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| ===[[Closing out]] an {{isdama}} following an {{{{{1}}}|Event of Default}}===
| | JC’s has updated the step-by-step guide to closing out an ISDA and it is now {{premium}}. You can access it '''[[pjc:Close out|here]]'''. |
| Here is the [[JC]]’s handy guide to [[closing out]] an {{isdama}}. We have assumed you are [[closing out]] as a result of a {{{{{1}}}|Failure to Pay or Deliver}} under Section {{{{{1}}}|5(a)(i)}}, because — unless you have inadvertently crossed some [[Tannhäuser Gate|portal, wormhole]] into a parallel but stupider universe — if an {{isdama}} had gone toes-up, that’s almost certainly why. That, or at a pinch {{{{{1}}}|Bankruptcy}}. Don’t try telling your [[credit officer]]s this, by the way: they won’t believe you — and they tend to get a bit wounded at the suggestion that their beloved [[NAV triggers]] are a waste of space.
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| In what follows “{{{{{1}}}|Close-out Amount}}” means, well, “{{isdaprov|Close-out Amount}}” (if under a {{2002ma}}) or “{{isda92prov|Loss}}” or “{{isda92prov|Market Quotation}}” amount (if under a {{1992ma}}), and “{{{{{1}}}|Early Termination Amount}}” means, for the {{1992ma}}, which neglected to give this key value a memorable name, “the amount, if any, payable in respect of an {{{{{1}}}|Early Termination Date}} and determined pursuant to Section {{isda92prov|6(e)}}”.
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| So, to close out following a {{{{{1}}}|Failure to Pay or Deliver}}, you will need:
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| ====1. There must be a failure to pay or deliver under Section {{{{{1}}}|5(a)(i)}}====
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| A {{{{{1}}}|Failure to Pay or Deliver}}, by the {{{{{1}}}|Defaulting Party}} to make a payment or delivery when due on day '''T'''. This is not, yet, an {{{{{1}}}|Event of Default}} under Section {{{{{1}}}|5(a)(i)}}. But we are on the way.
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| ====2. You must give notice of the failure under Section {{{{{1}}}|5(a)(i)}}====
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| The {{{{{1}}}|Non-defaulting Party}} must give the {{{{{1}}}|Defaulting Party}} notice of the failure. This is ''not'' a Section {{{{{1}}}|6(a)}} notice — calm, down, we will get to that in good time — but a Section 5(a)(i) notice of failure to pay or deliver. The sainted {{isdama}} does not directly prescribe the format for this notice, but Section {{{{{1}}}|12}} cautions that it may not be by {{isdaprov|e-mail}} or {{{{{1}}}|electronic messaging system}} or (if you have a {{1992ma}}, at any rate), by [[fax]]. The proper form is to have it hand-delivered by someone prepared to swear an affidavit as to when and where they delivered it to the {{{{{1}}}|Defaulting Party}}.<ref>Yes, it’s true: in ISDA’s alternative universe, [[Greenclose v National Westminster Bank plc|e-mail and electronic messaging systems are different things]].</ref>
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| Since payments and deliveries are generally due at [[close of business]] on a given day, [[Q.E.D.]], a Section {{{{{1}}}|5(a)(i)}} notice of {{{{{1}}}|Failure to Pay or Deliver}} can usually only be given ''after'' [[close of business]] on the due date.
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| Thanks to Section {{{{{1}}}|12(a)}} ({{{{{1}}}|Notices}}), the Section {{{{{1}}}|5(a)(i)}} notice will only be effective on the following {{{{{1}}}|Local Business Day}}: i.e., '''T+1'''. <ref>'''Spod’s note''': This notice requirement is key from a [[cross default]] perspective (if you have been indelicate enough to widen the scope of your [[cross default]] to include [[derivatives]], that is): if you don’t have it, ''any'' failure to pay under your {{isdama}}, however innocuous — even an operational oversight — automatically counts as an Event of Default, and gives a different person to the right to close ''their'' {{isdama}} with your Defaulting Party because of it defaulted to ''you'', even though (a) the Defaulting Party ''hasn’t'' defaulted to ''them'', and (b) you have decided not to take any action against the Defaulting Party yourself.</ref>
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| ====3. You must allow the [[grace period]] under Section {{{{{1}}}|5(a)(i)}} to expire====
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| At this point you have a {{{{{1}}}|Potential Event of Default}}, but not an ''actual'' one.
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| Once your Section {{{{{1}}}|5(a)(i)}} notice of {{{{{1}}}|Failure to Pay or Deliver}} is effective, the {{{{{1}}}|Defaulting Party}} has a “[[grace period]]” in which it may sort itself out and make the payment or delivery in question, thereby heading off a full-blown {{{{{1}}}|Event of Default}}.
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| The standard [[grace period]]s are set out in Section {{{{{1}}}|5(a)(i)}}. ''Be careful'': under a {{2002ma}} the standard is '''''one''''' {{{{{1}}}|Local Business Day}}. Under the {{1992ma}} the standard is '''''three''''' {{isda92prov|Local Business Day}}s. ''But check the {{{{{1}}}|Schedule}}'' because in either case this is the sort of thing that counterparties adjust: {{2002ma}}s are often adjusted to conform to the {{1992ma}} standard of three {{{{{1}}}|LBD}}s, for example.
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| So: once you have a clear, notified {{{{{1}}}|Failure to Pay or Deliver}}, you have to wait ''at least'' one and possibly three or more {{{{{1}}}|Local Business Day}}s before doing anything about it. Therefore, you are on tenterhooks until the [[close of business]] '''T+2''' {{{{{1}}}|LBD}}s (standard {{2002ma}}), or '''T+4''' {{isda92prov|LBD}}s (standard {{1992ma}}).
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| Let us imagine for a moment you have indeed waited the necessary time.
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| ====4. You may now send your Section {{{{{1}}}|6(a)}} notice designating an {{{{{1}}}|Early Termination Date}} ====
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| At the expiry of the Section {{{{{1}}}|5(a)(i)}} [[grace period]], you finally have a fully operational {{{{{1}}}|Event of Default}}. Now Section {{{{{1}}}|6(a)}} allows you, by ''not more than 20 days’ notice''<ref name="20days">See discussion on at Section {{{{{1}}}|6(a)}} about the silliness of that time limit.</ref> to designate an {{{{{1}}}|Early Termination Date}} for all outstanding {{{{{1}}}|Transaction}}s.
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| So, at some point in the next twenty days<ref name="20days"/> outstanding {{{{{1}}}|Transaction}}s will be at an end.<ref> By a striking oversight, not actually so named in the {{1992ma}}.</ref> Now this is a different thing from knowing what the amounts will be, much less knowing when they will be paid: this is the date ''by reference to which'' termination amounts will be calculated.
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| ====5. Determine {{{{{1}}}|Close-out Amount}}s<ref name="close out amounts">Or their equivalents under the {{1992ma}}, of course.</ref>====
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| One must now ascertain termination values for the {{{{{1}}}|Terminated Transaction}}s as of the {{{{{1}}}|Early Termination Date}} per the methodology set out in Section {{{{{1}}}|6(e)(i)}}.
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| Now armed with our crystalised {{{{{1}}}|Failure to Pay or Deliver}} {{{{{1}}}|Event of Default}} and with an {{{{{1}}}|Early Termination Date}} to target, we go directly to Section {{{{{1}}}|6(e)}}, noting as we fly over it, that Section {{{{{1}}}|6(c)}} reminds us [[for the avoidance of doubt]] that even if the {{{{{1}}}|Event of Default}} which triggers the {{{{{1}}}|Early Termination Date}} evaporates in the meantime — these things happen, okay? — yon {{{{{1}}}|Defaulting Party}}’s goose is still irretrievably cooked.<ref>If [[Credit department|Credit]] suddenly gets executioner’s remorse and wants to let the Defaulting Party off), the Non-defaulting Party will have to expressly terminate the close-out process, preferably by written notice. There’s an argument — though it is hard to picture the time or place on God’s green earth where a Defaulting Party would make it — that cancelling an in-flight close out is no longer exclusively in the Defaulting Party’s gift, and requires the NDP’s consent. It would be an odd, self-harming kind of Defaulting Party that would run ''that'' argument unless the market was properly gyrating.</ref>
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| There is a bit of a [[chicken licken]]-and-egg situation here as you can’t really work out their [[mark-to-market]] values for that date at any time ''before'' that date, unless you are able to see into the future or something. Anyway, that’s a conundrum for your [[Trader|trading]] people (and in-house [[Metaphysics|metaphysicians]]) to deal with and it need not trouble we [[Legal Eagles|eagles of the law]]. For our purposes, the trading and risk people need to come up with {{{{{1}}}|Close-out Amount}}s for all outstanding {{{{{1}}}|Transaction}}s. These are intended to be determined as of the Early Termination Date, that you designated before, and which is within 20 days of the date you sent your termination notice, but note:
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| {{quote|Each {{{{{1}}}|Close-out Amount}} will be determined as of the {{{{{1}}}|Early Termination Date}} ''or, if that would not be [[commercially reasonable]], as of the date or dates following the {{{{{1}}}|Early Termination Date}} as '''would''' be [[commercially reasonable]]''.<ref>This is in the definition of {{isdaprov|Close-out Amount}} ({{2002ma}}) and {{isda92prov|Loss}} ({{1992ma}}). Curiously, Market Quotation in the {{1992ma}} does it slightly differently, saying “The party making the determination (or its agent) will request each Reference Market-maker to provide its quotation to the extent reasonably practicable as of the same day and time (without regard to different time zones) ''on or as soon as reasonably practicable after the relevant Early Termination Date''.” We ''guess'' that gives a bit of flexibility, but is not quite so clear-cut. we suppose the point is that the Non-Affected Party can presumably hit the prices offered by the Reference Market Makers — making the enormous assumption any will actually provide a price — and so isn’t subject to any market risk; which is good. But on the other hand, block-trading a huge portfolio on one day is likely to move the market, and not in a good way, for the defaulted client. We would like to think common-sense would prevail for those dinosaurs still on the 1992, and using the MQ concept. Then again, the fact that you are still on a 1992 twenty years after it was superseded suggests somewhat that common sense may be lacking somewhere in the relationship. </ref>}}
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| '''This is very important'''. This means you don’t have to liquidate a portfolio in its entirety within 20 days, or even take the values as of that {{{{{1}}}|Early Termination Date}}. If you can, you should — but it may well not be commercially reasonable — or even possible — to. The [[Lehman]] insolvency took ''months'' to unwind. Note also that [[commercial reasonableness]] is viewed from the Non-Affected Party’s perspective. It is not a licence to do whatever the hell you want — but the court won’t second guess prudent application of your own models.
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| Once they have done that you are ready for your Section {{{{{1}}}|6(e)}} notice.
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| ====6. Calculate and notify====
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| The {{{{{1}}}|Early Termination Date}} is the date on which the {{{{{1}}}|Transaction}}s terminate; it is the date ''by reference to which'' you calculate their termination values, ''not'' the date by you have to have ''valued'', much less ''settled'' outstanding amounts due as a result of their termination — that would be a logical impossibility for those not imbued with the power of foresight. Here we move onto Section {{{{{1}}}|6(d)}}, under which, as soon as is practicable ''after'' the {{{{{1}}}|Early Termination Date}}, your boffins work out all the termination values for each {{{{{1}}}|Transaction}}, tot them up to arrive at the Section {{{{{1}}}|6(e)}} amount, and send a [[6(d) - ISDA Provision|statement]] to the defaulting party, specifying the {{{{{1}}}|Early Termination Amount}} payable, the bank details, and reasonable details of calculations.
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| ====7. Pay your {{{{{1}}}|Early Termination Amount}}====
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| Your in-house metaphysicians having calculated your {{isdaprov|Close-out Amount}}s,<ref name="close out amounts"/> and assembled all the values into an {{{{{1}}}|Early Termination Amount}}<ref>Or, in the {{1992ma}}’s estimable prose, “the amount, if any, payable in respect of an {{isdaprov|Early Termination Date}} and determined pursuant to this Section”.</ref> the party who owes it must pay the {{{{{1}}}|Early Termination Amount}}. With {{icds}} yen for infinite fiddlarity, this will depend on whether the Early Termination Date follows an Event of Default or an Termination Event. If the former, the {{{{{1}}}|Early Termination Amount}} is payable at once, as soon as the {{{{{1}}}|6(d)}} statement is deemed delivered; if a {{{{{1}}}|Termination Event}}, only two {{{{{1}}}|Local Business Day}}s {{ikr}} after the {{{{{1}}}|6(d)}} statement is delivered (or, where there are ''two'' {{{{{1}}}|Affected Parties}} and both are delivering each other {{{{{1}}}|6(d)}} statements {{ikr}} after both have done so).
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| ====8. Putting that all together====
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| Here are all the stages you must go through between becoming entitled to terminate and settlement for a {{{{{1}}}|Failure to Pay or Deliver}}:
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| *T: There must be a {{{{{1}}}|Failure to Pay or Deliver}} on a day, T.
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| *T+1: After close of business on T, the {{{{{1}}}|Non-defaulting Party}} must give the {{{{{1}}}|Defaulting Party}} a Section {{{{{1}}}|5(a)(i)}} notice of failure to pay of deliver. The prescribed [[grace period]] must expire. The grace periods may be between 1 and 3 {{{{{1}}}|LBD}}s. There may also be carve-outs for operational failures and so on, to add to the fun.
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| *T+4: You must send a Section {{{{{1}}}|6(a)}} notice designating an {{{{{1}}}|Early Termination Date}} for all outstanding {{{{{1}}}|Transaction}}s. Let’s say it is 3 {{{{{1}}}|LBS}}s. You must designate an Early Termination Date within [[By not more than 20 days’ notice|20 days]]. Let’s say it is 20 days, for the hell of it
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| *T+24: You are “off risk” and must start calculating your {{{{{1}}}|Close-out Amount}}s for all outstanding {{{{{1}}}|Transaction}}s. You must do this ass soon as reasonably practicable. Let’s say that takes another 30 days.
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| *T+54: having calculated all {{{{{1}}}|Close-out Amount}}s and totted them all up into a single {{{{{1}}}|Early Termination Amount}}: You send your Section 6(d) statement advising of that amount, giving bank details and supplying your workings.
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| *T+54: Your {{{{{1}}}|Early Termination Amount}} is due.
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