The following two sections address important provisions of the Securities Act of 1933,
as amended (the “Securities Act”) and of the Investment Company Act of 1940, as amended (the
“Investment Company Act”), each of which are relevant to the structuring of any ABCP deal.
However, some portions of the following discussion may not be relevant to certain ABCP
transactions because the applicability of the securities laws to an ABCP transaction depend, in
large measure, on the investment goals and final structure of the ABCP program.

III. THE SECURITIES ACT OF 1933

A. SECURITIES ACT OF 1933 - SECTION 3(a)(3)

Section 3(a)(3) (“Section 3(a)(3)”) of the Securities Act exempts from the registration
and prospectus delivery requirements of the Securities Act “any note, draft, bill of exchange, or
bankers’ acceptance which arises out of a current transaction or the proceeds of which have
been or are used for current transactions, and which has a maturity at the time of issuance of not
exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which
is likewise limited[.]”

In order to qualify for the Section 3(a)(3) exemption from the registration and prospectus
delivery requirements of the Securities Act, the proceeds of the commercial paper must be used
only for current transactions. The current transaction test will generally be satisfied when the
proceeds of the commercial paper issuance are used in producing, purchasing, carrying or
marketing goods or in meeting current operating expenses of a business. However, the test is
generally not satisfied when the proceeds are used for permanent or fixed investments, such as
land, buildings, or machinery, nor for speculative transactions or transactions in securities
(except direct obligations of the U.S. government).

In addition, the Section 3(a)(3) exemption applies only to prime quality negotiable
commercial paper of a type not ordinarily purchased by the general public, that is, paper issued
to facilitate well-recognized types of current operational business requirements and of a type
eligible for discounting by U.S. Federal Reserve banks.

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 B. SECURITIES ACT OF 1933 - SECTION 4(2)

Commercial paper that does not meet the Section 3(a)(3) requirements may nevertheless
be sold without registration under the Securities Act in reliance upon the Section 4(2) of the
Securities Act (“Section 4(2)”) private offering exemption from the registration requirements of
the Securities Act. Unlike Section 3(a)(3), Section 4(2) calls for a private placement of the
securities. Section 4(2) states that registration and prospectus requirements shall not apply to
“transactions by an issuer not involving any public offering”.

In order to satisfy the Section 4(2) private placement test, the commercial paper offering
must be conducted in such a manner so as not to constitute a “public offering”. This is
essentially a question of fact requiring an examination of the following factors:

(1) The offerees should be sufficiently sophisticated to be able to understand

and bear the risks of the investment and should be provided access to the type of
information that is necessary to make an informed investment decision.

(2) There should not be any general solicitation or advertising, and there
should not be any other public offering that could be integrated with the private
placement. Offers are generally made only by direct contact between the commercial
paper placement agent’s sales representatives and the person at the purchasing institution
responsible for making the investment decision.

(3) Commercial paper issued in a Section 4(2) program can generally only be
sold to accredited investors, as defined in Rule 501(a) under the Securities Act, and
comparable foreign institutions. There is no specific limit on the number of such
offerees. Minimum investments of $200,000 are generally required. To the extent there
are any non-institutional investors participating in the offering, however, there is a greater
risk that a public offering will be deemed to occur where there is more than a limited
number of such non-institutional investors participating.

(4) The issuer is responsible for ensuring that the initial purchasers do not
become conduits for a wider distribution of the securities being privately placed. Each
Note must bear a legend stating that it has not been registered and that it may not be sold
or otherwise transferred except to or through the originating placement agent. This
restriction on transfer is also referred to in the private placement memorandum.

Relying on the exemption from registration available under Section 4(2) will not
necessarily provide an ABCP issuer with a concurrent exemption from registration under state
securities laws (or "Blue Sky" laws). Any commercial paper notes that are privately placed in
compliance with Rule 506 of Regulation D under the Securities Act will be exempt from
the registration requirements of Blue Sky laws. In certain states, the issuer will be required
to submit a notice filing in connection with the offering. Commercial paper notes that are sold in
a Section 4(2) private placement, but that are not expressly sold pursuant to Rule 506, will
not automatically be exempt from Blue Sky registration requirements but such commercial paper
notes can nonetheless be sold in each state without registration to specified classes of
institutional investors.

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 C. INTEGRATION OF SECTION 3(a)(3) AND SECTION 4(2) PLACEMENTS

An “integration” problem can arise if an issuer decides to convert a commercial paper

program from a Section 3(a)(3) program to a Section 4(2) program or to simultaneously conduct
a Section 3(a)(3) offering and a Section 4(2) offering. The exemption from the registration
provisions of the Securities Act for Section 4(2) offerings requires that the offering does not
constitute a public offering. However, for purposes of Section 4(2), a Section 3(a)(3) offering is
viewed as the equivalent of a public offering. Accordingly, in order to effect a good private
placement of commercial paper under Section 4(2) concurrently with, or immediately following,
an offering of commercial paper under Section 3(a)(3), care must be taken to avoid the
“integration” of the Section 4(2) offering with the Section 3(a)(3) offering, since integration of
the Section 4(2) offering into the Section 3(a)(3) offering would make it impossible to satisfy the
non-public offering requirement of the Section 4(2) exemption. The loss of the exemption
provided by Section 4(2) would mean that if no other exemption were available, the offering
would be in violation of the registration requirements of Section 5 of the Securities Act.

The factors generally applicable to the question of integration are set forth in
Rule 502 (“Rule 502”) of Regulation D under the Securities Act. Under Rule 502, the question
of whether separate sales of securities are part of the same offering (i.e., are considered
integrated) depends on the particular facts and circumstances. Rule 502 sets out five factors to
be considered in determining whether offers and sales should be integrated:

(1) Whether the sales are part of a single plan of financing.

(2) Whether the sales involve the issuance of the same class of securities.

(3) Whether the sales have been made at or about the same time.

(4) Whether the same type of consideration is received.

(5) Whether the sales are made for the same general purpose.

These integration issues may be overcome if it can be shown that despite the fact that the
original issuance of commercial paper was effected under Section 3(a)(3), it could have been
effected pursuant to Section 4(2) as well. Because the commercial paper market is essentially an
institutional market, most placements of commercial paper are made solely to “accredited
investors” or “qualified institutional buyers” (“QIBs”) and are generally placed by dealers with
large investors in placements that do not involve general solicitation or advertising. Therefore, if
an issuer’s current Section 3(a)(3) program has been effected in such a way that it is able to
satisfy both the Section 4(2) test and the Section 3(a)(3) test, then such an issuer may be able to
modify its program documents and effect a Section 4(2) offering going forward.

If, however, the issuer’s Section 3(a)(3) offering has not, to date, been conducted in a
fashion which would also qualify the offering for the exemption provided by Section 4(2), such
issuer’s ability to convert its Section 3(a)(3) offering into a Section 4(2) offering may be subject
to some restrictions, including providing for a period (e.g., 6 months or some other appreciable
time) during which the Section 4(2) restrictions are substantively adopted and the

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Section 3(a)(3) exemption requirements continue to be satisfied. Thereafter, an issuer should be
able to issue all of its commercial paper under the Section 4(2) exemption.

D. RULE 144A

(1) Background

In 1990, the Securities and Exchange Commission (“SEC”) adopted

Rule 144A (“Rule 144A”). Rule 144A is designed to foster a more liquid and efficient
secondary trading market in restricted securities for institutional investors while
providing appropriate safeguards to ensure the continued integrity of the retail securities
market. Rule 144A provides a non-exclusive safe harbor exemption from the registration
requirements of the Securities Act for the resale of certain restricted securities to
specified institutions by persons other than the issuer of such securities. Typically, the
transactions are structured such that the initial purchaser (generally an investment bank)
purchases the securities as principal in a Section 4(2) private placement and then
immediately resells such securities to QIBs in exempt transactions.

(2) Resale Requirements

To qualify for the safe harbor exemption of Rule 144A, an offer or sale must meet
four basic conditions relating to the type of securities to be sold, the institutions to whom
the securities may be sold, the types of information required to be furnished, if any, and
the purchaser’s awareness of the seller’s reliance on Rule 144A.

(a) The securities offered or sold under Rule 144A may not be of the
same class as securities of the issuer that are listed on a U.S. securities exchange
or quoted in a U.S. automated inter-dealer quotation system.

(b) The securities must be offered or sold only to QIBs or to an offeree

or purchaser that the seller and any person acting on its behalf reasonably believes
is a QIB.

(c) There is generally no requirement that prospective purchasers be

provided with specific information with respect to the issuer of the securities
offered or sold under Rule 144A. If, however, the issuer is neither (i) a reporting
company under the Securities Exchange Act of 1934, as amended (the “Securities
Exchange Act”), (ii) a foreign private issuer that is exempt from reporting under
Rule 12g3-2(b) under the Securities Exchange Act by virtue of furnishing the
SEC with home-country published reports nor (iii) a government of any foreign
country or of any political subdivision of a foreign country eligible to register
securities under Schedule B of the Securities Act, the holder of the securities
offered or sold and any prospective purchaser designated by the holder must have
the right to obtain from the issuer certain basic information regarding the issuer.

(d) The seller of the securities, and any person acting on its behalf,
must take reasonable steps to ensure that the purchaser is aware that the seller
may rely on the Rule 144A safe harbor.

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 E. REGULATION S

Securities that are privately placed in the U.S. may be resold outside the U.S. without
registration provided the requirements of Regulation S (“Regulation S”) of the Securities Act are
satisfied. In order to qualify for Regulation S, the offering must occur off-shore and there must
be no directed selling efforts in the U.S.

Since the SEC’s adoption of Regulation S and Rule 144A in 1990, a significant number
of issuers have made global offerings of their securities under offering structures that have
included an offering outside the U.S. in compliance with Regulation S and a private placement of
a portion of the securities within the U.S. in compliance with Rule 144A. If properly structured,
such a non-U.S. offering and the contemporaneous private placement and Rule 144A resales will
be exempt from registration under the Securities Act.

IV. INVESTMENT COMPANY ACT OF 1940

The Investment Company Act is one of the many pieces of legislation to consider in an
ABCP structured financing because, without certain exemptions contained in the Investment
Company Act, a structured financing vehicle would ordinarily be required to register as an
investment company.

A structured financing vehicle will invariably fall within the definition of investment
company under the Investment Company Act because it is an issuer of securities and is primarily
engaged in the business of investing in, owning and holding securities. However, as noted in the
SEC’s release accompanying what was then the proposed Rule 3a-7 (“Rule 3a-7”) under the
Investment Company Act, structured financings are generally not well suited to operating as
registered investment companies under the Investment Company Act’s requirements. The cost
of complying with the registration and compliance requirements of the Investment Company Act
would generally remove the economic benefits which are offered in a structured finance
transaction.

A. SECTION 3(c)(1) - THE PRIVATE INVESTMENT COMPANY

EXEMPTION

Section 3(c)(1) (“Section 3(c)(1)”) of the Investment Company Act excepts from the
definition of investment company: “[a]ny issuer whose outstanding securities (other than short-
term paper) are beneficially owned by not more than one hundred persons and which is not
making and does not presently propose to make a public offering of its securities”.

The staff of the SEC have indicated that Section 3(c)(1) reflects “Congress’s [sic] belief
that federal regulation of private investment companies is not warranted”. This may be due to
the fact that the cost of compliance for small investment clubs would make them uneconomical

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or that well capitalized investment pools with sophisticated investors should be able to avoid
substantive regulation under the Investment Company Act.1

(1) The term “Short-term paper” is defined in Section 2(a)(38) of the

Investment Company Act to mean “any note, draft, bill of exchange, or banker’s
acceptance payable on demand or having a maturity at the time of issuance of not
exceeding nine months, exclusive of days of grace, or any renewal thereof payable on
demand or having a maturity likewise limited”. The effect of the inclusion of this “carve
out” in Section 3(c)(1) is to permit an issuer that only issues short-term notes, such as
commercial paper with maturities of 270 or fewer days and satisfies the other
requirements of Section 3(c)(1), to avoid registering under the Investment Company Act.

(2) The term “beneficially owned” is not specifically defined in the

Investment Company Act but the staff of the SEC have given meaning to this term
through no-action letters. One criterion used by the staff of the SEC to determine
whether a person has beneficial ownership of the securities of an issuer relying on the
exemption provided by Section 3(c)(1) is whether that person has the ability to decide
whether, or how much, to invest in those securities. For example, the staff of the SEC
take the position that each participant in a participant-directed defined contribution plan
may be treated as a beneficial owner because those participants decide whether, or how
much, to invest in the private investment company. By contrast, involuntary and
noncontributory holders of beneficial interests in employee benefits plans are not
considered holders of outstanding securities, because in such plans the beneficiaries have
no ability to decide whether or how much they will invest in the private investment
company.

(3) For the purposes of the term “one hundred persons”, each “person” is
counted if that person beneficially owns debt, equity or any other security of the issuer,
other than short-term paper.

(4) (a) An offering will qualify as an offering that is not a “public

offering” if that offering qualifies as nonpublic under Section 4(2) or Rule 506 of
Regulation D under the Securities Act. Furthermore, the SEC has stated that
resales of securities of private investment companies pursuant to Rule 144A do
not constitute a public offering of securities.

(b) An offer will be “public” for purposes of Section 3(c)(1) if it is

public for purposes of the Securities Act. The SEC takes the position that an offer
may be public for purposes of Section 3(c)(1) if the issuer:

· relies on the intrastate offering exemption in Regulation A of the

Securities Act (Conditional Small Issues Exemption);

1
Division of Investment Management, SEC, Protecting Investors: A Half Century of Investment Company
Regulation, (May 1992) at 103.

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 · relies on exemptions available in respect of Rule 504 or Rule 505 under
the Securities Act (Limited Offers of Sales of Securities not exceeding
certain dollar thresholds);

· publicly advertises the offer; or

· uses the facilities of an exchange to place the securities.

Rule 3c-5 (“Rule 3c-5”) under the Investment Company Act permits directors, executive
officers, general partners and certain knowledgeable employees of an issuer relying on
Section 3(c)(1) to acquire securities issued by the issuer without being counted for purposes of
the “hundred person” limit (refer to the more detailed discussion below). An “attribution”
provision has been included in the Investment Company Act to prevent a group of investors from
circumventing the “hundred person” limit by creating a single company or entity specifically for
the purpose of investing in an investment company and being counted as only 1 of the 100.

Section 3(c)(1)(A) of the Investment Company Act provides that a private investment
company will be required to “look-through” a company (i.e., count each of that company’s
security holders (other than holders of its short-term paper) as if they were beneficial owners of
the securities of the private investment company) if:

(1) the company owns 10% or more of the voting securities (a security
presently entitling the owner of such security to vote for the election of directors) of the
private investment company; and

(2) the company is an investment company, or would be an investment

company but for the exceptions contained in Section 3(c)(1) or Section 3(c)(7)
(“Section 3(c)(7)”) of the Investment Company Act.

The following additional “look-through” rules apply:

(1) The SEC will “look-through” a company that is created to avoid the
“hundred person” limitation. The staff of the SEC have taken the position that if the
entity is a “sham” created to avoid the limitation, then they may “look-through” it
whether the entity owns 10% of the issuer’s voting securities or not.

(2) The staff of the SEC have taken the position that it may be necessary to
“look-through” a company owning 10% or more of the non-voting securities of such
private investment company. This view is presumably based on the notion that control of
an entity may be effected other than through the ownership of voting securities of such
entity. However, the staff of the SEC will decide this issue on a case-by-case basis.

(3) For some years the staff of the SEC relied on a “40% test” to determine
whether a purchaser (that relied on Section 3(c)(1)) was formed solely for the purpose of
investing in a Section 3(c)(1) issuer. The test essentially provided that, if the purchaser’s
investment in the Section 3(c)(1) issuer constituted more than 40% of the committed
capital of the purchaser (regardless of whether or not the securities held were voting
securities), it would be necessary to “look-through” to the holders of the purchaser’s

OHS East:160049087.6 12
 securities for the purposes of deciding whether the “hundred person” limit had been
satisfied. In a 1996 no-action letter, the staff of the SEC modified their position and
provided that since the 40% test is not a statutory requirement, an investment in a
Section 3(c)(1) issuer by a purchaser that constitutes more than 40% of the committed
capital of such purchaser would not automatically place a Section 3(c)(1) issuer in
violation of the Investment Company Act. While the percentage of a purchaser’s assets
invested in a Section 3(c)(1) issuer is relevant to this analysis, exceeding a specified
percentage level, by itself, is not determinative, and a determination of whether there has
been a violation under the Investment Company Act will depend on an analysis of all the
surrounding facts and circumstances.

Also note that a private investment company (and any company or companies it controls)
is prohibited from purchasing or acquiring more than 3% of the total outstanding voting stock of
a registered investment company.

B. RULE 3a-7 - THE ASSET-BACKED SECURITY EXEMPTION

The SEC recognized that prior to the enactment of Rule 3a-7, the question of whether a
securitization vehicle was exempted from the Investment Company Act turned on the nature of
the assets securitized and not on the structure of the securitization transaction or the credit
quality of the underlying assets. Rule 3a-7 was designed to mitigate this inconsistency. Adopted
in 1992, Rule 3a-7 is intended to exclude virtually all structured financings from the definition of
“investment company”. In practice, however, Rule 3a-7 is seldom relied on in ABCP
transactions because the substance and structure of most ABCP transactions would not satisfy all
of the requirements of Rule 3a-7.

C. SECTION 3(c)(5) - COMMERCIAL FINANCING AND MORTGAGE

BANKING BUSINESS EXEMPTION

Paragraphs (A) and (B) of Section 3(c)(5) (“Section 3(c)(5)”) of the Investment Company
Act provide that issuers “primarily engaged” in purchasing or otherwise acquiring notes, drafts,
acceptances, receivables and other obligations representing part or all of the sales price of
merchandise, insurance and services or in making loans to manufacturers made in connection
with the purchase of specified merchandise and services are exempt from the Investment
Company Act. Paragraph (C) (“Paragraph C”) of Section 3(c)(5) provides the same exemption
for issuers that hold mortgages and other liens on and interests in real estate.

For an issuer to be “primarily engaged”, it must invest at least 55% of its assets in
“eligible loans and receivables” under paragraphs (A) and (B) under Section 3(c)(5) or
“qualifying interests” under Paragraph C. The SEC requires Paragraph C companies to invest an
additional 25% of their assets in “real estate related assets”.

To be eligible under paragraphs (A) and (B) of Section 3(c)(5), the loans and receivables
must represent part or all of the sales price of merchandise, insurance or services. The credit
must be for specific goods and services. It should be noted that:

OHS East:160049087.6 13
 (1) qualifying assets include auto loans, credit card receivables and equipment
leases, so long as the loans and receivables or extensions of credit relate to the purchase
price of specific goods or services; and

(2) general consumer or commercial loans do not qualify.

Under the mortgage banking provision contained in Paragraph C, securities that are
“qualifying interests” must represent an actual interest in real estate or be a loan or lien actually
backed by real estate. Note that:

(1) These include fee interests, leaseholds, mortgage loans, deeds of trust,
loans backed by interests in oil and gas properties and portfolios consisting of several
different types of qualifying interests.

(2) Whole pool certificates may be qualifying interests if:

(a) they are issued by a Government Agency (Federal National

Mortgage Association (“Fannie Mae”), Government National Mortgage
Association (“Ginnie Mae”), etc.); or

(b) they are privately issued and the holder of securities will share the
same economic risks and benefits as a person holding the underlying mortgages
(i.e., risk of prepayment, power to foreclose).

(3) Partial pool certificates, mortgage placement fees and securities issued by
entities that invest in real estate or that are engaged in the real estate business do not
qualify.

(4) In general, however, the interests referenced in (3) may qualify as part of
the 25% investment in real estate related assets.

D. SECTION 3(c)(7) - THE QUALIFIED PURCHASER EXEMPTION

Section 3(c)(7) creates an exception from the definition of the term “investment
company” for an issuer:

(1) that is not making and does not propose to make a public offering of its
securities; and

(2) all of whose outstanding securities are owned exclusively by “qualified

purchasers” (each a “QP”).

The term “qualified purchaser”, in summary, is defined in Section 2(a)(51)(A) of the

Investment Company Act to mean:

(1) a natural person or family company owning not less than $5 million in
investments;

OHS East:160049087.6 14
 (2) certain trusts not formed for the specific purpose of acquiring the
securities offered; and

(3) any other person (e.g., an institutional investor) that owns and invests on a
discretionary basis not less than $25 million in investments.

A company will not be deemed to be a QP if it was formed for the specific purpose of
acquiring the securities offered by a Section 3(c)(7) fund unless each beneficial owner of the
company’s securities is a QP. The term QP does not include a company that, but for the
exemptions provided by Section 3(c)(1) or Section 3(c)(7) would be an investment company (an
“excepted investment company”) unless the following persons have consented to its treatment as
a QP:

(1) all beneficial owners of its outstanding securities (other than short term
paper), determined in accordance with Section 3(c)(1)(A) of the Investment Company
Act, that acquired such securities on or before April 30, 1996 (“pre-amendment beneficial
owners”); and

(2) all pre-amendment beneficial owners of the outstanding securities (other

than short term paper) of any excepted investment company that, directly or indirectly,
owns any outstanding securities of such excepted investment company.

The Rules also contain certain grandfathering provisions providing for the conversion of
a Section 3(c)(1) fund to a Section 3(c)(7) fund provided certain notices are given to beneficial
owners of the securities along with an opportunity to redeem.

The exemption provided by Section 3(c)(7) may prove useful to issuers that otherwise
would rely on Section 3(c)(1) but are constrained by the “hundred person” limitation requirement
imposed by Section 3(c)(1).

E. COMPARISON BETWEEN QPs AND QIBs

The definition of QP in the Investment Company Act is different from the definition of a
QIB as defined in Rule 144A under the Securities Act. Consistency between the definitions may
have facilitated the establishment of programs pursuant to which an offering effected under
Section 4(2) and Rule 144A under the Securities Act would have simultaneously provided
exemption from the registration requirements of the Investment Company Act under
Section 3(c)(7).

However, while Rule 2a51-1 (“Rule 2a51-1”) under the Investment Company Act
provides that a QIB under Rule 144A of the Securities Act is generally deemed to be a QP, it
provides for two important exceptions:

(1) with respect to dealers, the SEC has prescribed that the dollar threshold for
a dealer to qualify as a QP is $25,000,000, rather than $10,000,000, as required by
Rule 144A.

OHS East:160049087.6 15
 (2) an employee investing pursuant to a self directed employee benefit plan
(such as a 401(k) plan under the Internal Revenue Code of 1978) generally would not be
considered to be a QP for purposes of Rule 2a51-1; rather, an employee could invest in a
Section 3(c)(7) fund through a self-directed plan only if the employee is a QP. However,
if the decision to invest in a Section 3(c)(7) fund is made by the plan trustee or other plan
fiduciary of a defined benefit or other retirement plan that makes investment decisions for
the plan, and the plan owns at least $25,000,000 of investments that is not subject to
participant direction, the plan would be a QP with respect to investments made by the
plan trustee or other plan fiduciary.

Accordingly, particular care needs to be taken when effecting a private offering in

compliance with Section 4(2) and Rule 144A under the Securities Act while simultaneously
relying on the exemption provided by Section 3(c)(7) of the Investment Company Act in order to
ensure that the securities are owned by persons who are both QIBs and QPs.

Significantly, the final version of Rule 2a51-1 as adopted conforms the standard for
determining whether a purchaser is a QP to the standard set forth in Rule 144A and Regulation D
under the Securities Act for determining whether a purchaser under those rules is a QIB. Rule
144A and Regulation D under the Securities Act each require a seller to have a “reasonable
belief” that the purchaser is a QIB. The final Rule 2a51-1 provides that: “The term “qualified
purchaser” as used in Section 3(c)(7) of the [Investment Company Act] means any person that
meets the definition of qualified purchaser in Section 2(a)(51)(A) of the [Investment Company
Act] and the rules thereunder, or that a Relying Person reasonably believes meets such
definition”. A “Relying Person” is defined under the Investment Company Act as a Section
3(c)(7) company or a person acting on its behalf.

The SEC has adopted, and the Rules set forth in detail, a definition of “investments” (for
the purposes of determining whether a prospective QP meets the dollar threshold applicable to it)
and how the value of such investments is to be calculated.

Rule 3c-5 has been adopted to permit “knowledgeable employees” of a fund and certain
of its affiliates to acquire certain securities issued by the fund without being counted for the
purposes of the “hundred person” limitation in Section 3(c)(1) or for the QP determination under
Section 3(c)(7). Rule 3c-5 defines knowledgeable employees as the directors, executive officers
and general partners of the fund or an affiliated person of the fund that oversees the fund’s
investments. It also treats persons who serve in capacities similar to directors, such as trustees
and advisory board members, as knowledgeable employees. Rule 3c-5 provides that any
employee who has performed substantially similar functions or duties for or on behalf of another
person during the preceding 12 months is deemed to be a knowledgeable employee.

F. NO-ACTION LETTER: FOREIGN ISSUERS AND U.S. OFFERINGS

On February 28, 1997, the SEC made publicly available a significant and fairly detailed
no-action letter which addresses some of the issues relevant to global offerings of securities by
non-U.S. issuers - in particular, where the U.S. portion of the offering is effected in accordance
with either Section 3(c)(1) or Section 3(c)(7) and the non-U.S. portion of the offering is effected
in accordance with Regulation S. In summary, the SEC’s no action letter:

OHS East:160049087.6 16
 (1) states that a foreign issuer may privately offer and sell its securities to QPs
in the U.S. in accordance with the provisions of Section 3(c)(7) without violating
Section 7(d) of the Investment Company Act (just as such an issuer is permitted to
privately offer and sell its securities in the U.S. pursuant to the provisions of Section
3(c)(1) and the related “Touche Remnant” doctrine);

(2) provides a detailed analysis of the meaning to be given to the term “U.S.
person” in the context of securities offered and sold outside the U.S. in compliance with
Regulation S;

(3) indicates that Section 7(d) of the Investment Company Act does not
prohibit a foreign issuer from conducting a private U.S. offering in compliance with
Section 3(c)(1) or Section 3(c)(7) simultaneously with an offshore public offering in
compliance with Regulation S. However, the SEC has confirmed that with respect to
offers and sales outside the U.S. to U.S. persons (as described in this no-action letter),
such U.S. persons must be “counted” with respect to the QP requirement
(for a Section 3(c)(7) offering) and the “hundred person” limitation (for a
Section 3(c)(1) offering) as the case may be; and

(4) provides that a foreign issuer must generally “count” as U.S. resident
beneficial owners all U.S. persons (as described in the referenced no-action letter) who
have purchased securities directly or indirectly from the foreign issuer, its agents,
affiliates, or intermediaries. As a corollary, the SEC has noted that a foreign issuer need
not “count” towards the “hundred person” limit (under Section 3(c)(1)) or the QP
determination (under Section 3(c)(7)): (a) non-U.S. persons who purchased the securities
outside the U.S. and then moved to the U.S.; or (b) anyone who purchased securities
outside the U.S. in secondary market transactions not involving the issuer or its agents,
affiliates, or intermediaries.

G. NO-ACTION LETTER: RESALE PROCEDURES AND PURCHASER

STATUS

In an April 1999 no-action letter, the Office of Chief Counsel of the Division of
Investment Management (the “Division”) of the SEC indicated the SEC’s view that a
Section 3(c)(7) Fund (as defined below) or other Relying Person may be able to develop
procedures for resales in the 144A market that, if followed, would be sufficient for it to form the
requisite reasonable belief under Rule 2a51-1 with respect to the status of a purchaser of its
securities as a QP. The Division issued the letter in response to a December 1997 “no-action
request” by the American Bar Association (the “ABA”). The Division stated:

(1) that any procedures developed for resales in the 144A market for purposes
of Rule 2a51-1 must be designed to provide a means by which the Section 3(c)(7) Fund
or other Relying Person can make a reasonable determination that all of the purchasers of
the Section 3(c)(7) Fund’s securities were QPs at the time that they acquired the
securities; and

OHS East:160049087.6 17
 (2) that whether a particular set of procedures would be sufficient for a
Section 3(c)(7) Fund or other Relying Person to form the requisite reasonable belief
depends on the facts and circumstances.

The Division noted in a footnote that a Relying Person might include, for example, a
participant of the Depository Trust Company (“DTC”), provided that the participant is acting on
the Section 3(c)(7) Fund’s behalf.

However, the Division refused to grant no-action relief with respect to the procedures
outlined in the ABA no-action request. The Division also stated that the SEC staff, as a matter of
policy, will not respond to requests to assess whether any particular set of procedures are
sufficient to permit a Section 3(c)(7) Fund to form such a reasonable belief consistent with
Rule 2a51-1.

In the same letter, the SEC also stated that it would not read into Section 3(c)(7) an
exemption from QP requirements for holders of short-term paper.

Although the Division has not issued any Rule 2a51-1 guidelines for satisfying
Section 3(c)(7) in book-entry securities offerings, securities lawyers have considered criteria
which could support the delivery of Section 3(c)(7) opinions in connection with such offerings.
Some examples of these criteria are as follows (such list not to be exhaustive):

(a) Offering Memorandum - Investor Representations: includes the

following disclosure and QIB/QP representations:

· Investor is a QIB/QP;

· Investor is not a broker-dealer owning less than $25 million in securities

of unaffiliated issuers;

· Investor is not a participant-directed employee plan, such as a 401(V) plan

under the Internal Revenue Code of 1978;

· QIB/QP is acting for his own account or the account of another QIB/QP;

· Investor was not formed for purpose of investing in issuer;

· Investor holds at least the minimum denomination of securities; and

· Investor will provide notice of transfer restrictions to subsequent

purchasers.

(b) Large Minimum denomination: for example, minimum

denomination set at $500,000.

(c) Distribution Agreement: indicates that distributor is a QIB/QP and

that distributor will only sell, in the primary offering or in any secondary market
transactions, to persons reasonably believed to be QPs. (Distributors should be

OHS East:160049087.6 18
 limited to sophisticated investment banks with developed ability to screen
purchasers).

(d) Trustee Option to Require Certification: through contractual

provisions, trustee reserves an option (to automatically become effective upon the
trustee receiving notice, or otherwise becoming aware, that a non-QP acquired a
security) to require beneficial owners to certify that they meet the requirements of
Section 3(c)(7). An alternative approach would be to require annual certifications
from beneficial owners to this effect. If such notification is not delivered upon
request, the trustee would either redeem the securities of such owner or force a
sale to a QP. These provisions will be reflected in the issuance documents and in
the form of security.

(e) Nullification of Sales to non-QPs: issuance documents and form of

security must contain language indicating that any sale to a non-QP is null and
void, to the extent permitted under applicable law.

(f) Password Protection for Website: any website relating to the

securities and maintained by the issuer, the distributor, the trustee or any other
administrator for the securities contains a password protected system allowing
access only to persons who certify electronically that they are, or were at the time
they acquired the securities, QPs.

(g) Bloomberg Requirements: where the securities are listed with

Bloomberg, the listing contains a Section 3(c)(7) indicator.

(h) Periodic Notification: periodic reports to holders include reminder

regarding QP limitations and the reservation of the right to force a sale or
redemption of any security held by a non-QP.

(i) DTC Descriptors: security description and deliver order include a

“3c7” marker.

(j) Publication in DTC Reference Directory: upon commencement of

this procedure by DTC, security is included in listing of Section 3(c)(7) issues
with attached description of limitations.

(k) List of DTC Participants: issuance documents and form of

security must contain language indicating that each investor shall acknowledge
that the issuer of the securities may receive from DTC a list of DTC participants
holding the securities, to the extent such securities are held in DTC.

(l) CUSIP Number: fixed field attachment indicates Section 3(c)(7)

limitation.

OHS East:160049087.6 19
Euroclear and Clearstream Banking Procedures and European Book Entry

Euroclear Bank S.A./N.V. ("Euroclear") and Clearstream Banking Luxembourg ("Clearstream

Banking") are now able to implement, upon issuer request, procedures that parallel those
available at DTC. It is the issuer's responsibility to request such procedures at these service
providers with respect to a particular security.

Euroclear
Euroclear has indicated that they are able to do the following to facilitate the issuer's ability to
monitor resales. The Issuer must specifically instruct Euroclear to take these or similar steps
with respect to its 3(c)(7) securities, as set forth below.

(a) Section (3)(c)(7) marker: the security name will reference

“144A/3(c)(7)” in the Euroclear securities database. All Euroclear participants
who settle Section (3)(c)(7) securities in the Euroclear system will see that
descriptor in the name field of Section (3)(c)(7) securities.

(b) Settlement Notice: participants receive a daily securities balances

report listing their positions in all securities held through Euroclear and a daily
securities transaction report confirming settlement in all trades executed by the
participant that day.

(c) User Manual: the New Issues Acceptance Guide, Euroclear’s user
manual for participants, will include a description of the Section 3(c)(7)
restrictions.

(d) Important Notice: Euroclear will periodically (and at least

annually) send to the Euroclear participants holding positions in Section 3(c)(7)
securities an electronic “Important Notice” outlining the restrictions applicable to
Section (3)(c)(7) securities.

(e) List of participants: Euroclear will provide to the issuer, upon its
request, a list of all Euroclear participants holding positions in its
Section (3)(c)(7) securities so that the issuer can periodically (and at least once
per year) send a notice to all such participants outlining the restrictions applicable
to Section (3)(c)(7) securities.

(f) List of securities: Euroclear will also distribute monthly to all

participants a list of all securities accepted within the securities’ database
(updated on a bi-monthly basis).

OHS East:160049087.6 20
Clearstream Banking
Clearstream Banking has indicated that they are able to do the following to facilitate the issuer's
ability to monitor resales. The Issuer must specifically instruct Clearstream Banking to take
these or similar steps with respect to its 3(c)(7) securities, as set forth below.

(a) Section (3)(c)(7) marker: The security name will reference

“144A/3(c)(7)” in the Clearstream Banking securities database. All Clearstream
Banking participants who settle Section (3)(c)(7) securities through Clearstream
Banking will see that descriptor in the name field of Section (3)(c)(7) securities.

(b) Settlement Notice: participants receive a daily portfolio report

listing their positions in all securities held through Clearstream Banking and a
daily settlement report confirming settlement in all trades executed by the
participants that day.

(c) User Manual: the Customer Handbook, Clearstream Banking’s

user manual for participants, will include a description of the Section (3)(c)(7)
restrictions.

(d) Important Notice: Clearstream Banking will periodically (and at

least annually) send to the Clearstream Banking participants holding positions in
Section (3)(c)(7) securities an electronic “Important Notice” outlining the
restrictions applicable to Section (3)(c)(7) securities.

(e) List of Participants: Clearstream Banking will provide to the

issuer, upon its request, a list of all Clearstream Banking participants holding
positions in its Section (3)(c)(7) securities so that the issuer can periodically (at
least once per year) send a notice to all such participants outlining the restrictions
applicable to Section (3)(c)(7) securities.

(f) List of securities: Clearstream Banking will also make available to

all of its participants, via its website, a continually updated list of all securities
accepted within its database.

In connection with a subsequent offering by any issuer (either through DTC, Euroclear,
or Clearstream Banking) using the above procedures, there will have to be a due
diligence investigation to confirm such procedures have been observed in any prior
offerings. In addition, the issuer will have to follow these procedures for the new
offering.

H. NO-ACTION LETTER: REGISTRATION AS AN INVESTMENT

COMPANY

On July 8, 2002, the Division released a no-action letter which addressed whether it
would seek an enforcement action against a bank or a U.S. domestic commercial paper conduit

OHS East:160049087.6 21
organized by such bank if such conduit does not register as an investment company under the
Investment Company Act where (i) such conduit issues short term paper in an offering in the
U.S. that satisfies the Section 4(2) exemption and (ii) such conduit simultaneously issues short
term paper in an offering outside the U.S. in compliance with the provisions of Regulation S.

The arranger of such a commercial paper conduit inquired whether the Division would
recommend enforcement of the registration of such conduit as an investment company because
the offshore public offering of short term paper could be construed to mean that the conduit
could not rely on the Section 3(c)(1) exception.

In supporting its position that registration should not be required, the arranger argued that
the SEC should apply the same extraterritorial approach envisioned by Regulation S to the
analysis of whether the registration of the conduit as an investment company is required. The
arranger also argued that public interest would not be served by requiring the registration of the
conduit as an investment company after considering (i) the practical costs involved in
registration and (ii) the marginal benefit that registration would yield.

After a lengthy review of the legal and practical analyses presented by the arranger, the
Division responded, “we would not recommend enforcement action against the [bank] or [the
conduit] if the [c]onduit does not register as an ‘investment company’…and the [c]onduit offers
and sells its [Notes] in an offering in the United States that is exempt from the registration
requirements of the [Securities Act], pursuant to Section 4(2)…while simultaneously offering
and selling its [Notes] in an offering outside of the United States in compliance with Regulation
S…”

I. RULE 2A-7

Set forth below is a summary of some of the more significant provisions of Rule 2a-7
(“Rule 2a-7”) of the Investment Company Act which are applicable to asset-backed securities
(“ABS”).

(1) Issuer Diversification

Rule 2a-7 provides that a money market fund shall not, immediately after the
acquisition of any security, have invested more than 5% of its total assets in securities
issued by the issuer of a security. However, the money market fund may invest up to
25% of its total assets in the first tier securities of a single issuer for a period of up to
3 business days - the 3 day safe harbor - after the acquisition thereof but cannot invest in
the securities of more than one issuer under the safe harbor at any time.
Rule 2a-7 permits a money market fund to exclude from the issuer diversification
standards a security subject to a guarantee provided by a person that does not control, or
is not controlled by or under common control with, the issuer of the security (a “non-
controlled person”).

Rule 2a-7 treats an SPE that issues ABS as the issuer of such securities and
therefore requires that the diversification standards be met with respect to the SPE.
Rule 2a-7 provides an exception to this treatment, however, and requires a money market
fund to “look-through” the SPE to any issuer of qualifying assets whose obligations

OHS East:160049087.6 22
 constitute 10% or more of the principal amount of the qualifying assets of the SPE (such
an Issuer being a “ten percent obligor”). For diversification purposes, a money market
fund is required to treat these ten percent obligors as if they issued a proportionate
amount of the securities issued by the SPE.

Some or all of the qualifying assets of certain ABS (“primary ABS”) also consist
of other ABS (“secondary ABS”). For purposes of identifying ten percent obligors,
money market funds are required to identify and treat as proportionate issuers of an ABS
acquired by a money market fund (primary ABS), only ten percent obligors of the
primary ABS and, if a ten percent obligor of a primary ABS is itself an SPE issuing ABS
(secondary ABS), any ten percent obligors of any secondary ABS. Money market funds
need not, however, “look-through” to the qualifying assets of any ten percent obligor of a
“tertiary ABS” (i.e., a ten percent obligor of a secondary ABS that is itself an SPE issuing
ABS) for purposes of compliance with Rule 2a-7’s diversification standards.

In addition, a particular type of ABS issuer, a “restricted special purpose entity”

that does not issue its ABS to anyone other than another specific ABS issuer (other than
securities issued to a company that controls, or is controlled by or under common control
with, the restricted special purpose entity), is excluded from treatment as a ten percent
obligor and thus not counted for diversification purposes.

Finally, the SEC adopted a proposed amendment to clarify that in the case of any
ten percent obligors deemed to be issuers for purposes of Rule 2a-7’s diversification
standards, any demand features or guarantees (each discussed below) supporting the
obligations of the ten percent obligors are treated as being held by the money market fund
and are subject to Rule 2a-7’s demand feature and guarantee diversification standards
(discussed below).

(2) Diversification For Guarantees and Demand Features

Rule 2a-7 provides that a money market fund may not invest, with respect to
seventy-five percent of its total assets, more than ten percent of its total assets in
securities issued by or subject to a guarantee or demand feature from the same institution.
A money market fund is not subject to the ten percent limitation with respect to the
remaining twenty-five percent of its total assets (such percentage referred to as “twenty-
five percent basket”) if the securities held in the basket are first tier securities and the
guarantee or demand features are issued by non-controlled persons.

Under Rule 2a-7, all guarantees must be rated by a Nationally Recognized

Statistical Rating Organization (“NRSRO”), except:

(a) a guarantee issued by a person that, directly or indirectly, controls,

is controlled by or is under common control with the issuer of the security subject
to the guarantee;

(b) a guarantee with respect to a repurchase agreement (“repo”) that is

“collateralized fully”;

OHS East:160049087.6 23
 (c) a guarantee issued by the U.S. Government; or

(d) a guarantee not relied upon for quality, maturity or liquidity

purposes.

Rule 2a-7 provides that any rating (long or short term) from an NRSRO will
satisfy this rating requirement.

A guarantee generally means an unconditional obligation of a person, other than

the issuer of the security, to undertake to pay, upon presentment by the holder of a
guarantee (if required), principal plus accrued interest on a security when due or upon
default. A guarantee includes a letter of credit, financial guaranty (bond) insurance, and
an unconditional demand feature provided by a party other than the issuer of the security.

Money market funds may disregard a guarantee that is not relied upon to satisfy
Rule 2a-7’s credit quality or maturity standards, or for liquidity, for all purposes under
Rule 2a-7.

Rule 2a-7 permits money market funds to treat a first loss guarantee as a
fractional guarantee when calculating compliance with Rule 2a-7’s guarantee and
demand feature diversification standards. The SEC has, however, cautioned money
market funds to carefully consider potential exposure to the credit risks of a first loss
guarantor when evaluating whether investment in an ABS is consistent with the money
market fund’s objective of maintaining a stable net asset value.

Footnote 68 from the Release that accompanied Rule 2a-7 is relevant in this
context. It states that: “ABS also may be subject to “second loss guarantees” that
guarantee a specific amount of losses in excess of losses covered by a first loss
guarantee. Money market funds should treat second loss guarantees of ABS in the same
manner as any other fractional guarantees or demand features under the amended rule.
Arrangers of ABS may provide additional credit risk protection by structuring an offering
such that the value of qualifying assets in the pool exceeds the amount of the ABS
offering. For example, a $1 billion dollar ABS offering might be collateralized by an
asset pool of $1.1 billion. The $100 million of “overcollateralization” may be applied to
cover any first losses incurred before drawing upon third-party guarantees or other
credit enhancements. Although overcollateralization would be relevant in determining
whether the ABS presents minimal credit risks, this type of seller-provided credit
enhancement does not fall within the rule’s definition of a guarantee or demand feature
and may be disregarded for purposes of the rule’s diversification standards.”

(3) Periodic Determinations Regarding Ten Percent Obligors

Rule 2a-7 does not require periodic determinations with respect to any ABS that a
money market fund’s board of directors initially has determined will never have, or is
unlikely to have, any ten percent obligors. This determination may be based upon a
structural analysis of the ABS or upon representations in the offering materials or
governing documents of an ABS that it will never have, or is unlikely to have, ten percent
obligors. Money market funds also must maintain a record of this determination.

OHS East:160049087.6 24
 (4) Swap Arrangements

Some types of ABS may consist of qualifying assets whose cash flow has been
“swapped” to a financial institution that ultimately acts as the primary source of payment
to money market funds holding the ABS. The SEC determined not to amend
Rule 2a-7 to specifically address the treatment of swaps or similar arrangements. The
SEC noted, however, that swaps and similar arrangements that fall within Rule 2a-7’s
definition of a guarantee or demand feature should be treated as such for purposes of
guarantee and demand feature diversification. Consistent with a belief that such swap
arrangements may provide substantively the same benefit as, for instance, a guarantee,
the SEC recommended in the Release that a money market fund’s adviser should seek to
ensure that investments by the money market fund in securities, subject to swap
arrangements, are consistent with Rule 2a-7’s overriding policy of limiting money market
funds to investments that are consistent with maintaining a stable net asset value and do
not expose the money market fund excessively to credit risks posed by swap
counterparties (e.g., if the money market fund is relying on the creditworthiness of the
institution acting as swap counterparty to the SPE).

(5) Repurchase Agreement

Rule 2a-7 permits a money market fund to “look-through” a repo to the

underlying collateral and disregard the counterparty in determining compliance with
Rule 2a-7’s diversification standards if the obligation of the counterparty is
“collateralized fully”. A repo will be “collateralized fully” if (i) the collateral consists
entirely of cash, U.S. government securities, or other securities that are rated in the
highest rating category by the requisite NRSROs, and (ii) upon an event of insolvency
with respect to the seller, the repo qualifies under a provision of applicable insolvency
law providing an exclusion from any “general stay” of creditors’ rights against the seller.

Three commentators urged that Rule 2a-7, as originally drafted, be modified to

refer to an “automatic stay” rather than a “general stay”. These commentators pointed
out that even a repo protected from an automatic stay under federal insolvency law may
be subject to a court-ordered general stay obtained by the Securities Investor Protection
Corporation (“SIPC”) or the Federal Deposit Insurance Corporation (“FDIC”). Because
no provision of insolvency law protects a purchaser of a repo from such orders, the
proposed amendments might have precluded money market funds from relying on
Rule 2a-7’s “look-through” provision for most repos, even though it is the policy of both
SIPC (as to broker-dealer counterparties) and FDIC (as to bank counterparties) generally
to allow the prompt liquidation of repos in insolvency proceedings.

The SEC adopted the rules in this regard, revised in part to reflect the
commentators’ suggestions. The SEC noted that, under Rule 2a-7, a fund entering into a
repo collateralized by U.S. government securities (which most are) should be able to
conclude that the repo qualifies for “look-through” treatment (assuming the other
requirements of Rule 2a-7 are met), while funds wishing to enter into repos using less
traditional forms of collateral may rely on opinions of bankruptcy counsel.

OHS East:160049087.6 25
 Two commentators suggested that the SEC exclude guarantees issued by the U.S.
government from Rule 2a-7’s guarantee and demand feature diversification standards as
finally amended, and thus treat government guarantees in the same manner as securities
issued directly by the U.S. government. The SEC amended the demand feature and
guarantee diversification standards accordingly.

J. EFFECT OF FIN 46R ON RULE 2a-7

This section discusses the effect, if any, of the Financial Accounting Standards Board
Interpretation No. 46R, Consolidation of Variable Interest Entities, as amended (“FIN 46R”) on
the application of Rule 2a-7 of the Investment Company Act to ABCP programs. In particular, it
considers whether U.S. registered money market funds should treat an arranger of an ABCP
program as the issuer of the ABCP for purposes of Rule 2a-7 if the arranger is required to
consolidate the activities of the SPE that issues such ABCP for U.S. generally accepted
accounting principles (“U.S. GAAP”) purposes pursuant to FIN 46R.

FIN 46R is a U.S. GAAP accounting interpretation that provides guidance for the
circumstances in which SPEs and other variable interest entities should be consolidated, for U.S.
GAAP purposes, onto the balance sheet of another entity that has a majority of the variable gains
or losses associated with the activities of the variable interest entity.

Before the adoption of FIN 46R, an ABCP program arranger could take the position that
it was not required to include the financial results of the SPE in its consolidated financial
statement because the administrator did not control the SPE through the ownership of the SPE’s
voting securities or otherwise. However, upon the effectiveness of FIN 46R, many SPEs may be
treated as a “variable interest entity” in which the ABCP program arranger has a controlling
financial interest. Such arrangers would be required to consolidate the SPE and its financial
results on the arranger’s balance sheet for U.S. GAAP purposes.

As a result, such arrangers and certain investors in ABCP programs have considered
whether the adoption of FIN 46R requires U.S. registered money market funds to treat the
arranger as the issuer of the ABCP for purposes of Rule 2a-7.

When the portions of Rule 2a-7 that relate to the required treatment of securitization
transactions were adopted in 1997, the SEC considered and rejected an approach that would have
required U.S. registered money funds to treat arrangers of asset backed securities transactions as
the issuers of such securities for purpose of Rule 2a-7. Rule 2a-7 instead treats the SPE as a
separate entity and requires registered money fund investors to treat the SPE as a separate issuer
and to further focus on any concentration of asset risk within any such SPE, in the form of one or
more 10% obligors. The consolidation of financial statements required by FIN 46R does not
affect the substance of the credit risk associated with the purchase by U.S. registered investment
companies of asset backed securities. Instead, FIN 46R merely provides guidance as to whether
the activities of an SPE should be consolidated onto the books of another party for U.S. financial
reporting purposes. Therefore, FIN 46R should not cause the arranger of an ABCP program to
be considered to be an issuer of the ABCP for Rule 2a-7 diversification purposes.

OHS East:160049087.6 26
 Although the arranger is not the issuer of the ABCP, it would be the issuer of any
fractional guarantee (e.g., a letter of credit) provided by it to support the issuer’s obligation to
pay the ABCP. Assuming that the arranger has received the highest short term rating (without
regard to pluses and minuses) from the requisite number of rating agencies, then, with respect to
75% of a money market fund’s total assets, the fund may not invest more than 10% of its total
assets in the portion of the ABCP guaranteed by the arranger plus other securities issued by,
subject to demand features provided by, or guaranteed by, the arranger.

For more information on FIN 46R see Article IX “Accounting Developments Impacting
ABCP Programs”, below.

V. RISK BASED CAPITAL – REVISED BASEL CAPITAL ACCORD

A banking institution arranging an ABCP program to effect an off-balance sheet

financing of assets will, in addition to addressing the structure and legal concerns described
above, need to satisfy certain capital adequacy requirements promulgated by the Basel
Committee on Banking Supervision2 (the “Committee”) and the relevant national bank
regulators. The U.S. Federal bank regulators include the Office of the Comptroller of the
Currency (the “OCC”), the Board of Governors of the Federal Reserve System (the “Board”), the
FDIC, and the Office of Thrift Supervision (the “OTS” and, together with the OCC, the Board
and the FDIC, the “Agencies”).

The Committee in late June 2004 issued the final version of the revised Basel Capital
Accord (“International Convergence of Capital Measurement and Capital Standards: A Revised
Framework”) (the “Revised Accord”). The Revised Accord replaces the original Basel Capital
Accord adopted in 1988 (the “Original Accord”). It sets forth a model set of capital adequacy
guidelines that - subject to implementation in individual jurisdictions - are intended for use by
regulators and banking organizations both in the countries represented on the Committee and
elsewhere.

On July 20, 2007, U.S. Federal bank regulators announced that they had resolved all
major outstanding issues regarding the implementation of the Revised Accord in the United
States and that they would expeditiously finalize rules that began implementing the Revised
Accord. The Revised Accord consists of three principal components: (a) minimum regulatory
capital requirements; (b) guidelines for the supervisory review of each institution’s capital
adequacy and internal assessment process; and (c) guidelines pertaining to the effective use of
market discipline. This article discusses the minimum regulatory capital requirements in the
Revised Accord with a particular focus on the treatment of asset securitizations.

2
The Basel Committee on Banking Supervision is a committee of banking supervisory authorities which was
established by the central bank Governors of the Group of Ten countries in 1975. It consists of senior
representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy,
Japan, Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States. It usually
meets at the Bank for International Settlements in Basel, where its permanent Secretariat is located.

OHS East:160049087.6 27
 A. SCOPE OF THE SECURITIZATION FRAMEWORK

In general, the securitization framework applies to transactions that involve the

stratification or tranching of credit risk. Securitization exposures include, but are not restricted
to, the following: asset-backed securities, mortgage-backed securities, credit enhancements,
liquidity facilities, interest rate or currency swaps and credit derivatives. Transactions that
constitute “specialized lending” (“SL”) will not be treated as securitizations but will instead be
treated as corporate exposures as described in the Revised Accord.

The securitization framework focuses on the risk related to different exposures and, in
certain circumstances, it applies different capital requirements for originating banks, as described
herein.3 In order for a bank to obtain capital relief with respect to a securitization transaction
(including both funded and synthetic transactions) certain operational criteria must be satisfied,
as further described in the Revised Accord. In addition, certain operational criteria apply to the
ability of a bank to use credit ratings provided by rating agencies to obtain capital relief with
respect to a securitization transaction, as further described in the Revised Accord.

The framework for the treatment of securitizations permits banks to calculate the capital
requirements in securitizations under either a Standardized Approach or (if the bank has received
regulatory approval) an Internal Ratings-Based (“IRB”) Approach. The Standardized Approach
and the IRB Approach are each discussed in detail below.

B. STANDARDIZED APPROACH FOR SECURITIZATION EXPOSURES

The risk-weighted amount of a securitization exposure is computed under the

Standardized Approach by multiplying the amount of the position by the appropriate risk weight
determined in accordance with Table 1 attached hereto. For off-balance sheet exposures, banks
must apply a credit conversion factor (“CCF”) and then risk weight the resultant credit
equivalent amount. For positions with long-term ratings of B+ and below and for those that are
unrated, deduction from capital will generally be required. Deduction is also generally required
for positions with short-term ratings other than A-1/P-1 (or higher), A-2/P-2 or A-3/P-3.

The capital treatment of positions retained by originators, liquidity facilities, recognition

of credit risk mitigants, and securitizations of revolving exposures are identified separately.

Only third-party investors, as opposed to banks that serve as originators, may recognize
external credit assessments that are equivalent to BB+ to BB- for risk weighting purposes of
securitization exposures. Originating banks must deduct all retained securitization exposures
rated below investment grade (i.e., BBB-).

3
A bank is considered to be an originator with regard to a certain securitization if it meets either of the
following conditions:
(a) the bank originates directly or indirectly exposures included in the securitization; or
(b) the bank serves as a sponsor of an asset-backed commercial paper conduit or similar program that acquires
exposures from third party entities. In the context of such programs, a bank would generally be considered a
sponsor and in turn, an originator if it, in fact or in substance, manages or advises the program, places securities into
the market, or provides liquidity and/or credit enhancements.

OHS East:160049087.6 28
Exceptions to General Treatment of Unrated Securitization Exposures

(a) Treatment of unrated most senior securitization exposures in

securitizations

If the most senior securitization exposure of a traditional or synthetic securitization is

unrated, a bank that holds or guarantees such an exposure may apply a “look-through” treatment
provided the composition of the underlying pool is known at all times. Banks are not required to
consider interest rate or currency swaps when determining whether a position is most senior for
the purpose of applying the “look-through” approach. In the “look-through” treatment, the
unrated most senior position receives the average risk weight of the underlying exposures subject
to supervisory review. Where the bank is unable to determine the risk weights assigned to the
underlying credit risk exposure(s), the unrated position must be deducted.

(b) Treatment of exposures that are in a second loss position or better

in asset-backed commercial paper (“ABCP”) programs

Deduction is not required for unrated securitization exposures provided by sponsoring

banks to ABCP programs that satisfy the following requirements:

(i) The exposure is economically in a second loss position or better and the first loss
position provides significant credit protection to the second loss position;

(ii) The associated credit risk is the equivalent of investment grade or better; and

(iii) The bank holding the unrated securitization exposure must not retain or provide
the first loss position.

Where these conditions are satisfied, the risk weight is the greater of (i) 100% or (ii) the
highest risk weight assigned to any of the underlying individual exposures covered by the
facility.

(c) Risk weights for eligible liquidity facilities

For eligible liquidity facilities, the risk weight applied to the exposure’s credit equivalent
amount is equal to the highest risk weight assigned to any of the underlying individual exposures
covered by the facility.

Eligible Liquidity Facilities

Banks are permitted to treat off-balance sheet securitization exposures as eligible

liquidity facilities if the following minimum requirements are satisfied:

(a) The facility documentation must clearly identify and limit the
circumstances under which it may be drawn. Draws under the facility must be
limited to the amount that is likely to be repaid fully from the liquidation of the
underlying exposures and any seller-provided credit enhancements. In addition,
the facility must not cover any losses incurred in the underlying pool of exposures

OHS East:160049087.6 29
 prior to a draw, or be structured such that draw-down is certain (as indicated by
regular or continuous draws);

(b) The facility must be subject to an asset quality test that precludes it
from being drawn to cover credit risk exposures that are in default.4 In addition,
if the exposures that a liquidity facility is required to fund are externally rated
securities, the facility can only be used to fund securities that are externally rated
investment grade at the time of funding;

(c) The facility cannot be drawn after all applicable (e.g., transaction
specific and program-wide) credit enhancements from which the liquidity would
benefit have been exhausted; and

(d) Repayment of draws on the facility (i.e., assets acquired under a

purchase agreement or loans made under a lending agreement) must not be
subordinated to any interests of any note holders in the program (e.g., ABCP
program) or subject to deferral or waiver.

Where these conditions are met, the bank may apply a 20% CCF to the amount of eligible
liquidity facilities with an original maturity of one year or less, or a 50% CCF if the facility has
an original maturity of more than one year. All “ineligible” liquidity facilities receive a 100%
CCF, regardless of maturity. However, if an external rating of the facility itself is used for risk-
weighting the facility, a 100% CCF must be applied.

Treatment of Overlapping Exposures

Banks are required to hold risk-based capital only once for any exposure covered by
overlapping facilities provided by the same bank. In particular, banks are required to hold risk-
based capital based on the highest amount of risk-based capital assessed against any such
overlapping facility. For example, if a bank provides a program-wide credit enhancement
covering 10 percent of the underlying asset pools in an ABCP program and pool-specific
liquidity facilities covering 100 percent of each of the underlying asset pools, the bank would be
required to hold capital against (i) 10 percent of the underlying asset pools because it is
providing the program-wide credit enhancement and (ii) 90 percent of the liquidity facilities it is
providing to each of the underlying asset pools.

If different banks provide overlapping exposures to an asset-backed issuer, each bank is

required by the final rule to hold capital against the entire maximum amount of its exposure. As

4
A ‘default’ is considered to have occurred with regard to a particular obligor when either or both of the two
following events has taken place:
• The bank considers that the obligor is unlikely to pay its credit obligations to the banking group in full,
without recourse by the bank to actions such as realizing security (if held).
• The obligor is past due more than 90 days on any material credit obligation to the banking group.
Overdrafts will be considered as being past due once the customer has breached an advised limit or been
advised of a limit smaller than current outstandings.

OHS East:160049087.6 30
a result, duplication of capital charges could occur where multiple banking organizations have
overlapping exposures to the same asset-backed issuer.

C. INTERNAL RATINGS-BASED APPROACH FOR SECURITIZATIONS

Banks that have received approval to use the IRB approach for the type of underlying
exposure(s) securitized (e.g., for their corporate, retail or SL portfolio) must use the IRB
approach for securitizations. Conversely, banks may not use the IRB approach to securitization
unless they receive approval to use the IRB approach for the underlying exposures from their
national supervisors. If the bank is using the IRB approach for some exposures and the
standardized approach for other exposures in the underlying pool, it should generally use the
approach corresponding to the predominant share of exposures within the pool. The bank should
consult with its national supervisors on which approach to apply to its securitization exposures.
To ensure appropriate capital levels, there may be instances where the supervisor requires a
treatment other than this general rule. Where there is no specific IRB treatment for the
underlying asset type, originating banks that have received approval to use the IRB approach
must calculate capital charges on their securitization exposures using the standardized approach
in the securitization framework, and investing banks with approval to use the IRB approach must
apply the ratings-based approach.

Hierarchy of approaches

The Ratings-Based Approach (“RBA”) must be applied to securitization exposures that

are rated, or where a rating can be inferred. Where an external or an inferred rating is not
available, either the Supervisory Formula (“SF”) or the Internal Assessment Approach (“IAA”)
must be applied. The IAA is only available to exposures (e.g., liquidity facilities and credit
enhancements) that banks (including third-party banks) extend to ABCP programs. Such
exposures must satisfy the IAA conditions (as described below). Liquidity facilities to which
none of these approaches can be applied may qualify for an alternative formula that avoids the
need for deduction. See “Liquidity Facilities” below. Eligible servicer cash advance facilities
may qualify for a 0% CCF as described above. Securitization exposures to which none of these
exposures can be applied must be deducted.

Maximum capital requirement

For a bank using the IRB approach to securitization, the maximum capital requirement
for the securitization exposures it holds is equal to the IRB capital requirement that would have
been assessed against the underlying exposures had they not been securitized and treated under
the IRB framework. In addition, banks must deduct the entire amount of any gain-on-sale and
credit enhancing I/Os arising from the securitization transaction in accordance with the Revised
Accord.

Ratings Based Approach (“RBA”)

Under the RBA, the risk-weighted assets are determined by multiplying the amount of the
exposure by the appropriate risk weights, provided in the tables below.

OHS East:160049087.6 31
 The risk weights depend on (i) the external rating grade or an available inferred rating,
(ii) whether the credit assessment (external or inferred) represents a long-term or a short-term
credit rating, (iii) the granularity of the underlying pool and (iv) the seniority of the position.

For purposes of the RBA, a securitization exposure is treated as a senior tranche if it is

effectively backed or secured by a first claim on the entire amount of the assets in the underlying
securitized pool. While this generally includes only the most senior position within a
securitization transaction, in some instances there may be some other claim that, in a technical
sense, may be more senior in the waterfall (e.g., a swap claim) but may be disregarded for
purposes of determining which positions are subject to the “senior tranches” column.

The ABS risk weights provided in the first table below apply when the external
assessment represents a long-term credit rating, as well as when an inferred rating based on a
long-term rating is available.

Banks may apply the risk weights for senior positions if the effective number of
underlying exposures (N)5 is 6 or more and the position is senior as described above. When N is
less than 6, the risk weights in column 4 of the first table below apply. In all other cases, the risk
weights in column 3 of the first table below apply.

ABS risk weights when the external assessment represents a long-term credit rating and/or
an inferred rating derived from a long-term assessment

Risk weights for

senior positions Risk weights for
External Rating and eligible senior Base risk tranches backed by
(Illustrative) IAA exposures weights non-granular pools
AAA 7% 12% 20%
AA 8% 15% 25%
A+ 10% 18% 35%
A 12% 20% 35%
A- 20% 35% 35%
BBB+ 35% 50% 50%
BBB 60% 75% 75%
BBB- 100% 100% 100%
BB+ 250% 250% 250%
BB 425% 425% 425%
BB- 650% 650% 650%
Below BB- Deduction Deduction Deduction

5
(N) is defined in the Revised Accord.

OHS East:160049087.6 32
 Risk weights for
senior positions
External Rating and eligible senior
(Illustrative) IAA exposures
and unrated
Risk weights for
Base risk tranches backed by
weights non-granular pools

The ABS risk weights in the table below apply when the external assessment represents a
short-term credit rating, as well as when an inferred rating based on a short-term rating is
available. The decision rules outlined above also apply for short-term ratings.

RBA risk weights when the external assessment represents a short-term credit
rating and/or an inferred rating derived from a short-term assessment

Risk weights for

senior positions and Risk weights for
External Rating eligible senior IAA Base risk tranches backed by
(Illustrative) exposures weights non-granular pools
A-1/P-1 7% 12% 20%
A-2/P-2 12% 20% 35%
A-3/P-3 60% 75% 75%
All other Deduction Deduction Deduction
ratings/unrated

Use of Inferred Ratings

When the following minimum operational requirements are satisfied a bank must
attribute an inferred rating to an unrated position. These requirements are intended to ensure that
the unrated position is senior in all respects to an externally rated securitization exposure termed
the ‘reference securitization exposure’.

Operational requirements for inferred ratings

The following operational requirements must be satisfied to recognize inferred ratings:

(a) The reference securitization exposure (e.g., ABS) must be

subordinate in all respects to the unrated securitization exposure. Credit
enhancements, if any, must be taken into account when assessing the relative
subordination of the unrated exposure and the reference securitization exposure.
For example, if the reference securitization exposure benefits from any third-party
guarantees or other credit enhancements that are not available to the unrated
exposure, then the latter may not be assigned an inferred rating based on the
reference securitization exposure.

(b) The maturity of the reference securitization exposure must be

equal to or longer than that of the unrated exposure.

OHS East:160049087.6 33
 (c) On an ongoing basis, any inferred rating must be updated
continuously to reflect any changes in the external rating of the reference
securitization exposure.

(d) The external rating of the reference securitization exposure must

satisfy the general requirements for recognition of external ratings as delineated in
the standardized approach to external credit assessments.

Internal Assessment Approach (“IAA”)

A bank may use its internal assessments of the credit quality of the securitization
exposures the bank extends to ABCP programs (e.g., liquidity facilities and credit enhancements)
if the bank’s internal assessment process meets the operational requirements below. Internal
assessments of exposures provided to ABCP programs must be mapped to equivalent external
ratings of an external credit assessment institution (“ECAI”). Those rating equivalents are used
to determine the appropriate risk weights under the RBA for purposes of assigning the notional
amounts of the exposures.

A bank’s internal assessment process must meet the following operational requirements
in order to use internal assessments in determining the IRB capital requirement arising from
liquidity facilities, credit enhancements, or other exposures extended to an ABCP program.

(a) For the unrated exposure to qualify for the IAA, the ABCP must be
externally rated. The ABCP itself is subject to the RBA.

(b) The internal assessment of the credit quality of a securitization

exposure to the ABCP program must be based on an ECAI criteria for the asset
type purchased and must be the equivalent of at least investment grade when
initially assigned to an exposure. In addition, the internal assessment must be
used in the bank’s internal risk management processes, including management
information and economic capital systems, and generally must meet all the
relevant requirements of the IRB framework.

(c) In order for banks to use the IAA, their supervisors must be
satisfied (i) that the ECAI meets the ECAI eligibility criteria and (ii) with the
ECAI rating methodologies used in the process. In addition, banks have the
responsibility to demonstrate to the satisfaction of their supervisors how these
internal assessments correspond with the relevant ECAI’s standards.

For instance, when calculating the credit enhancement level in the context of the IAA,
supervisors may, if warranted, disallow on a full or partial basis any seller-provided recourse
guarantees or excess spread, or any other first loss credit enhancements that provide limited
protection to the bank.

(d) The bank’s internal assessment process must identify gradations of

risk. Internal assessments must correspond to the external ratings of ECAIs so
that supervisors can determine which internal assessment corresponds to each
external rating category of the ECAIs.

OHS East:160049087.6 34
 (e) The bank’s internal assessment process, particularly the stress
factors for determining credit enhancement requirements, must be at least as
conservative as the publicly available rating criteria of the major ECAIs that are
externally rating the ABCP program’s commercial paper for the asset type being
purchased by the program. However, banks should consider, to some extent, all
publicly available ECAI ratings methodologies in developing their internal
assessments.

· In the case where (i) the commercial paper issued by an ABCP program is
externally rated by two or more ECAIs and (ii) the different ECAIs’
benchmark stress factors require different levels of credit enhancement to
achieve the same external rating equivalent, the bank must apply the ECAI
stress factor that requires the most conservative or highest level of credit
protection. For example, if one ECAI required enhancement of 2.5 to
3.5 times historical losses for an asset type to obtain a single A rating
equivalent and another required 2 to 3 times historical losses, the bank
must use the higher range of stress factors in determining the appropriate
level of seller-provided credit enhancement.

· When selecting ECAIs to externally rate an ABCP program, a bank must

not choose only those ECAIs that generally have relatively less restrictive
rating methodologies. In addition, if there are changes in the methodology
of one of the selected ECAIs, including the stress factors, that adversely
affect the external rating of the program’s commercial paper, then the
revised rating methodology must be considered in evaluating whether the
internal assessments assigned to ABCP program exposures are in need of
revision.

· A bank cannot utilize an ECAI’s rating methodology to derive an internal

assessment if the ECAI’s process or rating criteria is not publicly
available. However, banks should consider the non-publicly available
methodology – to the extent that they have access to such information – in
developing their internal assessments, particularly if it is more
conservative than the publicly available criteria.

· In general, if the ECAI rating methodologies for an asset or exposure are

not publicly available, then the IAA may not be used. However, in certain
instances, for example, for new or uniquely structured transactions, which
are not currently addressed by the rating criteria of an ECAI rating the
program’s commercial paper, a bank may discuss the specific transaction
with its supervisor to determine whether the IAA may be applied to the
related exposures.

(f) Internal or external auditors, an ECAI, or the bank’s internal credit

review or risk management function must perform regular reviews of the internal
assessment process and assess the validity of those internal assessments. If the
bank’s internal audit, credit review, or risk management functions perform the

OHS East:160049087.6 35
 reviews of the internal assessment process, then these functions must be
independent of the ABCP program business line, as well as the underlying
customer relationships.

(g) The bank must track the performance of its internal assessments
over time to evaluate the performance of the assigned internal assessments and
make adjustments, as necessary, to its assessment process when the performance
of the exposures routinely diverges from the assigned internal assessments on
those exposures.

(h) The ABCP program must have credit and investment guidelines,
i.e., underwriting standards, for the ABCP program. In the consideration of an
asset purchase, the ABCP program (i.e., the program administrator) should
develop an outline of the structure of the purchase transaction. Factors that
should be discussed include the type of asset being purchased; type and monetary
value of the exposures arising from the provision of liquidity facilities and credit
enhancements; loss waterfall; and legal and economic isolation of the transferred
assets from the entity selling the assets.

(i) A credit analysis of the asset seller’s risk profile must be

performed and should consider, for example, past and expected future financial
performance; current market position; expected future competitiveness; leverage,
cash flow, and interest coverage; and debt rating. In addition, a review of the
seller’s underwriting standards, servicing capabilities, and collection processes
should be performed.

(j) The ABCP program’s underwriting policy must establish

minimum asset eligibility criteria that, among other things:

· exclude the purchase of assets that are significantly past due or defaulted;

· limit excess concentration to individual obligor or geographic area; and

· limit the tenor of the assets to be purchased.

(k) The ABCP program should have collections processes established

that consider the operational capability and credit quality of the servicer. The
program should mitigate to the extent possible seller/servicer risk through various
methods, such as triggers based on current credit quality that would preclude
co-mingling of funds and impose lockbox arrangements that would help ensure
the continuity of payments to the ABCP program.

(l) The aggregate estimate of loss on an asset pool that the ABCP
program is considering purchasing must consider all sources of potential risk,
such as credit and dilution risk. If the seller-provided credit enhancement is sized
based on only credit-related losses, then a separate reserve should be established
for dilution risk, if dilution risk is material for the particular exposure pool. In

OHS East:160049087.6 36
 addition, in sizing the required enhancement level, the bank should review several
years of historical information, including losses, delinquencies, dilutions, and the
turnover rate of the receivables. Furthermore, the bank should evaluate the
characteristics of the underlying asset pool, e.g., weighted average credit score,
identify any concentrations to an individual obligor or geographic region, and the
granularity of the asset pool.

(m) The ABCP program must incorporate structural features into the
purchase of assets in order to mitigate potential credit deterioration of the
underlying portfolio. Such features may include wind down triggers specific to a
pool of exposures.

The notional amount of the securitization exposure to the ABCP program must be
assigned to the risk weight in the RBA appropriate to the credit rating equivalent assigned to the
bank’s exposure.

If a bank’s internal assessment process is no longer considered adequate, the bank’s

supervisor may preclude the bank from applying the internal assessment approach to its ABCP
exposures, both existing and newly originated, for determining the appropriate capital treatment
until the bank has remedied the deficiencies. In this instance, the bank must revert to the SF or,
if not available, to a specified alternative method.

Liquidity Facilities

Liquidity facilities are treated as any other securitization exposure and will generally
receive a CCF of 100%, except as provided below. If the facility is externally rated, the bank
may rely on the external rating under the RBA. If the facility is not rated and an inferred rating
is not available, the bank must apply the Supervisory Formula (as described below), unless the
IAA can be applied.

When (i) a bank’s position under a liquidity facility is not rated, (ii) a rating cannot be
inferred, (iii) the IAA is not available, and (iv) it is not practical for the bank to use either the
bottom-up or the top-down approach in calculating risk capital requirements under the
Supervisory Formula (the bottom-up and top-down approaches are specific methods set forth in
the Revised Accord for use in the calculation of the risk capital requirements for purchased
receivables), the bank may, on an exceptional basis and subject to supervisory consent,
temporarily be allowed to apply the following method. If the liquidity facility satisfies the
eligibility criteria for an “eligible” liquidity facility, as described above under “Standardized
Approach for Securitization Exposures—Eligible Liquidity Facilities,” the highest risk weight
assigned under the standardized approach to any of the underlying individual exposures covered
by the liquidity facility can be applied to the liquidity facility, and the CCF must be 50% for a
facility with an original maturity of one year or less, or 100% if the facility has an original
maturity of more than one year. In all other cases, the notional amount of the liquidity facility
must be deducted.

Treatment of Overlapping Exposures

OHS East:160049087.6 37
 Overlapping exposures are treated as described above under “Standardized Approach for
Securitization Exposures—Treatment of Overlapping Exposures.”

Supervisory Formula (“SF”)

Under the SF, the capital charge for a securitization tranche depends on five bank-
supplied inputs: the IRB capital charge had the underlying securitized exposures not been
securitized (KIRB); the tranche’s credit enhancement level (L) and thickness (T); the pool’s
effective number of exposures (N); and the pool’s exposure-weighted average loss-given-default
(LGD). Given these inputs, the IRB capital charge for the securitization tranche is calculated
with regard to the SF.

VI. RISK BASED CAPITAL - U.S. REVISIONS

As referenced above (under "Risk Based Capital – Revised Basel Capital Accord"), U.S.
Federal bank regulators indicated earlier this year that they are moving expeditiously towards
implementation of the Revised Accord in the United States. Pending adoption of the Revised
Accord by U.S. banks, the risk capital elements of ABCP programs will continue to be governed
by the existing U.S. risk capital framework, the background and substance of which follows.

In July 2004 the Board of Governors of the Agencies announced final amendments to
their risk-based capital rules as they apply to liquidity facilities provided by banking institutions
to asset-backed commercial paper programs. The final rule of each Agency increased the capital
requirement applicable to most short-term (i.e., one year or less) liquidity facilities that support
ABCP by increasing the credit conversion factor from zero percent to 10 percent. As of its
effective date, the final rule also set forth certain eligibility criteria that short-term liquidity
facilities must satisfy to qualify for the 10 percent credit conversion factor.

The final rule became effective on September 30, 2004. At that time, all short-term
liquidity facilities (whether or not they satisfy the eligibility criteria described below) were
subject to the 10 percent credit conversion factor. As of September 30, 2005, liquidity facilities
that do not satisfy the eligibility criteria will become subject to a 100% credit conversion factor.
Liquidity facilities with an original term exceeding one year will remain subject to the 50 percent
credit conversion factor that currently applies (but any such facilities that fail to satisfy the
eligibility criteria will be treated as direct credit substitutes or recourse obligations and will
become subject to the 100 percent credit conversion factor as of September 30, 2005).

The credit equivalent amount determined in respect of any liquidity facility under the
final rule is risk-weighted pursuant to the Agencies’ existing capital regulations. Accordingly, in
most cases the capital charge for an ABCP liquidity facility will increase as the credit quality of
the ABCP conduit’s investment portfolio decreases.

The Final Rule

The final rule has, for the first time, required banks to hold risk-based capital against
ABCP liquidity facilities with an original maturity of one year or less (the capital charge

OHS East:160049087.6 38
currently required for longer-term facilities would remain in effect).6 The capital charge for
ABCP liquidity facilities generally will apply even if FIN 46R would not require the program to
be consolidated. However, a separate capital charge on liquidity facilities provided to an ABCP
conduit will not be required if a banking organization consolidates the program for purposes of
computing its risk-based capital requirements.

The final rule requires banks to convert short-term liquidity facilities provided to ABCP
programs to on-balance sheet credit equivalent amounts utilizing a 10 percent credit conversion
factor. The final rule then provides for the credit equivalent amount so computed to be risk-
weighted based on the risk weights of the underlying assets or the underlying obligors, after
considering any collateral or guarantees, or external credit ratings. For example, if a short-term
liquidity facility provided to an ABCP program covered an asset-backed security (ABS)
externally rated AAA, then the amount of the security would be converted at 10 percent to an on-
balance sheet credit equivalent amount and assigned to the 20 percent risk category appropriate
for AAA-rated ABS.

The final rule requires banks to hold risk-based capital only once for any exposure
covered by overlapping facilities provided by the bank. In particular, the bank is required to hold
risk-based capital based on the highest amount of risk-based capital assessed against any such
overlapping facility. For example, if a bank provides a program-wide credit enhancement
covering 10 percent of the underlying asset pools in an ABCP program and pool-specific
liquidity facilities covering 100 percent of each of the underlying asset pools, the bank would be
required to hold capital against (i) 10 percent of the underlying asset pools because it is
providing the program-wide credit enhancement and (ii) 90 percent of the liquidity facilities it is
providing to each of the underlying asset pools.

If different banks provide overlapping exposures to an ABCP conduit, each bank will be
required by the final rule to hold capital against the entire maximum amount of its exposure. As
a result, duplication of capital charges could occur where multiple banking organizations have
overlapping exposures to the same ABCP program.

The final rule prohibits banks subject to the market risk capital rules from applying those
rules to any liquidity facilities held in the trading book. Rather, banks are required to convert the
notional amount of all liquidity facilities provided to ABCP programs (including facilities that
are structured or characterized as derivatives or other trading book assets and regardless of the
facilities’ maturities) to a credit equivalent amount using the appropriate credit conversion factor.
Thus, for example, all eligible short-term liquidity facilities provided to ABCP programs with an
original maturity of one year or less will be subject to a 10 percent credit conversion factor as
described above, regardless of whether the exposure is carried in the trading account or the
banking book.

6
The current exemption for short-term liquidity facilities applies only to “true” liquidity facilities that are not
deemed to provide credit enhancement; liquidity facilities that also comprise credit enhancement facilities are
treated as direct credit substitutes or recourse obligations and are subject to an appropriate capital charge.

OHS East:160049087.6 39
 In addition, on and after September 30, 2005, in order for a short or long-term liquidity
facility provided to an ABCP program not to be considered a recourse obligation or a direct
credit substitute, draws on the facility must be subject to a reasonable asset quality test that
(i) precludes funding assets that are 90 days or more past due or in default, and (ii) provides that
if the assets a bank would be required to fund pursuant to the facility are initially externally rated
exposures, the facility can only be used to fund such exposures if they are externally rated
investment grade at the time of funding (together, the “Eligibility Criteria”). If the Eligibility
Criteria are not satisfied, the relevant liquidity facility is subject to a 100 percent credit
conversion factor.7

Notwithstanding the above, a short or long-term liquidity facility will be in compliance

with the Eligibility Criteria if (i) the liquidity facility has access to certain types of acceptable
credit enhancements8 and (ii) the notional amount of such credit enhancements available to the
liquidity facility exceeds the amount of underlying assets that are 90 days or more past due,
defaulted, or below investment grade that the liquidity provider may be obligated to fund under
the facility.

Recourse directly to the seller, other than the funded credit enhancements enumerated in
footnote 8, regardless of the seller’s external credit rating, is not an acceptable form of credit
enhancement for purposes of satisfying the asset quality test. Furthermore, a banking
organization is responsible for demonstrating to the relevant agency whether acceptable credit
enhancements cover the 90 days or more past due, defaulted, or below investment grade assets
that the organization may be obligated to fund against in each seller’s asset pool. If a banking
organization cannot so demonstrate, the Agencies reserve the right to determine that a credit
enhancement is unacceptable for purposes of the asset quality test.

As stated above, the final rule has made permanent the capital relief provided by the
interim rule pursuant to which bank sponsors of ABCP programs that are required by FIN 46R to
consolidate such ABCP programs are not required to hold risk-based capital against the conduit’s
assets. The final rule specifies, however, that this relief is available only to bank sponsors of
“asset-backed commercial paper programs.” This term is defined in the final rule to include

7
The Eligibility Criteria do not apply to the extent the assets supported by the liquidity facility are guaranteed,
conditionally or unconditionally, by the United States government or its agencies or the central government of any other
OECD country.
8
The Agencies have determined that the following forms of credit enhancements are generally acceptable for
purposes of satisfying the Eligibility Criteria:
(a) Funded credit enhancements that the banking organization may access to cover delinquent, defaulted, or below
investment grade assets, such as overcollateralization, cash reserves, subordinated securities, and funded spread accounts;
(b) Surety bonds and letters of credit issued by a third party with a nationally recognized statistical rating
organization rating of single A or higher that the banking organization may access to cover delinquent, defaulted, or below
investment grade assets, provided that the surety bond or letter of credit is irrevocable and legally enforceable; and
(c) One month’s worth of excess spread that the banking organization may access to cover delinquent, defaulted, or
below investment grade assets if the following two conditions are met: (i) excess spread is contractually required to be
trapped when it falls below 4.5% (measured on an annualized basis), and (ii) there is no material adverse change in the
banking organization’s ABCP underwriting standards. The amount of available excess spread may be calculated as the
average of the current month’s and the two previous months’ excess spread.

OHS East:160049087.6 40
asset-backed issuers that “primarily” fund themselves by issuing “externally rated commercial
paper”. The Agencies have stated that “primarily” means “more than 50 percent” and that the
covered issuers generally should include (among other entities) structured investment vehicles
and securities arbitrage programs. However, bank sponsors of programs that issue asset-backed
commercial paper in amounts not greater than 50% of the program’s total liabilities will not
qualify for the capital relief and – to the extent that they are required by FIN 46R to consolidate
the program - will be required to hold risk-based capital against all of the program’s assets.

As under the interim rule, the final rule requires banks that are required to consolidate an
ABCP program under FIN 46R but that qualify for capital relief to exclude from tier 1 and total
capital any minority interest in such programs. In addition, the final rule does not entitle banking
organizations to exclude the assets of consolidated ABCP programs in calculating their tier
1 leverage capital ratios. The final rule instead requires banking organizations to include all
assets of consolidated ABCP programs as part of on-balance sheet assets for purposes of such
calculations.

VII. INTERNATIONAL ABCP PROGRAMS

A. GENERAL

International transactions present many issues which may not otherwise be present in
domestic securitizations. Figure 3 illustrates an example of an ABCP program structure where
the assets are originated outside the U.S. (in this example, Japan) and the ABCP is issued in the
U.S. Figure 4 illustrates an example of the reverse, where the assets are originated in the U.S.
and the ABCP is issued outside the U.S. Figure 5 illustrates an example of assets purchased
generally in the secondary market with ABCP issued in the U.S. and European markets. There
are exchange rate risks because a detrimental change may occur in the rate of exchange between
a sovereign’s currency and the currency in which securities pay. Exchange control issues need to
be addressed if there are limitations on the convertibility of the sovereign’s currency.

Cross border securitizations also need to address the regulatory issues and issues of
bankruptcy remoteness, perfection, true sale and taxation, all of which will be jurisdiction
specific. The materiality of these issues to investors and related disclosure issues should also be
addressed.

Most new ABCP transactions are now structured so that non-U.S. Dollar assets may be
acquired by the issuer and non-U.S. Dollar ABCP may be issued by the issuer.

B. THE ISSUANCE OF STERLING DENOMINATED ABCP

The U.K. Financial Services and Markets Act 2000 (Regulated Activities) Order
2001 (“RAO”) was implemented in November, 2001. This legislation provides a format through
which Sterling denominated ABCP has been more frequently issued.

Under RAO, deposits may be accepted by any person or any entity if the deposits
represent proceeds of an issue of commercial paper, provided that the conditions outlined below
are fulfilled:

OHS East:160049087.6 41
 (1) the commercial paper is offered to persons:

(a) whose ordinary activities involve them in acquiring, holding,

managing or disposing of investments (as principal or agent) for the purposes of
their businesses; or

(b) who it is reasonable to expect will acquire, hold, manage or

dispose of investments (as principal or agent) for the purposes of their businesses;
and

(2) the minimum denomination of commercial paper issued is £100,000.

The following categories of persons will for this purpose be considered to ‘manage’
investments: “professional/institutional investors” such as banks, brokers, dealers, pension fund
managers and insurance companies. Therefore, commercial paper that satisfies the minimum
denomination requirement may be issued by any person or entity to dealers who may then sell
the commercial paper to investors in the capital markets.

In order to be classified as “commercial paper” for the purposes of RAO, the commercial
paper must be paid within 365 days from the date of original issuance.

Although the restrictions regarding the taking of deposits in the U.K. are “currency
neutral”, the mechanics of issuance of Sterling denominated commercial paper are more likely to
involve the acceptance of deposits in the U.K., even if the proceeds of issuance are received by
an issuer in an account located outside the U.K. For this reason, issuance of Sterling
denominated commercial paper by non-authorized issuers had, prior to the effectiveness of the
RAO, been fairly limited. Now issuers (including ABCP conduits) regularly issue Sterling
denominated commercial paper.

VIII. INNOVATIVE FUNDING SOURCE FOR PROJECT FINANCE DEALS

As funding for project finance deals become costly and more difficult to obtain given the
current economic climate in the United States, Europe and other parts of the world, project
sponsors are finding it advantageous at this time to obtain funding for their projects through the
capital markets and, more specifically, through proceeds arising out of the issuance of Notes.
Alternative sources of funding available through the capital markets can provide cheaper
financing even after taking into account additional costs that may be associated with tapping into
the capital markets.

Lenders (including, for example, commercial banks, government or supranational bodies

like the World Bank and export credit agencies) have traditionally extended credit to project
sponsors by making loans to them (such loans sometimes reflecting subordinated, mezzanine
and/or senior levels of debt). Alternatively, project sponsors have obtained funding through the
private placement of ‘project bonds’ to certain institutional investors. These methods of
financing have proven to be an established and workable way of obtaining funding for projects
all over the world.

OHS East:160049087.6 42
 However, these sources of funding are increasingly being stretched as demands for
funding various projects have increased. The related pricing has risen and, perhaps more
importantly, these funding sources may one day be “tapped out” and not be able to meet
increased funding demands.

Given these conditions, investors in Notes have become an extremely attractive source of
alternative funding. Such investors have already provided funding for a number of projects.
Parties in need of debt funding for project deals have obtained these funds by having such
securities ‘repackaged’ to transfer risks of lending in respect of such projects to other investors
willing to take such risks.

There are a myriad of options for accessing the capital markets in this way for funding.
For example, in a relatively straight-forward transaction, a commercial paper conduit might
purchase a project bond. The commercial paper conduit finances its purchase of the bond by
issuing Notes to capital markets investors.

There are still other innovative structures that allow for an effective transfer of risk to
assist the project sponsor in obtaining cheaper funding. For example, in a recently closed deal, a
commercial bank purchased a surety-wrapped project bond. However, because the commercial
bank client (i) did not want to bear direct risk of default on the project bond and the related
surety bond and (ii) wanted to reduce the amount of its related risk based capital, the commercial
bank entered into a credit default swap with a commercial paper conduit pursuant to which the
commercial paper conduit (and hence the holders of the Notes issued by such conduit) assumed
the credit risk of the insured project bond. The commercial paper conduit raised money through
the issuance of commercial paper, but funds are released to the commercial bank only upon the
occurrence of the specified credit events. Risks associated with the project bond and the surety
bond were thereby effectively transferred to the commercial paper conduit and the holders of
Notes.

Tapping into the capital markets may, but does not necessarily, require a rethinking of the
financing structure used in the ‘typical’ project finance deal. The complexity involved in
obtaining funds for project transactions through the issuance of Notes into the capital markets
will depend in particular on the approach taken to obtain financing and the nature of the
financing taken.

A major consideration that a project sponsor will have to take into account when
structuring the deal is the role and perspective of the rating agencies. First, to the extent the
Notes offered are expected to be rated, the relevant rating agencies will need to analyze the
overall terms of the financing -- they will focus on the rights of the providers of the debt under
the project documents, as these rights will form the basis of the rights of the purchasers of the
Notes.

It is important to note here that a key factor in rating agency review is determining which
phase of the project is intended to be financed through the securitization. Specifically, rating
agencies will have some additional issues with respect to securitizations providing funding for
the construction phase of a project. In these securitizations, rating agencies are concerned with
the fact that (i) there may not be any cash flows supporting repayment of the financing during the

OHS East:160049087.6 43
construction phase of the project and (ii) there may be a number of additional risks related to the
completion of the construction phase that require consideration. Rating agency review is
generally more rigorous in securitizations supporting the construction phase of projects.

Second, the nature of the capital markets instruments being offered will be an important
factor in structuring the deal. If the project is funded through the issuance of Notes, the rating
agencies would likely shift their focus to the commercial paper program that provides the
funding in order to be sure the commercial paper holders will be paid in full and on time. If the
party engaged in the financing of the project is also the arranger of the commercial paper
program, the rating agencies would look to the arranger or other relevant third parties to cover
liquidity and credit issues to the extent they are not covered by the commercial paper program.
If the party engaged in the financing of the project obtains funds from another arranger’s
commercial paper program, the focus of the rating agencies will principally be on the third-party
arranger’s commercial paper program. In this situation, the entity engaged in the financing of
the project will need to negotiate any credit and pricing issues pertaining to the financing with
the third-party arranger rather than the rating agencies.

Depending on the rating agency requirements or the requirements of a third-party

commercial paper program arranger, there will be a number of other credit, liquidity and other
fairly standard issues that will also ultimately have to be resolved. However, any difficulties that
may be encountered in structuring the deal are likely to be far outweighed by the benefits of
attaining cheaper and more flexible financing through the capital markets.

IX. THE USA PATRIOT ACT AND ABCP PROGRAMS

In the months following September 11, 2001, President George W. Bush signed into law
the USA Patriot Act (the “Patriot Act”). The legislation has far reaching provisions which
significantly impact the financial community, including, for example, banks, brokers and dealers,
investment companies, insurance companies, depositary institutions, loan and finance companies
and credit card issuers and operators. The Patriot Act also broadly expands the U.S.
government’s powers by, among other things, establishing comprehensive new anti-money
laundering provisions, creating new financial crimes and penalties, requiring subject financial
entities to provide information to the government in respect of themselves and certain clients,
expanding the government’s extraterritorial jurisdiction over certain covered matters, prohibiting
entities from engaging in financial transactions with certain persons, and requiring subject
entities to perform due diligence in respect of existing clients and potential new clients.

Following the enactment of the Patriot Act, the U.S. Department of the Treasury (the
“Treasury Department”), the government agency responsible for administering the Patriot Act,
has promulgated numerous regulations pursuant to the Patriot Act, and market participants
expect many more regulations to be promulgated in the upcoming months. The Treasury
Department also has expansive powers to determine whether certain types of financial
institutions not explicitly covered by the Patriot Act should be covered.

Some basic requirements imposed by the Patriot Act are outlined below:

OHS East:160049087.6 44
 · subject financial institutions are required to establish anti-money
laundering compliance and due diligence programs which provide for,
among other things, the development of internal policies and procedures to
detect money laundering activities, the implementation of employee
training programs to identify suspicious transactions, and the
establishment of an independent audit function to test the due diligence
program.

· Depositary institutions are required to develop similar due diligence

policies in respect of accounts it opens on behalf of foreign persons or
institutions.

· Investment companies and brokers and dealers are required to report

suspicious activities and transactions.

· Certain financial institutions, including all depositary institutions and

registered broker-dealers, are prohibited from establishing, maintaining,
administering or managing correspondent accounts with foreign banks that
do not have a physical presence in any jurisdiction, unless that bank is
affiliated with a regulated, physically established bank.

· Under certain circumstances, a financial institution is required to provide

government officials with access to credit histories of targeted customers
without providing notice to such customers.

· Certain financial institutions are required to provide information or

various disclosures to specified government officials that relate to a
number of different subjects, including reports of suspicious activity,
transactions or violations of law.

On September 26, 2002, the Financial Crimes Enforcement Network, a division of the
Treasury Department, released a Notice of Proposed Rule Making under the Patriot Act
concerning the applicability of anti-money laundering programs for unregistered investment
companies. Under the proposed regulations, unregistered investment companies relying on the
exemption provided in Rule 3a-7 under the Investment Company Act would be exempt from
Patriot Act compliance while unregistered investment companies relying on the exemption
provided in either Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act would not.
The Treasury Department has not yet released a final rule in respect of these proposals.

The Patriot Act was renewed on March 2, 2006 by the Senate and on March 7, 2006 by
the House and was signed into law by President Bush on March 9, 2006.

OHS East:160049087.6 45
Figure 1: Fully Supported Asset Backed Commercial Paper

Support Provider Originator

Liquidity/Credit Assets $

Assets
SPE CP Seller
Conduit
$ Purchase Price
CP $

Investors

OHS East:160049087.6 46
Figure 2: Partially Supported Asset Backed Commercial Paper

Credit Provider Liquidity Provider Originator

Assets $
Partial Liquidity
Credit

Assets
SPE CP
Conduit Seller
$ Purchase Price

CP $

Investors

OHS East:160049087.6 47
Figure 3: Cross-Border Funding Alternatives - Conventional Structure - Japan

Receivables
Company A Commercial
$ Intracompany
Paper Placement
Loan
Agent

Receivables
Company B SPE ¥ SPE
$
Branch Home Office CP
Notes

Receivables U.S.
Company C $ CP Investors
$

Operating
Loss Reserves Home Office
Agent
Credit Enhancement Operating Agent
Liquidity
Foreign Exchange

OHS East:160049087.6 48
Figure 4: U.S. Assets -- Off-Shore Issuance of Notes

Documentation
U.S. Originator

Sale of Retail
$ Purchase Agreement
Finance Contracts

U.S. SPE Subsidiary

of Originator

Loan and Pledge $ Secured Loan Agreement

Off-Shore Issuer of
Euro CP

Liquidity Agreement

Bank Sponsor
Administration Agreement

Bank Sponsor Depositary/Issuing and

Paying Agency Agreement
Standby Letter of Credit Agreement

Bank Sponsor

Security Assignment Agreement

Deed of Charge

Issuing and Paying

Trustee Agent

CP $

OHS East:160049087.6 49
Figure 5: Secondary Market Assets - - U.S. and Offshore Issuance of Notes

Originator
Liquidity Agreement
Sponsor
Security Agreement
Bank
Assets $ Credit Enhancement

Administration Agreement

Hedging Agreement

Issuer
Co-Issuer Jersey SPE
Delaware SPE European
CP
Placement
Agent
U.S. CP
$
Placement CP $
Agent CP
CP

European Market
U. S. Market

OHS East:160049087.6 50
 Table 1

Long-term rating category

External B+ and
Credit BBB+ to below or
Assessment AAA to AA- A+ to A- BBB- BB+ to BB- unrated
Risk
Weight 20% 50% 100% 350% Deduction

Short-term rating category

All other
External Credit ratings or
Assessment A-1/P-1 A-2/P-2 A-3/P-3 unrated
Risk Weight 20% 50% 100% Deduction

OHS East:160049087.6 51
 Table 2

U.S. ABS risk weights when the external assessment represents a long-term credit rating
and/or an inferred rating derived from a long-term assessment

Risk weights for

thick tranches Risk weights for
External Rating backed by highly Base risk tranches backed by
(Illustrative) granular pools weights non-granular pools
AAA 7% 12% 20%
AA 10% 15% 25%
A 20% 20% 35%
BBB+ 50% 50% 50%
BBB 75% 75% 75%
BBB- 100% 100% 100%
BB+ 250% 250% 250%
BB 425% 425% 425%
BB- 650% 650% 650%
Below BB- and Deduction Deduction Deduction
unrated

OHS East:160049087.6 52
 Table 3

U.S. ABS risk weights when the external assessment represents a short-term credit rating
and/or an inferred rating derived from a short-term assessment

Risk weights for

thick tranches Risk weights for
External Rating backed by highly Base risk tranches backed by
(Illustrative) granular pools weights non-granular pools
A-1/P-1 7% 12% 20%
A-2/P-2 20% 20% 35%
A-3/P-3 75% 75% 75%
All other Deduction Deduction Deduction
ratings/unrated

OHS East:160049087.6 53
 Table 4

U.S. Risk Weighting Tables

Long-Term Rating Category Examples Risk Weight

Highest or second highest investment AAA or AA 20%

grade

Third highest investment grade A 50%

Lowest investment grade BBB 100%

One category below investment grade BB 200%

More than one category below B or unrated Not eligible for ratings
investment grade, or unrated based approach.

Short-Term Rating Category Examples Risk Weight

Highest investment grade A-1, P-1 20%

Second highest investment grade A-2, P-2 50%

Lowest investment grade A-3, P-3 100%

Below investment grade Not Prime Not eligible for ratings

based approach.

OHS East:160049087.6 54