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| ===How the {{isdaprov|Close-out}} mechanism Works===
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| An {{isdaprov|Event of Default}} gives the {{isdaprov|Non-defaulting Party}} a right (but not an obligation) to designate an {{isdaprov|Early Termination Date}} with respect to all outstanding {{isdaprov|Transactions}} on not more than 20 days' notice.
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| * Note that {{isdaprov|Automatic Early Termination}} removes that optionality in the event of a counterparty's insolvency and is therefore sub-optimal from the {{isdaprov|Non-defaulting Party}}'s perspective, and thus should only be employed where the consequences of not having it would be worse (e.g. in jurisdictons where [[close-out netting]] may be challenged in an insolvency but not before). (That is to say, this is one provision you should {{isdaprov|not}} insist on just because the other party insists upon it against you).
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| * For what this optionality not to terminate means, and how controversial it can be, see the commentary to Section {{isdaprov|2(a)(iii)}}. <br>
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| Once all {{isdaprov|Transactions}} are terminated, you move to Section {{isdaprov|6(e)}} which directs how to value the transactions (it depends on who is the Defaulting Party, and whether you have alected {{isdaprov|Loss}} or {{isdaprov|Market Quotation}}, and {{isdaprov|First Method}} or {{isdaprov|Second Method}}. Under the {{2002ma}} it is much easier.
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2002 ISDA Master Agreement
A Jolly Contrarian owner’s manual™
6 in a Nutshell™
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Original text
6. Early Termination
6(a) Right to Terminate Following Event of Default. If at any time an Event of Default with respect to a party (the “Defaulting Party”) has occurred and is then continuing, the other party (the “Non-defaulting Party”) may, by not more than 20 days’ notice to the Defaulting Party specifying the relevant Event of Default, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect of all outstanding Transactions. If, however, “Automatic Early Termination” is specified in the Schedule as applying to a party, then an Early Termination Date in respect of all outstanding Transactions will occur immediately upon the occurrence with respect to such party of an Event of Default specified in Section 5(a)(vii)(1), (3), (5), (6) or, to the extent analogous thereto, (8), and as of the time immediately preceding the institution of the relevant proceeding or the presentation of the relevant petition upon the occurrence with respect to such party of an Event of Default specified in Section 5(a)(vii)(4) or, to the extent analogous thereto, (8).
6(b) Right to Terminate Following Termination Event.
- 6(b)(i) Notice. If a Termination Event other than a Force Majeure Event occurs, an Affected Party will, promptly upon becoming aware of it, notify the other party, specifying the nature of that Termination Event and each Affected Transaction, and will also give the other party such other information about that Termination Event as the other party may reasonably require. If a Force Majeure Event occurs, each party will, promptly upon becoming aware of it, use all reasonable efforts to notify the other party, specifying the nature of that Force Majeure Event, and will also give the other party such other information about that Force Majeure Event as the other party may reasonably require.
- 6(b)(ii) Transfer to Avoid Termination Event. If a Tax Event occurs and there is only one Affected Party, or if a Tax Event Upon Merger occurs and the Burdened Party is the Affected Party, the Affected Party will, as a condition to its right to designate an Early Termination Date under Section 6(b)(iv), use all reasonable efforts (which will not require such party to incur a loss, other than immaterial, incidental expenses) to transfer within 20 days after it gives notice under Section 6(b)(i) all its rights and obligations under this Agreement in respect of the Affected Transactions to another of its Offices or Affiliates so that such Termination Event ceases to exist.
- If the Affected Party is not able to make such a transfer it will give notice to the other party to that effect within such 20 day period, whereupon the other party may effect such a transfer within 30 days after the notice is given under Section 6(b)(i).
- Any such transfer by a party under this Section 6(b)(ii) will be subject to and conditional upon the prior written consent of the other party, which consent will not be withheld if such other party’s policies in effect at such time would permit it to enter into transactions with the transferee on the terms proposed.
- 6(b)(iii) Two Affected Parties. If a Tax Event occurs and there are two Affected Parties, each party will use all reasonable efforts to reach agreement within 30 days after notice of such occurrence is given under Section 6(b)(i) to avoid that Termination Event.
- 6(b)(iv) Right to Terminate.
- (1) If:―
- (A) a transfer under Section 6(b)(ii) or an agreement under Section 6(b)(iii), as the case may be, has not been effected with respect to all Affected Transactions within 30 days after an Affected Party gives notice under Section 6(b)(i); or
- (B) a Credit Event Upon Merger or an Additional Termination Event occurs, or a Tax Event Upon Merger occurs and the Burdened Party is not the Affected Party,
- the Burdened Party in the case of a Tax Event Upon Merger, any Affected Party in the case of a Tax Event or an Additional Termination Event if there are two Affected Parties, or the Non-affected Party in the case of a Credit Event Upon Merger or an Additional Termination Event if there is only one Affected Party may, if the relevant Termination Event is then continuing, by not more than 20 days notice to the other party, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect of all Affected Transactions.
- (2) If at any time an Illegality or a Force Majeure Event has occurred and is then continuing and any applicable Waiting Period has expired:―
- (A) Subject to clause (B) below, either party may, by not more than 20 days notice to the other party, designate (I) a day not earlier than the day on which such notice becomes effective as an Early Termination Date in respect of all Affected Transactions or (II) by specifying in that notice the Affected Transactions in respect of which it is designating the relevant day as an Early Termination Date, a day not earlier than two Local Business Days following the day on which such notice becomes effective as an Early Termination Date in respect of less than all Affected Transactions. Upon receipt of a notice designating an Early Termination Date in respect of less than all Affected Transactions, the other party may, by notice to the designating party, if such notice is effective on or before the day so designated, designate that same day as an Early Termination Date in respect of any or all other Affected Transactions.
- (B) An Affected Party (if the Illegality or Force Majeure Event relates to performance by such party or any Credit Support Provider of such party of an obligation to make any payment or delivery under, or to compliance with any other material provision of, the relevant Credit Support Document) will only have the right to designate an Early Termination Date under Section 6(b)(iv)(2)(A) as a result of an Illegality under Section 5(b)(i)(2) or a Force Majeure Event under Section 5(b)(ii)(2) following the prior designation by the other party of an Early Termination Date, pursuant to Section 6(b)(iv)(2)(A), in respect of less than all Affected Transactions.
6(c) Effect of Designation.
- (i) If notice designating an Early Termination Date is given under Section 6(a) or 6(b), the Early Termination Date will occur on the date so designated, whether or not the relevant Event of Default or Termination Event is then continuing. (ii) Upon the occurrence or effective designation of an Early Termination Date, no further payments or deliveries under Section 2(a)(i) or 9(h)(i) in respect of the Terminated Transactions will be required to be made, but without prejudice to the other provisions of this Agreement. The amount, if any, payable in respect of an Early Termination Date will be determined pursuant to Sections 6(e) and 9(h)(ii).
6(d) Calculations; Payment Date.
- (i) Statement. On or as soon as reasonably practicable following the occurrence of an Early Termination Date, each party will make the calculations on its part, if any, contemplated by Section 6(e) and will provide to the other party a statement
- (1) showing, in reasonable detail, such calculations (including any quotations, market data or information from internal sources used in making such calculations),
- (2) specifying (except where there are two Affected Parties) any Early Termination Amount payable and
- (3) giving details of the relevant account to which any amount payable to it is to be paid.
- In the absence of written confirmation from the source of a quotation or market data obtained in determining a Close-out Amount, the records of the party obtaining such quotation or market data will be conclusive evidence of the existence and accuracy of such quotation or market data.
- (ii) Payment Date. An Early Termination Amount due in respect of any Early Termination Date will, together with any amount of interest payable pursuant to Section 9(h)(ii)(2), be payable
- (1) on the day on which notice of the amount payable is effective in the case of an Early Termination Date which is designated or occurs as a result of an Event of Default and
- (2) on the day which is two Local Business Days after the day on which notice of the amount payable is effective (or, if there are two Affected Parties, after the day on which the statement provided pursuant to clause (i) above by the second party to provide such a statement is effective) in the case of an Early Termination Date which is designated as a result of a Termination Event.
6(e) Payments on Early Termination. If an Early Termination Date occurs, the amount, if any, payable in respect of that Early Termination Date (the “Early Termination Amount”) will be determined pursuant to this Section 6(e) and will be subject to Section 6(f).
- 6(e)(i) Events of Default. If the Early Termination Date results from an Event of Default, the Early Termination Amount will be an amount equal to (1) the sum of (A) the Termination Currency Equivalent of the Close-out Amount or Close-out Amounts (whether positive or negative) determined by the Non-defaulting Party for each Terminated Transaction or group of Terminated Transactions, as the case may be, and (B) the Termination Currency Equivalent of the Unpaid Amounts owing to the Non-defaulting Party less (2) the Termination Currency Equivalent of the Unpaid Amounts owing to the Defaulting Party. If the Early Termination Amount is a positive number, the Defaulting Party will pay it to the Non-defaulting Party; if it is a negative number, the Non-defaulting Party will pay the absolute value of the Early Termination Amount to the Defaulting Party.
- 6(e)(ii) Termination Events. If the Early Termination Date results from a Termination Event:―
- (1) One Affected Party. Subject to clause (3) below, if there is one Affected Party, the Early Termination Amount will be determined in accordance with Section 6(e)(i), except that references to the Defaulting Party and to the Non-defaulting Party will be deemed to be references to the Affected Party and to the Non-affected Party, respectively.
- (2) Two Affected Parties. Subject to clause (3) below, if there are two Affected Parties, each party will determine an amount equal to the Termination Currency Equivalent of the sum of the Close-out Amount or Close-out Amounts (whether positive or negative) for each Terminated Transaction or group of Terminated Transactions, as the case may be, and the Early Termination Amount will be an amount equal to (A) the sum of (I) one-half of the difference between the higher amount so determined (by party “X”) and the lower amount so determined (by party “Y”) and (II) the Termination Currency Equivalent of the Unpaid Amounts owing to X less (B) the Termination Currency Equivalent of the Unpaid Amounts owing to Y. If the Early Termination Amount is a positive number, Y will pay it to X; if it is a negative number, X will pay the absolute value of the Early Termination Amount to Y.
- (3) Mid-Market Events. If that Termination Event is an Illegality or a Force Majeure Event, then the Early Termination Amount will be determined in accordance with clause (1) or (2) above, as appropriate, except that, for the purpose of determining a Close-out Amount or Close-out Amounts, the Determining Party will:―
- (A) if obtaining quotations from one or more third parties (or from any of the Determining Party’s Affiliates), ask each third party or Affiliate (I) not to take account of the current creditworthiness of the Determining Party or any existing Credit Support Document and (II) to provide mid-market quotations; and
- (B) in any other case, use mid-market values without regard to the creditworthiness of the Determining Party.
- 6(e)(iii) Adjustment for Bankruptcy. In circumstances where an Early Termination Date occurs because Automatic Early Termination applies in respect of a party, the Early Termination Amount will be subject to such adjustments as are appropriate and permitted by applicable law to reflect any payments or deliveries made by one party to the other under this Agreement (and retained by such other party) during the period from the relevant Early Termination Date to the date for payment determined under Section 6(d)(ii).
- 6(e)(iv) Adjustment for Illegality or Force Majeure Event. The failure by a party or any Credit Support Provider of such party to pay, when due, any Early Termination Amount will not constitute an Event of Default under Section 5(a)(i) or 5(a)(iii)(1) if such failure is due to the occurrence of an event or circumstance which would, if it occurred with respect to payment, delivery or compliance related to a Transaction, constitute or give rise to an Illegality or a Force Majeure Event. Such amount will (1) accrue interest and otherwise be treated as an Unpaid Amount owing to the other party if subsequently an Early Termination Date results from an Event of Default, a Credit Event Upon Merger or an Additional Termination Event in respect of which all outstanding Transactions are Affected Transactions and (2) otherwise accrue interest in accordance with Section 9(h)(ii)(2).
- 6(e)(v) Pre-Estimate. The parties agree that an amount recoverable under this Section 6(e) is a reasonable pre-estimate of loss and not a penalty. Such amount is payable for the loss of bargain and the loss of protection against future risks, and, except as otherwise provided in this Agreement, neither party will be entitled to recover any additional damages as a consequence of the termination of the Terminated Transactions.
6(f) Set-Off. Any Early Termination Amount payable to one party (the “Payee”) by the other party (the “Payer”), in circumstances where there is a Defaulting Party or where there is one Affected Party in the case where either a Credit Event Upon Merger has occurred or any other Termination Event in respect of which all outstanding Transactions are Affected Transactions has occurred, will, at the option of the Non-defaulting Party or the Non-affected Party, as the case may be (“X”) (and without prior notice to the Defaulting Party or the Affected Party, as the case may be), be reduced by its set-off against any other amounts (“Other Amounts”) payable by the Payee to the Payer (whether or not arising under this Agreement, matured or contingent and irrespective of the currency, place of payment or place of booking of the obligation). To the extent that any Other Amounts are so set off, those Other Amounts will be discharged promptly and in all respects. X will give notice to the other party of any set-off effected under this Section 6(f).
For this purpose, either the Early Termination Amount or the Other Amounts (or the relevant portion of such amounts) may be converted by X into the currency in which the other is denominated at the rate of exchange at which such party would be able, in good faith and using commercially reasonable procedures, to purchase the relevant amount of such currency.
If an obligation is unascertained, X may in good faith estimate that obligation and set off in respect of the estimate, subject to the relevant party accounting to the other when the obligation is ascertained.
Nothing in this Section 6(f) will be effective to create a charge or other security interest. This Section 6(f) will be without prejudice and in addition to any right of set-off, offset, combination of accounts, lien, right of retention or withholding or similar right or requirement to which any party is at any time otherwise entitled or subject (whether by operation of law, contract or otherwise).
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Resources and Navigation
Index: Click ᐅ to expand:
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Comparisons
Redlines
Discussion
See section 12 for what this all means in a time of global pandemic lockdown. See also the separate article all about Automatic Early Termination, which features in the 1992 ISDA and the 2002 ISDA and deserves a page all of its own.
Section 6(a)
Redlines
Discussion
No change in the Early Termination Date definition from 1992 ISDA to 2002 ISDA (no real surprise there) but the close-out methodology between the two versions, by which one works out what must be paid and by whom on an Early Termination Date, and which you are encouraged to follow in all its gory detail starting at Section 6(a), is really quite different, and notwithstanding the fact that the 2002 ISDA version was meant to address the many and varied complaints levelled by market practitioners at the 1992 ISDA we still find the 1992 version in use in the occasional market centred in unsophisticated rural backwaters like, oooh, I don’t know, New York.
Those with a keen eye will notice that, but for the title, Section 6(a) of the 2002 ISDA is the same as Section 6(a) of the 1992 ISDA and, really, not a million miles away from the svelte form of Section 6(a) in the 1987 ISDA — look on that as the Broadcaster to the 1992’s Telecaster. There is one key difference, though: the evolution of the Automatic Early Termination provision. And the 1987 ISDA saw no call to have a “Non-Defaulting Party”.
It has its own entire page — Automatic Early Termination — so we have refrained from discussing it here.
Section 6(b)
Between the 1987 ISDA and the 1992 ISDA the changes were very superficial, as this comparison demonstrates.
Between the 1992 ISDA and the 2002 ISDA, there was a but more re-engineering, largely to account for the new Force Majeure Event and some tidying up, but beyond that Section 6(b) works in the same general way under the 1992 ISDA and 2002 ISDA. Here is a comparison of that.
Section 6(b)(i)
Updated in 2002 with special pleadings relating to the newly-introduced Force Majeure Termination Event.
Section 6(b)(ii)
Note in the 2002 ISDA there is no reference to Illegality (or for that matter Force Majeure, which did not exist under the 1992 ISDA but tends to treated rather like a special case of Illegality and therefore, we think, would have been included in this provision of the 1992 ISDA if it had existed ... if you see what I mean).
When the 2002 ISDA gets on to the topic of Illegality and Force Majeure it allows the Unaffected Party to cherry-pick which Affected Transactions it will terminate, but then seems almost immediately to regret it (see especially in Section 6(b)(iv)). Under the 1992 ISDA if you wanted to pull the trigger on any Termination Event, you had to pull all Affected Transactions. Under the 2002 ISDA it is only binary for the credit- and tax-related Termination Events.
Otherwise, but for one consequential change — 1992’s “excluding” became 2002’s “other than” — I mean, you can just imagine the barney they must have had in the drafting committee for that one, can’t you — the provisions are identical.
Section 6(b)(iii)
Be careful here: Under the 1992 ISDA, if your Failure to Pay is also an Illegality it is treated as an Illegality: if there are two Affected Parties you will face a significant delay when closing out. A bit of a trick for young players.
Note also that reference to Illegality has been excised from the 2002 ISDA version. They changed this because, in practice, it turned out to too be hard to implement a transfer or amendment after an Illegality. Folks realised that if an Illegality happens you don’t want to have to wait 30 days to terminate, especially if you can’t rely on 2(a)(iii) to withhold payments in the meantime.
Section 6(b)(iv)
Oh, this section 6(b)(iv) stuff
Is sure stirring up some ghosts for me.
She said, “There’s one thing you gotta learn
Is not to be afraid of it.”
I said, “No, I like it, I like it, it’s good.”
She said, “You like it now —
But you’ll learn to love it later”
- — Robbie Robertson[1]
One’s right to terminate early following an Illegality or the newly introduced Force Majeure Termination Event get a proper makeover in the 2002 ISDA, but otherwise, the provisions are the same, but for some formal fiddling in the drafting.
Section 6(c)
The framers of the 2002 ISDA daringly changed a “shall” to a “will” in the final line. We approve, to be clear, but this is kind of out of character for ISDA’s crack drafting squad™. Otherwise, identical.
Section 6(d)
Broadly similar between the versions. Main differences are basic architectural ones (no definition of “Early Termination Amount” or “Close-out Amount” in the 1992 ISDA, for example), and the 2002 is a little more finicky, dealing with what to do if there are two Affected Parties, and also blithering on for a few lines about interest.
Section 6(e)
Redlines
Discussion
The 1987 ISDA was half-cocked and shambolic, and laboured under the wishful illusion that if the other guy blew up, even if he was in the money, it was kind of okay to just flip him the bird and walk off with a windfall (in the form of not owing him the money you like, actually owed him). Not cool these days. Once folks realised this wouldn’t fly from a netting perspective they tried to fix it in the 1992 ISDA, whose close-out methodology is truly hideous.
ISDA’s crack drafting squad™ overhauled whole close-out process, soup to nuts, in the 2002 ISDA, and is now much more straightforward — as far as you could ever say that about ISDA’s crack drafting squad™’s output. But a large part of the fanbase — that part west of Cabo da Roca — sticks with the 1992 ISDA. Odd.
Differences, in very brief:
The 1992 ISDA has the infamous Market Quotation and Loss measures of value, and the perennially-ignored First Method and the more sensible Second Method means of evaluating the termination value of terminated Transactions. The 2002 ISDA has just the Close-out Amount to cover everything. So while the 1992 ISDA is far more elaborate and over-engineered, this is not to deny that the 2002 ISDA is elaborate or over-engineeered.
The 2002 ISDA has a new Section 6(e)(iv) dealing with Adjustment for Illegality or Force Majeure Event. This wasn’t needed in the 1992 ISDA, which didn’t have Force Majeure Event at all, and a less sophisticated Illegality.
Basics
Dive in ⇒
This is one of the monster clauses of the ISDA Master Agreement.
JC has given each of its subclauses its own page. You can access them by clicking on the links in the wikitext, or, okay, by clicking here:
But, generally:
No general “no-fault” termination right under the ISDA
Unlike the 2010 GMSLA and many other — ahh, less sophisticated master agreements[2] — the ISDA Master Agreement doesn’t have a general termination right of this sort at all. It is like one of those fancy fixie pushbikes that cost seven grand and don’t even have brakes. You can only terminate Transactions, not the master agreement construct which sits around them. The empty vessel of a closed-out ISDA thus remains for all eternity as an immortal, ineffectual husk. This is to do with paranoid fears about the efficacy of the ISDA’s sainted close-out netting terms if you do terminate the agreement — meh; maybe — but I like to think it is because, before he was cast out from heaven, the Dark Lord[3] made plans to unleash his retributive fury upon the world through a sleeping army of wight-walker zombie ISDAs, doomed to roam the earth until the day of judgment, apropos nothing but there, not alive, but un-dead, ready to reanimate and rally to the Dark Lord’s banner and rain apocalyptic hell on we errant descendants of the Good Man, who did not heed His warnings of financial weapons of mass destruction.
How the close-out mechanism works
It’s optional ...: An Event of Default gives the “Non-defaulting Party” a right (but not an obligation) to designate an Early Termination Date with respect to all outstanding Transactions on not more than 20 days’ notice.
... Unless AET applies: Where Automatic Early Termination applies to a party (being jurisdiction-dependent, it often will only apply to one party) the Non-defaulting Party loses its optionality should the Event of Default be Bankruptcy: all Transactions automatically terminate whehter you want them to or not, and whether you realise it or not. This is plainly sub-optimal from a Non-defaulting Party's perspective. You should therefore only switch on AET if you are sure you need it (e.g. for counterparties in jurisdictions where close-out netting may fail in an insolvency, but not before). Being sure generally means “having a netting opinion telling you netting does not work without it.” In other words, AET is one provision you should not insist on just because the other party insists upon it against you).
Not triggering an Event of Default can be controversial: For what this optionality not to terminate means, and how controversial it can be, see the commentary to Section 2(a)(iii).
Once all Transactions are terminated, you move to Section 6(e) which directs how to value the Transactions (it depends on who is the Defaulting Party, and whether you have elected Loss or Market Quotation, and First Method or Second Method. Under the 2002 ISDA it is much easier.
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See also
References