1. 8th Annual Gas & Power Institute September 10-11, ISDA and its Commodity Annexes: The New EEI or NAESB? Craig R. Enochs
Craig R. Enochs
Jackson Walker L.L.P.
1401 McKinney, Suite 1900
Houston, Texas 77010
(713) phone

2. Issues
Are the ISDA Gas and Power Annexes becoming more widely-used than the NAESB and EEI?
Why use the ISDA Gas and Power Annexes instead of the NAESB and EEI?
What are the “gap risks” between the ISDA Gas and Power Annexes, the NAESB and the EEI?

3. Use of the ISDA Commodity Annexes: A Growing Trend
ISDA originally intended for use with financial products
Drafted by bankers and lawyers in New York and London to standardize derivative transactions
In the last few years, the ISDA has gained popularity in the energy industry because of the publication of various commodity annexes
Power Annex (2003), Gas Annex (2004), Emissions Allowance Annex (2006), Coal Annex (2007), Crude Oil Annex (2008)

4. ISDA Gas Annex and the NAESB
Joint Effort:
After NAESB published in 2002, ISDA and NAESB worked together in creating the Gas Annex
Gas Annex published by ISDA in 2004
Similar Provisions:
Gas Annex closely follows the NAESB’s provisions relating to the purchase and sale of physical gas
Clauses (b) through (g), (h) and (i) of the Gas Annex are similar to Sections 3 through 8, 11 and 13 of the 2002 NAESB, respectively

5. ISDA Power Annex and the EEI
Joint Effort:
After EEI Master Agreement published in 2000, ISDA and EEI worked together in creating the Power Annex
Power Annex published by ISDA in 2003
Similar Provisions:
Power Annex closely follows the EEI’s provisions relating to the purchase and sale of physical power
Clauses (b)-(c), (d)-(e), (f) and (g) of the Power Annex are similar to Articles 3-4, 6-7, 9 and Sections of the EEI Master Agreement, respectively

6. Why Use the ISDA Instead of the NAESB or EEI?
Trade various energy commodities under a single agreement by using the ISDA Annexes
Net credit exposures across transactions and products
Single agreement setoff rights in bankruptcy
Payment netting across transactions and products

7. Why Use the ISDA Instead of the NAESB or EEI? (cont.)
Streamlines negotiation and documentation process
Once ISDA Master Agreement and Schedule are in place, fairly simple to added Gas and/or Power Annex.

8. Sources of Gap Risk in ISDA, NAESB and EEI
Though similar to the NAESB and EEI, the Gas and Power Annexes (respectively) are not exclusive agreements
Annexes form only part of entire ISDA agreement
Contain only those provisions necessary to implement purchase/sale and delivery of gas and power
E.g., delivery/receipt, scheduling, title, force majeure

9. Sources of Gap Risk in ISDA, NAESB and EEI (cont.)
ISDA Master Agreement, Schedule and Credit Support Annex (as applicable) govern all transactions under Gas and Power Annexes
Provisions not specifically related to physical commodities, but still applicable to gas and power transactions
E.g., events of default, termination and settlement, credit provisions, notices, confirmation procedures

10. Sources of Gap Risk in ISDA, NAESB and EEI (cont.)
Common reasons for gap risk across trading agreements:
ISDA, NAESB and/or EEI with same counterparty at the same time
E.g., ISDA for new transactions with Counterparty A, and NAESB/EEI for existing transactions with Counterparty A
ISDA, NAESB and/or EEI with different counterparties at the same time
E.g., ISDA for all transactions with Counterparty A, and NAESB/EEI for all transactions with Counterparty B.
To mitigate gap risk, must be aware of differences across agreements.

11. Gap Risks in the NAESB, EEI and ISDA
A. Confirmation Procedures
B. Netting
C. Notices
D. Credit Obligations
E. Events of Default & Termination Event
F. Termination, Liquidation and Settlement
G. Setoff

12. A. Confirmation Procedures
1. NAESB § 1.2: Procedure elected on Cover Sheet
Oral Transaction Procedure
Transaction is binding when parties orally agree upon terms
Failure to send Transaction Confirmation does not affect performance obligations
Written Transaction Procedure
Parties must exchange non-conflicting Transaction Confirmation before parties legally obligated to perform

13. A. Confirmation Procedures
2. EEI § 2.3
Parties evidence a transaction by exchanging a written Confirmation
Seller provides Confirmation to Buyer (or if Seller fails to provide, then Buyer may send)
Similar to a written transaction procedure
Failure to send or return an executed Confirmation does not invalidate the oral transaction agreed-upon by the parties
Similar to oral transaction procedure under NAESB

14. A. Confirmation Procedures
3. Gas and Power Annexes: ISDA Master § 9(e)(ii)
Parties legally bound from the moment they agree on commercial terms
Confirm transaction terms by sending written Confirmations
No other specific terms or procedures in Master Agreement, Gas Annex or Power Annex

15. A. Confirmation Procedures
4. NAESB, EEI and ISDA: Risk Analysis
Confirmation procedures should conform to risk in underlying transactions
Short-term v. Long-term
Risk of disagreement regarding future performance obligations
Operational Risk in Confirming Transactions
Seller confirms in NAESB and EEI, but ISDA does not specify
Inconsistent Dispute Resolution Procedures
NAESB v. EEI v. ISDA

16. B. Netting
1. NAESB § 7.7
All payments due and owing (or past due and owing) netted into single amount
The party owing the greater amount shall make a single payment to the other party
Not limited to amounts owed under a single transaction

17. B. Netting
2. EEI § 6.4
All payments owed by each party in a monthly billing period are netted into single amount
The party owing the greater amount makes a single payment to the other party
Netting applies across all transactions

18. B. Netting 3. Gas and Power Annexes: ISDA Master § 2(c)
Netting generally limited to amounts due (i) on the same date; (ii) in the same currency; and (iii) in respect of the same Transaction
Often modified by the parties in the ISDA Schedule

19. B. Netting 4. Risk Analysis
Inconsistent netting provisions across multiple agreements may create cash flow and operational risks
Incorrect calculations on invoices
Incorrect payments to counterparty
Cross-Transactional Netting
NAESB v. EEI v. ISDA

20. C. Notices
1. NAESB § 9.2
Methods: Fax, mutually-accepted electronic means, overnight courier, first class mail or hand delivery
General Rule: deemed delivered when received on a Business Day
If no proof of actual receipt, the following presumptions apply:
Fax: deemed delivered when sending party receives fax machine’s confirmation of successful transmission. If after 5:00 p.m., deemed received the following Business Day
Overnight Courier or Mail: deemed delivered on following Business Day after sent, or earlier if confirmed by receiving party
First Class Mail: deemed delivered five (5) Business Days after mailing

21. C. Notices 2. EEI § 10.7 Fax or Hand Delivery:
If received during business hours on a Business Day, notice deemed effective at the close of business on such day
If received after business hours, deemed effective at close of business on following Business Day
Overnight Courier or U.S. Mail:
Deemed effective on the following Business Day after sent

22. C. Notices 3. Gas and Power Annexes: ISDA Master § 12(a)
Writing/Hand Delivery: effective on date delivered
Fax: effective on date received by responsible recipient in legible form
Proof of receipt is on sending party and cannot be proven through fax confirmation
Certified or Registered Mail: effective on date delivered (or delivery is attempted)
Electronic Messaging System: effective on date received
(2002 ISDA): effective on date delivered

23. C. Notices 3. Gas and Power Annexes: ISDA Master § 12(a) (cont.)
If notice (i) not delivered on Local Business Day, or (ii) is delivered after close of business, notice deemed delivered on following Local Business Day
Notices relating to Events of Default or Termination Events may not be sent by electronic messaging system (1992/2002), fax (1992) or (2002 ISDA).

24. C. Notices 4. Risk Analysis Operational Risk:
Various methods of notice permitted in trading contracts
Ex: ISDA contemplates electronic means, including (2002 ISDA), but EEI does not contemplate electronic means unless otherwise elected by the parties
Inconsistent notice provisions across trading agreements
More likely that manner or method of notice may be insufficient

25. C. Notices 4. Risk Analysis (cont.) Credit and Payment Risk:
Ineffective notice may create credit risk as to a defaulting counterparty:
Ex: ISDA does not allow electronic means (1992/2002), fax (1992) or (2002) notices with respect to Events of Default or Termination Events
If notice is ineffective, Non-Defaulting Party cannot declare an Early Termination Date
Parties should consider consistent notice provisions across trading contracts

26. D. Credit Obligations 1. NAESB § 10.1
Either party can demand Adequate Assurance of Performance if it has “reasonable grounds for insecurity” regarding other party’s performance
“Reasonable grounds for insecurity” not defined in NAESB, except that it includes a “material change in creditworthiness”
Only credit provision in NAESB apart from any CSA incorporated into the Contract

27. D. Credit Obligations 2. EEI §§ 8.1 and 8.2: Elected on Cover Sheet
Credit Assurances (8.1(b) and 8.2(b))
Can demand Performance Assurance upon “reasonable grounds” for believing that Party’s creditworthiness or performance is unsatisfactory
Collateral Threshold (8.1(c) and 8.2(c))
Threshold margining, similar to Collateral Annex
Downgrade Event (8.1(d) and 8.2(d))
Parties can demand Performance Assurance upon the occurrence of a “Downgrade Event”
Downgrade Event defined by the Parties on the Cover Sheet

28. D. Credit Obligations 3. ISDA Gas and Power Annexes: 4. Risk Analysis:
No credit provisions in the Master Agreement or Commodity Annexes
Parties generally rely on threshold margining under the ISDA CSA
4. Risk Analysis:
Inconsistent credit requirements across agreements (e.g., Adequate Assurances under NAESB v. margining under ISDA)
Benefit of ISDA: netting of exposures across products to minimize collateral obligations

29. E. Events of Default & Termination Events
1. NAESB v. ISDA Gas Annex
Common Events of Default: NAESB § 10.2; ISDA § 5(a)
Failure to pay when due
Breach of credit obligations
Insolvency and bankruptcy-related events
Events of Default in ISDA not found in NAESB:
Breach of Agreement (other than failure to pay)
Misrepresentations
Default under Specified Transaction
Similar to Transactional Cross Default election in 2006 NAESB
Cross Default
Similar to Indebtedness Cross Default election in 2006 NAESB
Merger Without Assumption

30. E. Events of Default & Termination Events
1. NAESB v. ISDA Gas Annex (cont.)
Termination Events in ISDA not found in NAESB:
Illegality
Force Majeure Event (2002)
Tax Event and Tax Event Upon Merger
Credit Event Upon Merger
Additional Termination Event

31. E. Events of Default & Termination Events
2. EEI v. ISDA Power Annex
Common Events of Default: EEI § 5.1 and ISDA § 5(a):
Failure to pay when due
False or misleading representations
Breach of Agreement (other than failure to pay)
Insolvency and bankruptcy-related events
Breach of credit obligations
Merger without assumption
Cross Default

32. E. Events of Default & Termination Events
2. EEI v. ISDA Power Annex (cont.)
Events of Default and Termination Events in ISDA not found in EEI:
Default under Specified Transaction
Illegality
Force Majeure Event (2002 ISDA)
Tax Event and Tax Event Upon Merger
Credit Event Upon Merger
Additional Termination Event

33. E. Events of Default & Termination Events
3. Automatic Early Termination under ISDA
How it works:
Upon occurrence of certain bankruptcy events, an Early Termination Date is deemed to occur
Parties do not follow Early Termination Date notice procedures
Not in standard NAESB or EEI
May be useful in jurisdictions without U.S. Bankruptcy Code “safe harbor” provisions

34. E. Events of Default & Termination Events
3. Automatic Early Termination under ISDA (cont.)
Between U.S. counterparties, often not elected:
Avoids risk of termination without Non-Defaulting Party’s knowledge
Allows for cure and/or negotiation of better terms
Avoids risk of unwanted Settlement Payments by Non-Defaulting Party

35. E. Events of Default & Termination Events
4. Risk Analysis
Events of Default mitigate credit and payment risks with respect to the Defaulting Party
More ways to terminate under ISDA than under NAESB or EEI, but all may not be necessary for every transaction
Risks of underlying transaction help determine which Events of Default make sense (short term v. long-term; index v. fixed price)
Automatic Early Termination: May be beneficial under certain circumstances
May create operational and credit risk if elected in some but not all contracts with a counterparty

36. F. Termination, Liquidation & Settlement
1. NAESB v. ISDA Gas Annex
NAESB §
Non-Defaulting Party determines:
Amount owed by each party for Gas delivered and received on or before the Termination Date
All other applicable charges related to such deliveries and receipts for which payment has not yet been made
If “Additional Termination Damages” apply:
Liquidation and acceleration of Terminated Transactions at Market Value
If Market Value greater than Contract Value, difference due to Buyer
If Market Value less than Contract Value, difference due to Seller
Default two-way payment

37. F. Termination, Liquidation & Settlement
1. NAESB v. ISDA Gas Annex (cont.)
ISDA § 6(e): Market Quotation and Loss
Market Quotation:
Value of Terminated Transactions based on quotations from Reference-Market Makers plus any Unpaid Amounts owed to Non-Defaulting Party; minus
Unpaid Amounts owed to the Defaulting Party
Loss:
Non-Defaulting Party’s total losses and costs resulting from early termination and liquidation, including loss of bargain, costs of funding, and costs of terminating, liquidating or reestablishing any hedge
ISDA § 6(e): First and Second Method
One-way v. two-way payment

38. F. Termination, Liquidation & Settlement
2. EEI v. ISDA Power Annex
EEI:
§ 5.2: Non-Defaulting Party calculates Settlement Amount for each Terminated Transaction in a “commercially reasonable manner”
§ 5.3: Settlement Amounts netted into Termination Payment, payable either to or from the Non-Defaulting Party
Default two-way payment unless changed by parties
ISDA:
§ 6(e): Market Quotation or Loss, as elected by parties
ISDA § 6(e): First or Second Method, as elected by the parties (one-way or two-way payment)

39. F. Termination, Liquidation & Settlement
3. NAESB, EEI and ISDA: Risk Analysis
Inherent operational risks in various calculation methods:
NAESB method and Market Quotation are substantively similar, while EEI requires calculation in a “commercially reasonable manner”
Use of market quotes may not accurately reflect actual or anticipated value of transactions
Subjective nature of Loss calculation
Inconsistent Payment Risks to Defaulting Party:
NAESB and EEI are two-way payment
Potential exposure if one-way payment elected in ISDA

40. G. Setoff 1. NAESB v. ISDA Gas Annex
NAESB § : Election on Cover Sheet
Other Agreement Setoffs Apply:
2002 NAESB: Bilateral
2006 NAESB: Bilateral or Triangular, as elected by the parties
Other Agreement Setoffs Do Not Apply
Setoff limited to amounts owed under the NAESB.
ISDA Gas Annex:
2002 ISDA § 6(f): Setoff provision
Setoff amounts owed between the parties arising under ISDA or any other agreement
No cross-Affiliate setoff
Identical to bilateral setoff in 2002 NAESB

41. G. Setoff 2. EEI v. ISDA Power Annex
EEI § 5.6: Setoff options elected on Cover Sheet
Option A: Non-Defaulting Party sets off obligations owed by Defaulting Party to Non-Defaulting Party under any agreements between the Parties
Options B: Non-Defaulting Party sets off obligations owed by Defaulting Party (or its Affiliates) to the Non-Defaulting Party (or its Affiliates) under any agreements between the Parties and/or their Affiliates
ISDA Power Annex:
2002 ISDA: Setoff provision in § 6(f)
Setoff amounts owed between the parties arising under ISDA or any other agreement
No cross-Affiliate setoff

42. G. Setoff 3. Risk Analysis: Risks Mitigated by Setoff
Commercial Risks:
Immediately extinguishes payment obligations
Reduces involvement in bankruptcy proceedings
Credit Risks:
Amounts owed by Defaulting Party are immediately setoff
Cash Flow Risk:
No waiting for payments from Defaulting Party
Enterprise-wide risks among Affiliates:
Manages risk of having to pay Termination Payments across trading contracts and Affiliates

43. Conclusion
ISDA is becoming more widely-used in energy commodity industry
Differences exist between ISDA Gas Annex, Power Annex, NAESB and EEI
May be difficult to make all agreements consistent
Important to prioritize issues and determine scope of transactions when deciding whether to use ISDA Commodity Annexes and/or the NAESB and EEI
Research paper
Gap risk summaries located at Appendices 1 and 2
Craig R. Enochs
Jackson Walker L.L.P.
1401 McKinney, Suite 1900
Houston, Texas 77010
(713) phone