Subject: RE: ... Urgent Weather Derivative Advice ...
From: [email-masked]
To: [email-masked]
Cc: [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked]
Date: Mon, 23 Oct 2000 08:32:00 -0700 (PDT)

Jane:

This responds to your questions relating to the gambling issues for weather
derivatives which we discussed last week.  This advice is based on discussions
with Naoaki Eguchi and Shinji Toyohara.  We have tried to provide a practical
response to all of the issues raised.  If you need further discussion on the
theoretical underpinnings, please let me know.

As background, the main advice to date on this issue has been our initial 
advice
of January 14, 2000, a memorandum to John Viverito dated July 7, 2000 and an
email to John Viverito dated July 13, 2000.

Question 1: (Can/Should ToaRe and Enron Japan give a mutual representation
to the effect that they are each entering into the transaction "to hedge 
weather
related risks arising in the ordinary course of [their] business".  If not, 
can
the representation be deleted or amended?)

    ToaRe has taken the position that it is a "risk
taker" in this transaction and that, accordingly, it cannot give the
representation because it is not hedging risk.  Similarly, Enron Japan does
currently have weather exposure in Japan and, accordingly, cannot be said to 
be
hedging weather risk.

    It follows, that the representation, as
currently drafted, does not fit the actual circumstances of either party and
needs to be modified or deleted.

    Our recommendation would be to modify the
representation as follows:

    (a) each party represents to the other that
it understands the transaction, it is entering into the transaction in the
ordinary course of its business and that it has a legitimate business purpose
for entering into the transaction;

    (b) ToaRe represents to Enron Japan that it
has the power and authority to enter into the transaction under the Insurance
Business Law.

    The modification to paragraph (a) removes the
word "hedge" which would have been problematic to both parties, but retains 
the
basic concept that this is a  commercial transaction within the ordinary scope
of business of both parties.  We understand that Enron Japan's business 
purposes
allow Enron Japan to engage in weather derivative transaction.  We also note
that the Financial Law Board (Paper on Derivatives Transactions and Gambling,
issued on November 29, 1999; the Financial Law Board is an unofficial
organisation of legal practitioners) has stated that a company that enters 
into
derivative transactions as a business may be able to argue that it has a
legitimate business purpose in entering into the transactions - particularly
where the parties to the transaction are sophisticated and the transactions 
are
conducted within reasonable parameters.  Based on these factors, we believe 
that
Enron Japan should be able to give both representations.  However, Enron Japan
should note that the issue is not entirely clear under Japanese law and there
remains a remote possibility that a Japanese court might determine that Enron
Japan did not have a legitimate business purpose in entering into the
transaction.

    The representation in paragraph (b) is based on
the provisions of the Insurance Business Law that enable insurance companies
(including Japanese reinsurance companies) to enter into certain types of
derivative transactions.  We understand that the FSA has provided informal
guidance to certain financial institutions to the effect that the provisions
allowing financial institutions to enter into financial derivatives are wide
enough to also allow financial institutions to enter into weather derivatives.
However, this is a matter that ToaRe would need to confirm with the FSA
directly, and we are not able to express a general view - all that is possible
is for Enron Japan to request the representation from Toa Re.

    Please note that in cases where Enron Japan's
counterparty is a manufacturing company, the representation, as originally
drafted, should be given by the counterparty.

Question 2:  (Exposure for Enron Japan).

 As discussed in our earlier advice, the issue of whether weather
derivatives constitute gambling under the Japanese Criminal Code is not clear,
and we are not able to provide a definite opinion on these issues.

 There are two defenses to an allegation of gambling under the Criminal
Code:  "acts in accordance with law" and "legitimate business purpose".  In
principle, each counterparty must be able to show that one of the defenses
applies to it.  There is at least a suggestion in the Financial Law Board 
paper
that if the "act in accordance with law" defense applies to one party, the
counterparty should also be able to rely on this defense.  However, this
argument does not have judicial support, and the more conservative position is
to ensure that each party meets one or more of the defenses.

 In this case, looking at each defense in turn:

    (a) ToaRe is a reinsurance company and will
be entitled to rely on the provisions of the Insurance Business Law to argue
that entering into a weather derivative transaction is an act in accordance 
with
law, and thus does not constitute gambling; and

    (b) it is arguable that, consistent with the
comments of the Financial Law Board discussed above,  both ToaRe and Enron 
Japan
have a legitimate business purpose in entering into the transaction on the 
basis
that:

* each party is carrying on a business of trading weather risk;

* each party is a sophisticated investor (as Enron Japan is a new company,
it would need to rely on the experience of Enron Japan traders previously
located offshore to show "sophistication"); and

* each party (at least in the case of Enron Japan) is conducting the
transaction in accordance with reasonable parameters.

    Accordingly, assuming that ToaRe is able to give
the representations referred to above, and that these representations are
correct, both paragraph (a) and paragraph (b) appear to apply.  Thus, we do 
not
believe that the risk for Enron Japan in entering into this transactions with
ToaRe will be any higher than would have been the case if Enron Japan had
entered into the transaction with a legitimate end user (for example an air
conditioning company).  We have previously characterised this risk as being
"relatively low".

    It is conceivable that Enron Japan may, in the
future, enter into transactions with entities that are neither financial
institutions nor end users (for example, other traders like Enron itself would
fall into this category).  In such a case, Enron Japan will not be able to 
rely
on the "act in accordance with law" argument, and will be obliged to rely only
on the "legitimate business purpose" argument based on the fact that the
counterparty is a trader of financial products.  In our view, the risk for 
Enron
Japan in this scenario would increase, but could still be characterised as 
being
"relatively low".  In this situation, Enron Japan and the counterparty would
give mutual representations to the effect of the representation set out in
paragraph (a) under Question 1 above.

Question 3: (Criminal Sanctions)

    From a technical point of view, criminal
sanctions apply only to individuals, and not to companies.  In this case, the
criminal sanctions (if any) for gambling could potentially apply to the trader
that entered into the transaction.  The responsible managers may also have
criminal liability on the basis that they controlled the acts of the trader, 
or
solicited the acts of the trader.

    The penalties are:

    Simple gambling  - up to Yen 500,000 fine
    Habitual gambling - imprisonment up to 3 years;
    Booking - imprisonment of between 3 months and 5
years.

Question 4: (Conducting the transactions using an Enron affiliate located
outside Japan)

 As noted in section 5 of our July 7, 2000 memorandum, we consider that
the risk that the activity constituted gambling would be reduced if Enron were
to enter into weather transactions from offshore.

Embedded in the foregoing comments is the concept that the representations in
the GTC's need to vary depending on whether the counterparty is a financial
institution, another unregulated trader or an end user of weather derivatives.
The representations previously proposed were proposed on the basis that the
counterparty would be an end user. If appropriate, we would be happy to 
provide
alternate forms of representations for your reference.

Please let us know if you have any questions.

Best regards

Jeremy Pitts

Registered Foreign Lawyer - Jurisdiction of Primary Qualification - New South
Wales
Designated Jurisdictions - England and Wales and the State of Victoria
Direct Tel:  (81-3) 3479 3839
Direct Fax:  (81-3) 3479 0225
Voice/Fax Messaging: (81-3) 4464 6094

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Thank you.

  -----Original Message-----
  From: [email-masked] [mailto:[email-masked]]
  Sent: Friday, October 20, 2000 6:18 PM
  To: [email-masked]
  Cc: [email-masked]; [email-masked];
[email-masked]
  Subject: ... Urgent Weather Derivative Advice ...

   << File: Weather-HDD-Floor-OTC-ToaRejmb2000-10-20!.doc >> Dear
Jeremy,

  Pls see for your information my email to Alan, Mark and Alan.

  As discussed, your answers to my questions can be quite brief
and pls cross
  reference previous advice rather than repeating it.

  I think the answer to question 1 - whether we can give the
warranty - has
  got to be no.  So short and sweet on this is fine.

  Re whether we can go ahead without the same (c)(ii) from them
(but with
  (c)(iii)) is a harder question and I understand that all you can
do is
  explain our risk and exposure, in light of the current factual
situation.

  This is a risk appetite question at the end of the day.

  Jane

  ----- Forwarded by Jane McBride/AP/Enron on 10/20/2000 05:57 PM
-----

                      Jane McBride

                                           To:     Alan
Aronowitz/HOU/ECT@ECT, Mark Taylor/HOU/ECT@ECT
                      10/20/2000           cc:
[email-masked], John Viverito/Corp/Enron@Enron,
                      05:57 PM             Jonathan
Whitehead/AP/Enron@Enron, Mark Evans/Legal/LON/ECT@ECT,

[email-masked], Morten E Pettersen/AP/Enron@Enron, Joseph P
                                           Hirl/AP/ENRON@ENRON

                                           Subject:     ... Urgent
Weather Derivative Advice ...(Document link: Jane
                                           McBride)

  Dear Alan and Mark,

  I am going to need you to help me make a risk decision.  I
welcome input
  from Mark Evans but he may be more comfortable leaving this up
to Alan and
  Mark because Alan and Mark have been involved in this gambling
issue from
  the beginning.

  Jeremy Pitts and I have had a brief conversation re my email to
him below,
  this afternoon, but he will not be able to get written comments
signed off
  by Japanese lawyers to me until Monday.

  The situation relates to the Tokyo's office's first weather
derivatives
  deal, which is with a company called Toa Reinsurance.  In a
nutshell the
  situation is that negotiations have come to a standstill because
neither
  side can move on their positions re the gambling warranties.
The deal of
  course though has already been done over the telephone several
weeks ago.

  In a nutshell then, based on discussions with Jeremy Pitts, but
to be
  clarified by Japanese lawyer on Monday, the situation is:

  1.   In terms of Enron Japan's ability to trade weather
derivatives here,
  we are operating in the grey even if we can get warranty
5(c)(ii) from
  them.

  2.   ToaRe will not give us the important warranty - 5(c)(ii)
below,
  because they say they can't.  They say they are not actually
"entering into
  the deal to hedge weather related risks arising in the ordinary
course of
  their business" - which is what the subject warranty says.  B&M
have
  advised that the obtaining of this warranty from a counter party
helps keep
  us in the grey and out of the red in terms of what we are doing
and also
  gives us comfort that the counter party can do the deal.

  3.   ToaRe is, in addition, separately asking us to give them
the same
  warranty.

  Jane McBride analysis

  Re 3 - Given that our legal situation is grey at best, I do not
think we
  should be giving the warranty they have requested.  They say
they will not
  give us that warranty.  The issue then is whether we can go
ahead without
  getting the warranty from them, bearing in mind that a binding
telephone
  deal has been done.

  If you agree with me that we can't give the warranty, then we
have to
  decide whether we can go ahead without getting the warranty
referred to in
  (2) above, from them.  I am not sure however that in practice we
even have
  a choice given that the trade has been done.

  If we go ahead without giving and without getting the warranty,
the risk to
  us is that we are more likely to be in breach of the prohibition
on
  gambling in the Criminal Law.  Are we willing to take this risk
and who
  needs to give me this answer?

  Jane

                      Jane McBride

                                           To:
[email-masked]
                      10/20/2000           cc:
[email-masked], Alan Aronowitz/HOU/ECT@ECT, John
                      02:06 PM
Viverito/Corp/Enron@Enron, Mark Evans/Legal/LON/ECT@ECT, Jonathan

Whitehead/AP/Enron@Enron, Mark Taylor/HOU/ECT@ECT
                                           Subject:     ... Urgent
Weather Derivative Advice ...(Document link: Jane
                                           McBride)

  (See attached file:
Weather-HDD-Floor-OTC-ToaRejmb2000-10-20!.doc)

  Dear Jeremy,

  I would like to refine the following instructions.  There are
two (only)
  issues on which we need specific written advice and they both
relate to
  Warranty (c)(ii) of the draft which says "XYZ is entering into a
weather
  derivative transaction to hedge weather related risks arising in
the
  ordinary course of its business".

  1.   (a)  Can Enron Japan give the warranty at this stage in its
growth?
  Have we already had any written advice from you on whether Enron
Japan can
  warrant along these lines?  If so, when?  If not, the facts seem
to be
  that:

     Enron Japan plans to trade commodities which are energy
related but
     because we are still building up the business we are not
trading these
     products yet.
     As you know, we are getting into the power market.  If we
have done a
     weather derivative, then we can of course offer better prices
on the
     electricity deals we are negotiating.
     Other Enron companies are of course already trading many
weather
     dependant commodities and power.

  It could be argued therefore that unless we can rely on the
weather related
  risks of other Enron companies to justify our weather derivative
  transacting in these early days, that this is a speculative
transaction
  constituting gambling (depending on how the law on this works).
It is
  understandable that ToaRe would want us to warranty in effect
that we are
  not gambling because we are asking them to do so.  I know we
have had sign
  off from B&M re our weather derivative trading but I wonder if
anyone
  considered what the situation would be before we ourselves had
other
  transactions giving us weather related risks.

  (b)  If not, how could it be amended so that we can give it?

  (c)  If still relevant in the context of your answers to (a) and
(b) above,
  they did offer previously to take out all warranties so that
neither party
  gives any warranties.  The deal cannot be cancelled because it
was done on
  the telephone late Sept.  Accordingly, what is the practical
risk of us
  proceeding without the benefit of any warranties from ToaRe
(including the
  warranty that they are under the Insurance Business Law - ie an
insurance
  company.)?

  2.   They are insisting they not give (ii) and that we be
satisfied with
  (iii) only for the purposes of the Gambling Law  Pls confirm in
writing
  whether you think we can still go ahead on this basis.

  Thanks.

  Jane McBride
  Senior Legal Counsel
  Enron Japan Corp.

  Otemachi 1st Square Bldg.
  West 11th Floor
  1-5-1 Otemachi, Chiyoda-ku
  Tokyo 100-0004
  Japan

  Tel.:       81-3-5219-4500 (Main)
                81-3-5219-4553 (Direct)
  Fax:       81-3-5219-4510

  Assistant (Maggy Yamanishi)
  Tel.:        81-3-5219-4554
  Email:      [email-masked]

                      Jane McBride

                                           To:
[email-masked], [email-masked]
                      10/20/2000           cc:

                      10:57 AM             Subject:     RE: ToaRe
documentation(Document link: Jane McBride)