Ratings

The risks that the SIV will need to manage to a 'AAA' level of certainty therefore include:

• Credit risk associated with each obligor (assets and hedges);
• Market risk associated with the marginal cost of liquidating assets and hedges;
• The potential default of the SIV for lack of liquidity;
• Potential losses arising from unhedged changes in currencies and interest rates; and
• Management and operational risks.

Standard & Poor's analyzes whether, in all of the vehicle's operating states, the credit, market, liquidity, hedging, and operational risks are covered to a 'AAA' level.

When the SIV is forced to sell assets under unfavorable conditions, the value of such assets will suffer a loss that needs to be accounted for in the vehicle's capital level. Standard & Poor's will, therefore, want to understand in detail the investment manager's proposals for measuring potential losses to the market value of the portfolio in the event of a wind-down during a stressed market period.

Investment managers will most likely maintain a portfolio that is a mixture of highly rated, highly liquid assets and less liquid, higher-yielding investments. Standard & Poor's expects to see market value decline calculations appropriate for all of the assets that an investment manager may consider for its SIV.

Standard & Poor's will expect the SIV to calculate its one-year peak liquidity requirements on a daily basis, taking into account the expected inflows and outflows of cash to and from the vehicle. Liquidity will need to be provided from a combination of cash flow from assets, bank liquidity loan lines, and highly liquid assets.

Standard & Poor's will also undertake a full documentation review, and will look to the SIV's legal counsel for appropriate opinions on tax and legal issues to obtain comfort with respect to the robustness of the vehicle and the activities contemplated.

On an ongoing basis, Standard & Poor's receives extensive weekly reports from all SIVs in order to fully survey all operating guidelines, asset prices, liquidity levels, etc.

Finally, regular external audits are expected to be undertaken on the operations of the SIV.

The investment manager's objectives can be summarized as follows:

• Achieve a stable return on the investment portfolio above LIBOR/EURIBOR that is attractive to capital note investors;
• Minimize the SIV's cost of funding while maximizing the diversity of its funding providers;
• Undertake investment decisions with a general view to holding the investments until maturity;
• Manage market risk, i.e., currency, interest, or basis risk associated with assets and liabilities, by entering into hedge agreements;
• Manage liquidity risk arising from the maturity mismatch of assets and liabilities;
• Manage credit risk associated with each obligor (assets and hedge agreements); and
• Issue and redeem capital notes in line with the respective documentation.

The activities of the investment manager (or any person who is appointed by the investment manager to perform certain duties) will, therefore, include:

• Decision-making as to which assets to buy or sell and when to do so;
• Making funding decisions as to the issuance of senior debt and capital notes;
• Promoting senior notes and capital notes to investors;
• Entering into hedge agreements on an asset-by-asset basis and on the liabilities side;
• Making and receiving payments in respect of assets, liabilities, and hedge agreements;
• Making payments (coupon and principal) to senior creditors as they fall due;
• Making payments (e.g., base coupon and profit share) to capital noteholders;
• Negotiating and entering into liquidity agreements with banks;
• Obtaining bid market prices from a source independent of the SIV and the investment manager and as approved by Standard & Poor's;
• Valuating hedge agreements and senior debt;
• Performing the interest rate sensitivity tests and foreign exchange sensitivity test each day to ensure that the SIV is managed to the very tight thresholds of market risk exposure required to maintain 'AAA/A-1+' ratings;
• Performing the capital adequacy and leverage tests each day to determine that the SIV is in compliance with the thresholds required to maintain 'AAA/A-1+' ratings;
• Performing the liquidity compliance tests to determine that the SIV is in compliance with the thresholds required to maintain 'AAA/A-1+' ratings; and
• In general, providing advisory and organizational services arising in connection with the transactions mentioned above.

Non-rating-dependent triggers should be established by distinguishing between operating limits and enforcement limits and should be set by the investment manager at an appropriate level that mirrors the likely capital buffer that the investment manager will choose to maintain. Standard & Poor's is less concerned with the specific level at which a trigger may be set and more concerned to see that such early warning procedures are indeed in place. A breach of an operating limit for either of the capital adequacy or leverage variables would result in a vehicle moving into limited operations.

Standard & Poor's is open to consideration of other triggers that an investment manager may view as appropriate for its vehicle. Generally speaking, however, Standard & Poor's would expect a trigger focused on leverage and another on capital adequacy in some form. Both measurements are considered important as a vehicle can be in a position where its leverage test is not breached but, due to credit deterioration, it fails the operating limit for capital adequacy. Equally, a vehicle can breach its leverage test while still passing the operating limit for capital adequacy.

During the limited operations mode, all actions taken by the investment manager must aim to avoid a further deterioration of the investment portfolio and the results of the risk tests. Therefore, Standard & Poor's expects the investment manager to comply with the following restrictions: firstly, senior debt can be issued for the purpose of refinancing existing senior liabilities, but not to increase the size of the investment portfolio; secondly, asset purchases can be made only for highly liquid assets or assets that reduce risk in the vehicle. Apart from these two basic restrictions, the activities of the investment manager remain as outlined for the normal operations mode. The investment manager will still be required to operate in accordance with all the portfolio composition requirements and to perform all tests covering market risk, liquidity risk, and capital adequacy, the results of which will be closely monitored by Standard & Poor's. Breaches of the enforcement tests that have not been rectified within the applicable cure periods will result in an enforcement event.

In limited operations mode the investment portfolio is unlikely to be fully wound down, but the ultimate aim of the actions taken by the investment manager must be to return to the normal operations mode. This can be achieved by attracting additional capital note investors, de-levering the portfolio, or reducing the risk of the overall portfolio to bring it in line with its capital requirements. At any time, payments to capital noteholders can continue to be made while the vehicle is in limited operation mode, but subject to the documented priority of payment "waterfall" tests for normal operations.

In defeasance mode the vehicle is, therefore, in wind-down. The primary difference between the defeasance and enforcement modes is that in defeasance the investment manager manages the wind-down and in enforcement the security trustee manages the process. Also, in defeasance, because the security trustee has not yet enforced its security, there is potential for the vehicle to return to limited or normal operations.

For the defeasance mode, Standard & Poor's expects the investment manager to set rating, leverage, and capital triggers that are in between those set for the limited operations and enforcement modes.

Enforcement triggers can include:

• Downgrade by Standard & Poor's of any MTN/CP below pre-agreed levels (normally 'A/A-1' or investment grade);
• The insolvency of the SIV;
• Failure, without cure within five business days, of the interest rate sensitivity test;
• Failure, without cure within five business days, of the currency test;
• Failure, without cure within five business days, of the liquidity tests;
• Failure, without cure within five business days, of the capital adequacy test;
• Failure, without cure within five business days, of the leverage test;
• Failure, without cure within five business days, of the capital loss limit, which applies to model-driven structures, and is normally breached if 50% or more of the face value of capital has been lost;
• Failure to pay hedge counterparties;
• An event of default under a liquidity facility agreement (i.e., failure to pay by the vehicle); and
• Failure to pay principal and/or interest in respect of any senior note and the continuation of such failure to pay for a pre-defined period.

Once an enforcement event has occurred, the trustee (or any person appointed to act on its behalf) is required to enforce the security constituted by the security trust deed entered into by the company, the investment manager, and the security trustee. In doing so, the trustee is likely to be inclined to follow certain documented "enforcement guidelines" until all assets and proceeds from the assets have been used to discharge all senior debt, i.e., the portfolio is fully wound down. Nevertheless, as in all structured transactions, the security trustee's overriding concern will be to act in the best interests of all senior noteholders.

The enforcement guidelines specify which strategy the trustee should follow when selling the assets. For example, one possibility could be to sell riskier assets, such as the longest-dated, lowest-rated, first. The enforcement guidelines supersede and override all tests and procedures that the vehicle has to follow in normal and limited operations. They are documented in the security trust deed and the operating manual of the SIV and will depend on how the concept of enforcement has been defined for that particular vehicle.

Broadly speaking, there are two theoretical concepts behind the wind-down of a portfolio: "orderly unwind" and "cash flow matching". The concept of cash flow matching requires that the coupon, principal, and maturity characteristics exactly match those of the senior liabilities. Thus, assets that are held by the vehicle at the time of enforcement may need to be sold and related hedge agreements terminated in order to buy assets whose cash flows exactly match those of the senior notes. In such a case, the period needed to wind down the portfolio could be as long as the maturity of the longest senior note outstanding or any mandatory call dates that may be incorporated in the terms and conditions of the vehicle's notes. Bearing in mind that Standard & Poor's 'AAA' rating of a SIV assumes that the vehicle will be in enforcement mode in a 'AAA' market scenario, it is expected that the ability of the vehicle to purchase new assets to cash flow match its liabilities will be severely limited in such an event and that the asset proceeds will be held by the vehicle in cash, cash equivalents, or highly liquid assets until liabilities mature.

The orderly unwind or "pay as you go" method simply requires the trustee (or any person appointed by the trustee) to sell assets in order to meet liabilities as they come due, which again may result in the wind-down period extending until the date of any mandatory call features.

Chart 4 provides a graphic illustration of a typical priority of payment waterfall in enforcement mode.

It is essential that the enforcement guidelines be in line with the scenario that is reflected in the capital model exercise. For example, in structures that assume all senior liabilities will be repaid within one year of enforcement, Standard & Poor's must be satisfied that, in fact, after one year no senior liabilities will be outstanding. In this case, an investor put option on the senior notes would be insufficient and Standard & Poor's would expect the issuer to incorporate a mandatory issuer call in the terms and conditions of the notes. Similarly, structures that assume that assets will be sold only as liabilities mature ("pay as you go") should have capital calculations that reflect the fact that assets may be held for several years following enforcement.

The capital adequacy requirements and leverage restrictions that SIVs adhere to are itemized in the individual contracts entered into by the vehicle. The particular treatment of each asset class and hedge instrument should be itemized in the investment manager's operating manual. A prudent investment manager may also establish reserves for extraordinary circumstances.

Capital charges are fixed using a matrix, but will require regular updates. As capital is determined on a 'AAA' worst-case basis for each asset, capital levels can be higher for a matrix output than for a simulator running 'AAA' probabilities. Matrix capital charges are inflexible as not all assets can be accommodated within the one capital charge number concept (e.g., credit derivatives) and there is often a need for several matrices for a SIV's different assets.

A matrix calculation does not take into account the actual liability structure that a SIV might have at any particular point in time, but determines capital based on a number of set and standard liability structures.

Finally, substantial work on historical spread volatility is still required for a matrix calculation.

Regardless of the capital calculation method employed, Standard & Poor's expects a funded SIV to have a minimum level of capital of about $75 million from the outset. Standard & Poor's also expects the investment manager to have taken into account (either in the capital buffer or in the stresses applied to any individual asset) an appropriate amount of capital for operating risk. The actual level of capital will be determined by the SIV's operating manuals, etc. Standard & Poor's is, however, keen to see that real commitment has been provided from sponsors and investors to a level commensurate with a vehicle that should be aiming to achieve an asset base in excess of $1 billion within its first year of operation. Standard & Poor's also considers that a capital commitment of this magnitude is appropriate for a vehicle during its ramp-up phase where it will necessarily be breaching certain operating guidelines.

Given the credit exposure to each obligor and the simulated rating transitions and defaults, credit and market losses over all obligors can then be aggregated. For each random evolution of the counterparty defaults and rating changes, together with the simulated market variables, a cumulative loss amount can be created. The simulated losses can then be used to construct an empirical distribution of potential losses. The required allocation of capital would correspond to a stressed level of potential losses at a high level of statistical confidence based upon the probability distribution created. The exact level of confidence will be a function of the model that the investment manager uses, but is normally more than 98%. Standard & Poor's also expects that, while the minimum number of simulations will most likely be in excess of 100,000, the actual number of runs that an investment manager may undertake will be a function of the need to achieve stability in the distribution output of the model. The allocation of capital derived from the default simulation exercise provides the amount of capital required to support the vehicle against credit and market value losses at a 'AAA' level.

Chart 5 above shows how the SIV is likely to incur small levels of losses relatively frequently, and large dollar losses very infrequently. The area to the right of the dotted line represents 0.005% of the area under the curve. If the SIV holds capital equivalent to the loss amount at the point where the dotted line falls on the horizontal axis, there is a 99.995% confidence level that with all the various combinations of credit and market losses, total losses will not be more than the capital held by the vehicle.

Standard & Poor's will want to spend time with the investment manager to understand in detail the historical information being used in the simulator. Standard & Poor's will also want to achieve a level of comfort with respect to the robustness of any historical pricing indices and other information, their relevance to the assets the investment manager intends to purchase, how any index proposed to be used has been created, and, for less liquid assets, how accurate the data might be for tracking actual trade information, etc. It is at this point that Standard & Poor's analysts working on the SIV may liaise closely with colleagues in Standard & Poor's Market Value group.

As the capital model is dynamic, new simulations and, therefore, new capital calculations will need to be undertaken every day. The then current variables of asset price (or spread), interest rates, foreign exchange rates, and ratings on assets and hedge counterparties will also need to be updated on a daily basis. The parameters of asset, interest rate, and foreign exchange volatility, as well as rating migration are expected to be updated on a less frequent basis.

As in the case of simulation model inputs, Standard & Poor's will want to understand why the capital "haircuts" being taken in the matrix are appropriate for a 'AAA' rated vehicle. Standard & Poor's will also want to understand the robustness and appropriateness of any reference indices and other information that is intended to apply to specific asset classes, and analyze in detail price volatility data from such indices. Standard & Poor's analysts may work closely with its Market Value group in setting appropriately stressed volatility factors.

As shown in table 1, a capital matrix can have a simplistic two-dimensional structure with the capital charge being a function of rating and tenor. Equally, however, it can have three dimensions with the capital charge being a function of rating, tenor, and asset class.

Table 1 shows a range of capital charges for one asset type. The numbers in this example are for illustrative purposes only.

Table 1 Example of Capital Charge Matrix
	Capital charge (%)
Rating	One-year tenor	Three-year tenor	Five-year tenor
AAA	2	3	5
AA	3	4	7
A	6	9	12
BBB	10	15	18
BB	15	22	30

To determine the required level of capital for the SIV until the last liability matures or until any mandatory call date, a limited number of runs are performed assuming different asset and liability compositions. Standard & Poor's will work with the investment manager to construct hypothetical portfolios that could be held by the SIV while remaining within the agreed portfolio parameters. In this way, for example, the adequacy of capital for a 'AAA' rated five-year maturity portfolio can be compared with that of a portfolio containing the maximum permitted amount of lower-rated assets with the longest permitted maturities.

Standard & Poor's will also consider whether the level of capital is adequate for a vehicle with a liability profile that is very short, compared with a profile that is very long. Using both the weighted-average life of the liabilities and the date of any mandatory call option, and using the capital charges for the individual assets, Standard & Poor's will want to understand the minimum capital requirements determined by the matrix to derive comfort that under a range of scenarios the 'AAA' liabilities will be repaid in full.

In any case, the capital charges will depend on the enforcement guidelines. Therefore, SIV structures with the same enforcement guidelines and similar asset profiles should have similar capital charges. A prudent investment manager is expected to update the underlying credit and market price variables on a regular basis.

Investment managers are expected to define at the outset investment guidelines that are consistent with the investment manager's expertise and experience as well as with the data provided for the validation of the capital model or capital charge matrices.

Basic investment guidelines that Standard & Poor's would expect to see in the SIV's operating manual include:

• The average life of the assets and legal final maturity;
• The composition of assets by rating category. Basically, this test allows for some rating migration upon acquisition that will be determined based on certain transition matrices published on RatingsDirect, Standard & Poor's Web-based credit analysis system (see the latest transition studies, for example, "European Asset-Backed Transactions Transition Study 2001: Volumes Rocket Yet Stability Remains", published Feb. 14, 2002, and "Rating Transitions 2001: U.S. ABS Credit Ratings Endure the Test of Recession", published Jan. 14, 2002).
• Portfolio composition by sectors (sovereign, corporate, structured finance, etc.);
• Portfolio composition by asset classes, namely, RMBS, ABS, CMBS, CDOs, etc.;
• Portfolio composition by geographic region (see table 2 for example of country concentration limits);
• For ABS in which the collateral is domiciled in different countries, the predefined categorization of such collateral, e.g., emerging market CDOs etc.; and
• A limit on the percentage holding of any single issue.

Such guidelines are intended to create a level of diversity appropriate for a 'AAA' rated vehicle that may not necessarily be captured by the capital calculations, while still providing the investment manager with room to follow its own particular investment strategy.

Table 2 Example of Country Concentration Limits of Portfolio
Country	Percentage
U.S.	100
AAA rated country*	50
AA rated country	25
A rated country	10
BBB rated country	5
BB rated country	3
*Other than the U.S.

In addition to the above tests, Standard & Poor's requires two additional tests intended to limit the vehicle's single obligor exposure. One test is in relation to the net asset value (NAV) of the SIV (i.e., market value of assets less par value of senior liabilities), and a second test is in relation to the assets as a percentage of the portfolio. Note that both tests need to be consistent with the portfolio of securities to be purchased.

The first test requires that the NAV of the portfolio be at least equal to:

• The largest 'AAA' asset; or
• The two largest 'AA' assets; or
• The three largest 'A' assets; or
• The five largest 'BBB' assets; or
• The 10 largest 'BB' assets.

For the second test, the maximum that the asset can represent as a percentage of the overall portfolio will depend on its rating. Table 3 gives an example of acceptable single obligor concentration limits at each rating level.

Table 3 Example of Single Obligor Limits
Asset rating	Maximum holding of a single asset as a percentage of the portfolio
AAA	15
AA	10
A	5
BBB	3
BB	1

To be confident that the investment manager will comply with the predefined investment guidelines, Standard & Poor's will want to confirm that if an asset in the portfolio causes a breach of any investment guidelines (e.g., due to rating action on a bond that previously fully complied with the guidelines) the market value of the proportion of the bond causing the breach is 100% capital charged.

For example, a 'BBB' asset representing, say, 2.5% of the overall portfolio could be in compliance with all tests. If this asset were downgraded to 'BB', however, the asset would breach the 'BB' single obligor test of 1% in table 3. Capital would, therefore, be calculated based on 'BB' capital charges for the portion of the bond up to the single obligor limit of 1%, and the remaining portion of the bond that represented the excess of 1.5% over the single obligor limit would be 100% capital charged.

• Electronic pricing sources, including Data Resources Inc.; Interactive Data Services; ISMA; JJ Kenny (municipal securities only); Muller Data Corp.; Reuters (non-U.S. securities only); Standard & Poor's (municipal securities only); Telerate; Trepp Pricing (structured securities only); Bridge Fixed Income Services; and Bloomberg (not the fair value);
• Broker/dealer quotes (firm not indicative); and
• Illiquid grid. In addition to the pricing services outlined and the broker/dealer quotes, a grid is often agreed with the investment manager that may be used for up to 5% of the portfolio in the exceptional circumstance when no price is available for a particular asset when required.

Most SIVs run systems that allow the use of both pricing services and dealer quotes for their assets. Standard & Poor's regularly and systematically monitors and cross checks the performance of pricing behavior between the different pricing services and dealer quotes. Investment managers are strongly encouraged to do the same with their individual portfolios wherever possible.

As Standard & Poor's expects a minimum level of capital of approximately $75 million, the SIV's available capital should be sufficient to cover potential losses if the portfolio needs to be liquidated during the ramp-up period.

For example, for each five-day period there will be five different cumulative values, except for the last four, three, two, and one business days of the one-year period. The net cumulative outflow will be the largest of the five different values, calculated as shown in table 5.

Table 5 Example of an NCO5 Calculation (T to T+4)
Day	Cumulative values
T	Daily NCO for T
T+1	Sum of daily NCOs for days T and T+1
T+2	Sum of daily NCOs for days T, T+1, and T+2
T+3	Sum of daily NCOs for days T, T+1, T+2, and T+3
T+4	Sum of daily NCOs for days T, T+1, T+2, T+3, and T+4

In the example above (as shown in tables 4 and 5), the largest five business days NCO is negative $36 million, which is the two-day cumulative sum of the daily NCO for days T and T+1. In this example, if the NCO5 test is run for the rest of the year (i.e., out to T+364) and no higher NCO5 amount is encountered, then the vehicle will need to have eligible liquidity at least equivalent to $36 million. The vehicle will run the other NCO tests (e.g. NCO1, NCO10, and NCO15) and if any produce a higher NCO requirement than the NCO5 peak discussed, that higher amount will become the eligible liquidity requirement.

Unlike most other vehicles that Standard & Poor's rates, a SIV's eligible liquidity can be provided through a mixture of external liquidity facilities from 'A-1+' rated banks and highly liquid assets held by the SIV. Standard & Poor's expects, however, that the SIV will cover the peak NCO5 eligible liquidity requirement with external liquidity lines only (on the basis that a five-day liquidity period for even highly liquidity assets is not an appropriate assumption at a 'AAA' level). Therefore, in the above example, if the NCO1 test resulted in a peak of $30 million, the NCO10 test resulted in a peak of $80 million, and the NCO15 test resulted in a requirement of $60 million, the actual liquidity amount held by the vehicle, based on the calculations on that day, would be $80 million, with $36 million provided by bank liquidity lines (i.e., the peak NCO5 requirement) and the remaining $44 million coming from liquid assets.

The forms of eligible liquidity, therefore, are(i) bank-funded liquidity facilities or breakable deposits or (ii) liquidity eligible assets (LEAs) or additional liquidity eligible assets (ALEAs).

• All liquidity providers must have a short-term rating of 'A-1+' in order to be eligible. Liquidity may be provided by 'A-1' institutions as long as an 'A-1+' provider also covers the obligations of the largest 'A-1' provider.
• The liquidity facility is normally provided for at least 365 days with a renewal period of 30 days or cash collateralized.
• Funds must be available to the SIV with same-day notice and normally before 2:00 p.m. London time on the day notice is given to allow the liability to be repaid.
• The investment manager can normally terminate the liquidity facility with 30 days' notice. If the facility is terminated in this situation, it should be with zero termination costs.
• If a liquidity provider loses its 'A-1+' rating, there is normally a grace period of 30 days to allow the investment manager to find a replacement.

If there is a failure to renew a facility when it matures and a new liquidity provider to take the current provider's place cannot be found, the investment manager will often have the ability to draw down the facility amount in full. The same procedure can be followed if any existing liquidity provider is downgraded below 'A-1+' and no replacement is found within the 30-day grace period. However, as the draw-down would have an effect on the NCO tests (increasing the outflow side of the equation if no offsetting repayment of liabilities is made), potentially causing a breach of the liquidity tests and, therefore, triggering an enforcement event, Standard & Poor's expects that this would be a last resort. In reality, the investment manager will actively manage and monitor its liquidity lines to ensure that this event does not arise.

Standard & Poor's treats the breakable deposit as an investment and, therefore, expects the deposit to be either capital charged at the one-year charge for the long-term rating of the deposit bank (for those SIVs using a matrix calculation) or be considered in the capital model to capture the default risk of the counterparty.

Table 6 Capital Charges for LEAs
Industry / industry sector	Long-term ratings	Remaining maximum tenor (in years) or remaining maximum expected life for credit cards	Floating-rate haircuts (%)	Fixed-rate haircuts (%)
Sovereign - all	AAA	0-1	1.5	5.0
		1-5	3.0	17.0
		5-10	5.0	25.0
	AA	0-1	2.5	5.0
		1-5	17.5	35.0
		5-10	17.5	35.0
Financial institutions--commercial bank (senior debt)	AAA	0-1	1.5	5.0
		1-5	3.0	17.0
	AA	0-1	2.5	5.0
		1-5	17.5	35.0
Corporate -- all	AAA	0-1	1.5	5.0
		1-5	3.0	17.0
ABS -- credit cards	AAA	0-3	8.5	N/A
N/A--not applicable.

As with the investment guidelines described above, Standard & Poor's expects that the investment manager will prudently include more than one industry, more than one industry sector, and more than one individual issuer in its LEA portfolio at any point in time, but leaves it to the investment manager to determine its own specific mix. For credit card LEAs, the asset must be 'AAA' rated, indexed against LIBOR, CP, or treasury bills, and have a minimum issue size of $200 million. The SIV can only hold a maximum 25% of any one issue with a minimum position size of $10 million.

Standard & Poor's applies capital charges to ALEAs as shown in table 7.

Table 7 Capital Charges for ALEAs
Industry	Industry sector	Long- term ratings	Remaining expected life (years)	Floating-rate haircuts (%)
ABS	Credit cards	AAA	3-7	8.5
ABS	Auto loans	AAA	0-3	8.5
ABS	Student loans	AAA	0-3	8.5

Note that, given the nature of ABS, the maximum tenor included in table 6 is replaced by the assets' expected life which will be a function of (i) a pre-set amortization schedule, (ii) constant prepayment rate or other appropriate measures of prepayment, and (iii) step-up calls. Standard & Poor's must be satisfied that the expected life of such a debt issue will be determined according to the term to which it trades in the market, as verified by active market makers in the specific debt issue.

ALEAs can be used as eligible liquidity for the NCO15 test only.

Standard & Poor's is willing to consider other asset classes that an investment manager deems eligible as ALEAs. In such a case, Standard & Poor's would expect to receive detailed information on the asset class and its market to assist its analysis. Such information would include, for example, the following:

• A market overview, i.e., background, growth, the large issuers, and existing deals;
• The size of the market;
• Deal size;
• Ticket size;
• Bid/offer spread;
• Relative oversubscription at initial launch;
• Type of deal;
• Comparison of bid/offers with other LEA classes;
• Effect of jurisdiction on liquidity;
• Effect of a stressed period in history and supporting data; and
• Other opinions from market participants.

To be confident that the eligible liquidity amounts will be sufficient, Standard & Poor's requires a weighted-average life for the SIV's senior liabilities (WALSL) of at least three months. The reason for this limit is that, if an enforcement event occurs and is not cured within five business days, the trustee and the enforcement manager could end up in a situation in which the entire portfolio needs to be sold in a very short time frame just outside the time frame captured by the NCO15 test. The three-month limit ensures that not all liabilities will become immediately due after enforcement. A very short time frame would create a desperate situation for the enforcement manager, who would be forced to take bids that do not reflect the potential market price of the assets. Investment managers will want to carefully balance the WALSL as it will have a direct effect on the NCO calculations: the shorter the WALSL, the greater the outflows and the greater the requirements for costly committed liquidity and lower-yielding eligible assets. Equally, a longer WALSL suggests higher funding costs.

Finally, Standard & Poor's expects the SIV to report on a weekly basis its maximum NCO amounts until the maturity of its last liability. While these tests do not trigger any enforcement or other events, Standard & Poor's considers that it is prudent for the investment manager to look beyond the one-year NCO horizon.

The methodology for this test is as follows:

(i) Calculate the present value for each currency portfolio denominated in eligible currencies with each respective yield curve using certain minimum monthly points (one, three, six, nine, 12, 24, 36, 48, 60, 84, 120) and such other independent points on the curve as will ensure that this test is applied to the maturity of the longest-dated asset or rated liability and reflects the asset composition of the SIV at the time of the test.

(ii) Aggregate present values of all currency portfolios by converting first the non-dollar-denominated portfolio by the spot rate.

(iii) Calculate the present value of all senior liabilities, using the same methodology as in step one and two.

(iv) Subtract the present value of all currency portfolios from the present value of all senior liabilities. This gives the base NAV, or NAV(0).

(v) Replicate steps one to four but move each yield curve up by 1 bps, and then calculate the new NAV aggregating the worst case absolute values regardless of positive or negative results {NAV(Up)}.

(vi) Replicate step five but move each yield curve down by 1 bps, and calculate the new NAV aggregating the worst case absolute values regardless of positive or negative results {NAV(Down)}.

(vii) Compare the results of NAV(0) minus NAV(Up), and NAV(0) minus NAV(Down). The highest absolute value of these two calculations is called NAV(1).

For example, assume that a SIV has two bonds, one denominated in U.S. dollars and another in euros, and the €/$ spot rate is 0.90. Also assume that outstanding senior liabilities are $180.

The U.S. asset pays U.S. dollar LIBOR plus 50 bps, has a three-year maturity, and a present value of $100. The euro asset pays three-month EURIBOR plus 30 bps, also matures in year three, and has a present value of €100 ($90). The present value of the portfolio is, therefore, $190.

Senior liabilities pay three-month LIBOR plus 20 bps and consist of a principal bullet payment in year two with a present value equal to $180.

The base NAV or NAV(0) is $10 (i.e., $190-$180).

The parallel shift calculations are followed, resulting in a NAV(1) of $9.9999.

Thus, the test will be passed if {NAV(0)–NAV(1)}/NAV(0)<0.2 bps. In the example, ($10-$9.9999)/$10=0.00001 or 0.1 bps, therefore the test is passed.

The test is then repeated assuming a 100 bps parallel shift and a tolerance of 2 bps.

This test assumes that yield curves do not necessarily move in a parallel fashion. The test particularly stresses cash flows that might be concentrated in a specific part of the curve.