AIG 2010 Annual Report Download - page 202

American International Group, Inc., and Subsidiaries
execution of these documents. The Master Agreement and CSA permit any provision contained in these
documents to be further varied or overridden by the individual transaction confirmations, providing flexibility to
tailor provisions to accommodate the requirements of any particular transaction. A CSA, if agreed by the parties
to a Master Agreement, supplements and forms part of the Master Agreement and contains provisions (among
others) for the valuation of the covered transactions, the delivery and release of collateral, the types of acceptable
collateral, the grant of a security interest (in the case of a CSA governed by New York law) or the outright
transfer of title (in the case of a CSA governed by English law) in the collateral that is posted, the calculation of
the amount of collateral required, the valuation of the collateral provided, the timing of any collateral demand or
return, dispute mechanisms, and various other rights, remedies and duties of the parties with respect to the
collateral provided.
In general, each party has the right under a CSA to act as the ‘‘Valuation Agent’’ and initiate the calculation of
the exposure of one party to the other (Exposure) in respect of transactions covered by the CSA. The valuation
calculation may be performed daily, weekly or at some other interval, and the frequency is one of the terms
negotiated at the time the CSA is signed. The definition of Exposure under a standard CSA is the amount that
would be payable to one party by the other party upon a hypothetical termination of that transaction. This amount
is determined, in most cases, by the Valuation Agent using its estimate of mid-market quotations (i.e., the average
of hypothetical bid and ask quotations) of the amounts that would be paid for a replacement transaction. AIGFP
determines Exposure typically by reference to the mark-to-market valuation of the relevant transaction produced
by its systems and specialized models. Exposure amounts are typically determined for all transactions under a
Master Agreement (unless the parties have specifically agreed to exclude certain transactions, not to apply the
CSA or to set a specific transaction Exposure to zero). The aggregate Exposure less the value of collateral already
held by the relevant party (and following application of certain thresholds) results in a net exposure amount
(Delivery Amount). If this amount is a positive number, then the other party must deliver collateral with a value
equal to the Delivery Amount. Under the standard CSA, the party not acting as Valuation Agent for any
particular Exposure calculation may dispute the Valuation Agent’s calculation of the Delivery Amount. If the
parties are unable to resolve this dispute, the terms of the standard CSA provide that the Valuation Agent is
required to recalculate Exposure using, in substitution for the disputed Exposure amounts, the average of actual
quotations at mid-market from four leading dealers in the relevant market.
After an Exposure amount is determined for a transaction subject to a CSA, it is combined with the Exposure
amounts for all other transactions under the relevant Master Agreement, which may be netted against one another
where the counterparties to a Master Agreement are each exposed to one another in respect of different
transactions. Actual collateral postings with respect to a Master Agreement may be affected by other agreed CSA
terms, including threshold and independent amounts, that may increase or decrease the amount of collateral
posted.
Regulatory Capital Relief Transactions
As of December 31, 2010, 85.7 percent of the Capital Markets regulatory capital relief transactions (measured
by net notional amount) were subject to CSAs linked to AIG’s credit rating and 14.3 percent of the regulatory
capital relief transactions were not subject to collateral posting provisions. In general, each regulatory capital relief
transaction is subject to a stand-alone Master Agreement or similar agreement, under which the aggregate
Exposure is calculated with reference to only a single transaction.
The underlying mechanism that determines the amount of collateral to be posted varies by counterparty, and
there is no standard formula. The varied mechanisms resulted from individual negotiations with different
counterparties. The following is a brief description of the primary mechanisms that are currently being employed
to determine the amount of collateral posting for this portfolio.
Reference to Market Indices — Under this mechanism, the amount of collateral to be posted is determined based
on a formula that references certain tranches of a market index, such as either iTraxx or CDX. This mechanism
is used for CDS transactions that reference either corporate loans, or residential mortgages. While the market
index is not a direct proxy, it has the advantage of being readily obtainable.
186 AIG 2010 Form 10-K