Swap-Based Structures Under Rule 2a-7 Under the 1940 Act
Investment Lawyer (08/01/02) Vol. 9, No. 8 p.3; Kaplowitz, Brian M.; Keeley, Elizabeth

Money funds sometimes have trouble finding enough investment products, due to changes in the interest rate environment, and the Investment Company Act of 1940's Rule 2a-7, among other things. The rule limits the maturity and quality of a money market fund's investments, and swap-based structures can be a good source of eligible investments. A traditional swap agreement lets counterparties exchange cash flows at particular intervals, based on a designated amount, and the payments can be fixed or may float. Such agreements are usually based on forms developed by the International Swaps and Derivatives Association that define responsibilities and include a Master Agreement, a schedule, and a confirmation; the agreement sets standards for payments and provisions, and defines the obligations in case of default or other termination events. Common swaps include total return, interest rate, credit default, and currency swaps, with credit default swaps involving the exchange of a fixed face amount of one obligation for the same face amount of a referenced debt obligation and satisfaction of certain conditions. Total return swaps involve the exchange of the total return of one financial instrument for the total return of another instrument, or several instruments, on the same termination date. Repayment of the face amount of notes depends on the trust and the swap agreement, but if the counterparty does not default, payments are dependent on the cash flow from the swap agreement, and the counterparty must pay the full amounts to make scheduled interest and principal payments; if it defaults, the portfolio securities can be liquidated to make payment to noteholders. In another structure, the trust bears the obligation to repay the notes' face amount, and if it fails, the noteholders have the right to enforce their right to payment.

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