Template:M summ 2002 ISDA 5(a)(vi): Difference between revisions

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===General===
{{isda 5(a)(vi) summ|isdaprov}}
{{isdaprov|Cross Default}} is intended to cover off the unique risks associated with ''lending money to counterparties who have also borrowed heavily from other people''. If you try to apply it to contractual relationships which aren't debtor/creditor in nature — as starry-eyed young [[credit officer]]s in the thrall of the moment like to — it will give cause trouble. This will not stop credit officers doing that. Note also that it is, as are most ISDA provisions, bilateral. If you are a regulated financial institution, the boon of having a {{isdaprov|Cross Default}} right against your counterparty may be a lot smaller than the bane of having given away a {{isdaprov|Cross Default}} right against yourself.
 
Under the {{isdama}}, if the cross default applies, default by a party under a contract for “{{isdaprov|Specified Indebtedness}}” with a third party in an amount above the “{{isdaprov|Threshold Amount}}” is an {{isdaprov|Event of Default}} under the {{isdama}}.
==={{isdaprov|Specified Indebtedness}}===
{{isdaprov|Specified Indebtedness}} is generally any [[borrowed money|money borrowed]] from any third party (e.g. bank debt; [[deposits]], loan facilities etc.). Some parties will try to widen this: do your best to resist the temptation.
 
The {{isdaprov|Threshold Amount}} is usually defined as a cash amount or a percentage of shareholder funds, or both, in which case — [[Trick for young players|schoolboy error]] hazard alert — be careful to say whether it is the greater or lesser of the two. It should be big: like, life-threateningly big - because the consequences of triggering it are dire. Expect to see 2-3% of shareholder funds, or (for banks) sums in the order of hundreds of millions of dollars. For funds it could be a lot lower — like, ten million dollars — and, of course, will reflect [[NAV]] not shareholder funds.
 
{{isdaprov|Cross default}} imports all the default rights from the {{isdaprov|Specified Indebtedness}} into the {{isdama}}. For example, if you breach a financial covenant in your Specified Indebtedness, your swap counterparty could close you out '''even if the lender of the facility took no action on the breach'''. Cross default is, therefore, theoretically at least, a very dangerous provision. Financial reporting dudes get quite worked up about it. Oddly enough, it is very rarely triggered: It is actually very nebulous, and most credit officers would prefer to act on a clean {{isdaprov|Failure to Pay}} or a {{isdaprov|Bankruptcy}} event. Generally one will be along presently.
 
===Cross Aggregation===
The {{2002ma}} updates the {{1992ma}} cross-default so that if the combined amount outstanding under the two limbs of {{isdaprov|Cross Default}} exceed the {{isdaprov|Threshold Amount}}, then it will be an {{isdaprov|Event of Default}}. Normally, under the {{1992ma}}, {{isdaprov|Cross Default}} requires one ''or'' the other limbs to be satisfied — you can’t add them together.
 
As per the above, the two limbs are:
*a default under a financial agreement that would allow a creditor to [[accelerate]] any [[indebtedness]] that party owes it;
*a [[failure to pay]] on the due date under such agreements after the expiry of a [[grace period]].

Latest revision as of 20:18, 26 December 2023

Cross Default is intended to cover the unique risks associated with lending money to counterparties who have also borrowed heavily from other people.

Now, if — as starry-eyed young credit officers in the thrall of the moment are apt to — you apply this thinking to contractual relationships which aren’t “term loany” in nature — that is, that don’t have long spells where one party is deeply in the hole to the other, with not so much as interest payment due for months whose failure could trigger any acceleration — it will give you trouble. We go into this more in the premium JC.

Specified Indebtedness

Specified Indebtedness is generally any money borrowed from any third party (e.g. bank debt; deposits, loan facilities etc.). Some parties will try to widen this: do your best to resist the temptation. Again, more details on why in the premium section.

Threshold Amount

The Threshold Amount is a key feature of the Cross Default Event of Default in the ISDA Master Agreement. It is the level over which accumulated indebtedness defaults comprise an Event of Default. It is usually defined as a cash amount or a percentage of shareholder funds, or both, in which case — schoolboy error hazard alert — be careful to say whether it is the greater or lesser of the two.

Because of the snowball effect that a cross default clause can have on a party’s insolvency it should be big: like, life-threateningly big — because the consequences of triggering a Cross Default are dire, and it may create its own chain reaction beyond the ISDA itself. So expect to see, against a swap dealer, 2-3% of shareholder funds, or sums in the order of hundreds of millions of dollars. For end users the number may well be a lot lower (especially for thinly capitalised investment vehicles like funds — like, ten million dollars or so — and, of course, will key off NAV, not shareholder funds.

Cross acceleration

For those noble, fearless and brave folk who think Cross Default is a bit gauche; a bit passé in these enlightened times of zero-threshold VM CSAs[1] but can’t quite persuade their credit department to abandon Cross Default altogether — a day I swear is coming, even if it is not yet here — one can quickly convert a dangerous Cross Default clause into a less nocuous (but still fairly nocuous, if you ask me — nocuous, and yet strangely pointless) cross acceleration clause — meaning your close-out right that is only available where the lender in question has actually accelerated its Specified Indebtedness, not just become able to accelerate it, with some fairly simple edits, which are discussed in tedious detail here.

  1. ↑ Your correspondent is one of them; the author of that terrible FT book about derivatives is not.
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