© Allen & Overy LLP Jennifer Marshall and Paul Cluley 30 November 2010 Another Lehman Brothers Update

© Allen & Overy LLP Contents –Setting the scene –Cross-border aspects –Client money –Client assets and the “CRA” –Unsecured claims and the “consensual approach” –A few “test cases” –Lessons learned (and still being learned)

© Allen & Overy LLP Setting the scene: two years and counting … –No distributions of securities by LBI and still £3.6bn of securities being held by LBIE –No distributions to unsecured creditors (estimated 2013 for LBIE) –No resolution re client money claims –Large number of intercompany claims and other disputes Likely to be ongoing for next 5 years

© Allen & Overy LLP Cross-border aspects –No international treaty or framework (even across Europe) –Court-approved protocol of limited use –Throwing up some interesting debates re cross-border insolvency law: –What regime applies where custodian (LBIE) in UK and sub- custodian (LBI) in the US? –What regime performs better? –The Perpetual issue: what happens if there is a direct conflict between the bankruptcy laws of particular jurisdictions?

© Allen & Overy LLP Client money –Certain cash protected by statutory trust under FSA client money rules (CASS 7 and 7A) –Battle between the “innies” and the “outies” –Decision of Mr Justice Briggs in December 2009 –Estimated dividend of 54%? –Decision of the Court of Appeal in August 2010: –Trust on receipt, not segregation –All those whose money ought to have been segregated are entitled –Client money pool includes identifiable money in house accounts –Estimated dividend of 20%?

© Allen & Overy LLP Client money –Permission to appeal sought from Supreme Court –Unlikely to be heard until late 2011 –Impact of decision: –What claims have client money protection? –What assets / money forms client money pool? –The Bankhaus issue

© Allen & Overy LLP Client assets and the “CRA” –More cross-border issues: –LBI / LBIE reconciliation process –Affiliate liens –RASCALs judgment: success for LBIE –CRA: –launched in November 2009 –approved by over 90% (by value) of eligible counterparties –£1.7bn assets returned to 53% signatories –Claim Agreement Notices (CANs) to 96% signatories –parallel bilateral process for non-CRA signatories –issues with trading CRA positions

© Allen & Overy LLP Filing of unsecured claims –Bar date for unsecured claims remains at 31 December 2010 –LBIE intends to make an application to extend 2 month period for first distribution by up to 2 years –LBIE continues to encourage use of online Portal, but: –Take care as portal seems to get updated without warning (e.g. disclosure of guarantees) –Automatic currency conversion in Portal may lead to wrong result –As at mid-Sept 2010 unsecured creditors representing approx 13.7% by number and 60% by value had filed. –Portal is not obligatory, but is the only way to be eligible for the “consensual” approach

© Allen & Overy LLP The “consensual approach” to unsecured claims I –Previously envisaged as: –Eligibility limited to creditors who had filed through Portal by 17 Sept 2010 –Conditional on overwhelming majority uptake –Creditors agree to adopt LBIE-based valuation methodology –Possible early interim distribution Q –Now rethought as a consequence of: –Client money judgment –Level of actual filings by 17 Sept 2010 ‘deadline’

© Allen & Overy LLP The “consensual approach” to unsecured claims II –Still need to have filed through Portal to be eligible –Bilateral arrangement for each creditor –Not conditional on any acceptance thresholds being met –LBIE will make an offer to agree a claim based on its valuation methodology –Valuation methodology will not necessarily be the same as the CRA approach –Value at mid-market prices –Whilst methodology will be described in generic terms, no full disclosure and no negotiation – “take it or leave it” –If accepted, LBIE provides a standard form settlement deed

© Allen & Overy LLP The “consensual approach” to unsecured claims III –Points to consider –Mid-market pricing will be at odds with contractual terms in most cases. –Bid/offer costs have formed a significant part of the claims –Will LBIE offer take account of non-mutual set-offs? –Whilst LBIE promises “freely tradeable” claims, check that Settlement deed achieves this, e.g. –Does it prescribes a form of transfer? – Does it make transfer conditional upon counter-signature by LBIE? –Will LBIE provide confirmation that claim has been agreed to show to a prospective transferee? –What’s in it for you as creditor?

© Allen & Overy LLP Commonly heard (but not necessarily valid!) challenges to close-out valuations –Timings –As of when were calculations made (what day; what time of day)? –Does Automatic Early Termination affect this? –Section 562 of U.S. Bankruptcy Code –Failure to seek Market Quotations under ISDA –Inclusion of bid/offer costs in claims –“Netting” of transactions pre-valuation –Relevance of earlier Collateral / Margin calculations –Illiquid underlyings –Portfolio, not individual, hedging –How much information are you required to provide?

© Allen & Overy LLP Interesting “test cases” arising out of LBIE –Section 2(a)(iii) of the ISDA Master Agreement –Ranking of pensions deficit –Validity of contractual set-off in “set-off window”

© Allen & Overy LLP Lessons learned (and still being learned) –HM Treasury consultation paper on special administration regime for investment firms: –Using powers under Banking Act –Special administration objectives including return of client assets –Imposition of statutory bar date re client assets –Interaction with special resolution regime if deposit-taking entity –Otherwise no special resolution regime for “pure” investment firm

© Allen & Overy LLP Lessons learned (and still being learned) –Changes to documentation: –Limits on rights of use –Limits on use of affiliates as bankers and sub-custodians –Restrictions on affiliate liens –SPV / third party custodian structures –Changes to market practice: –Greater emphasis on clearing for derivative products

© Allen & Overy LLP Questions? These are presentation slides only. The information within these slides does not constitute definitive advice and should not be used as the basis for giving definitive advice without checking the primary sources. Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term partner is used to refer to a member of Allen & Overy LLP or an employee or consultant with equivalent standing and qualifications or an individual with equivalent status in one of Allen & Overy LLP's affiliated undertakings.