Template:M summ Equity Derivatives 12.9(a)(ii)

“It has become illegal”

For those inclined to look even gift horses in the mouth, this provision may appear to leave some things unsaid.

Some other way of holding Shares

What if it has become illegal to hold Shares the way the Hedging Party is holding them, but it remains legal to hold them some other way? For example, if Shares needed to be listed on a certain Exchange, or cleared across a certain clearinghouse? At first blush this seems fanciful but before you laugh don’t forget this was one of the potential consequences of Brexit — and for the Swissies — when the EU share trading obligation row blew up in 2019.

Even leaving aside the direction that one must act in good faith in arriving at one’s conclusion, it is hard to see how one could say it was “illegal to hold Shares” if in fact one could legally hold those Shares some other way. So this one’s a bit silly.

Other hedges, without Shares, still possible

What if one could hedge via futures, derivatives, GDRs or some other instrument without significant extra cost or inconvenience? Would that still count as a Change in Law, just because you couldn't hedge with actual Shares?

But is “hold, acquire or dispose of Shares relating to such Transaction” too narrow when a Hedging Party may be able to hedge some other way (i.e., via futures, swaps, depositary receipts and so on)?

Well, as fussy as it may seem, it is hard to fault in its basic logic. The scope entertained by ISDA’s crack drafting squad™ does seem a shade narrow, talking as it does only of Shares and not other instruments by which one could hedge an exposure. Not even our old friend the good faith rider can win the day here, since the clause only talks about acquiring, holding or disposing of Shares themselves. On the other hand, if a jurisdiction has declared the very act of holding a physical Share illegal, it is hard to see anyone in the jurisdiction offering a swap on it, so this may be more of a theoretical than a practical objection, especially where it is a synthetic equity swap where the hedging party has no incentive not to accommodate its client if it can source an alternative legal, somehow-derivative, hedge.

You may be inclined, therefore, gracefully to concede. We don’t think you’ll have to do this often, this is a bit of an aficionado’s point. So, knee-slide and jet wings to the whoever the negotiator was who thought of it.

“Amended Change In Law” for closed markets

The Standard 2002 ISDA Equity Derivatives Definitions definition of Change in Law is often amended as follows (for example in the 2007 European Master Equity Derivatives Confirmation Agreement:

Section 12.9(a)(ii) of the Equity Definitions is replaced in its entirety by the words: “Change in Law” means that, on or after the Trade Date of any Transaction: (A) due to the adoption of or any change in any applicable law or regulation (including, without limitation, any tax law), or (B) due to the promulgation of or any change in the interpretation by any court, tribunal or regulatory authority with competent jurisdiction of any applicable law or regulation (including any action taken by a taxing authority), the Calculation Agent determines in good faith that it has become illegal for a party to that Transaction to hold, acquire or dispose of Hedge Positions relating to such Transaction, provided that this Section 12.9(a)(ii) shall not apply if the Calculation Agent determines that such party could have taken reasonable steps to avoid such illegality.

The reason usually given is that in a closed market, it is often difficult to determine whether a party could have taken reasonable steps to avoid the Illegality.