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| ===Negotiation points===
| | {{isda 2(a)(iii) gen|isdaprov}} |
| {{isda 2(a)(iii) gen}} | |
| {{isda 2(a)(iii) detail}}
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| ====Non-payment delivery defaults====
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| Say you’re a corporate in the habit of buying [[OTC]] [[call]]s or [[put]]s from your broker under the ISDA framework. This is all quite ordinary, unglamorous prudent treasury hedging activity. The basic structure, as for any option, is:
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| {{Quote|''Customer pays broker premium, day one; if the option is [[in-the-money]] on the exercise date, broker pays customer market price minus strike price''.}}
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| That is, after the {{isdaprov|Trade Date}}, the customer never has to pay anything further: it just has what ''should be'' an unconditional right to be paid if it {{Strike|wins its bet|is in-the-money on the Exercise Date}}.
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| Now: imagine you are such a corporate, having executed and settled premium on such a trade, your bet turns out to be wildly successful but, before you can exercise it, you suffers an independent {{isdaprov|Event of Default}}. Some of the ISDA EODs are, as we rehearse elsewhere, rather nebulous or indeterminate: {{isdaprov|Cross Default}}, {{isdaprov|Misrepresentation}} and {{isdaprov|Bankruptcy}} in particular. And some are trivial: ''any'' {{isdaprov|Breach of Agreement}} is, if uncured after 30 days, an {{isdaprov|Event of Default}} and therefore, ''from the instant it is committed'' a [[Potential Event of Default - ISDA Provision|''Potential'' Event of Default]] in that it is contingent only on the passage of time.
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| ===Why the regulators don’t like Section {{isdaprov|2(a)(iii)}}===
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| While not concluding that {{isdaprov|2(a)(iii)}} is ''necessarily'' a “[[Walkaway clause|walk-away clause]]” (or an “[[ipso facto clause|ipso facto]]” clause, as it is called in the US) UK regulators were concerned after the financial crisis that Section {{isdaprov|2(a)(iii)}} could be used to that effect and wondered aloud whether such practices should be allowed to continue. Why? Because you are kicking a fellow when he is down, in essence.
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| An insolvent counterparty may be in a weakened moral state, but if it still made ''some'' good bets under its derivative trading arrangements, so it ought to be allowed to realise them. On the other hand, the contract has a fixed term; you wouldn’t be entitled to realise those gains early if you ''hadn’t'' gone insolvent<ref>This is true in legal theory but in most cases not in practice: usually a swap dealer will offer you a price to close out your trade early — at its side of the market, naturally — and unless you are doing something dim-witted like selling tranched [[credit protection]] to [[broker-dealer]]s under [[CDO Squared]]s they have put together themselves, you should be able to find another [[swap dealer]] to give you a price on an off-setting trade.</ref> so why should it be any different just because you’ve blown up? The answer to that is, put up or shut up: If you don’t like it that I can’t pay your margin, you are entitled to close out. If you don’t want to close out, then you can jolly well carry on performing. In any case, regulators also wonder: ''how long'' can this state of suspended animation last? Indefinitely? What is to stop a non-defaulting party monetising the gross obligations of a defaulting party not closing out, invoking {{isdaprov|2(a)(iii)}}, suspending its performance and then realising value by [[set-off]]?
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| On the other hand, suggesting a fundamental part of the close-out circuitry of an {{isdama}} is a “walk-away” takes prudentially regulated counterparties to an uncomfortable place with regard to their [[risk-weighted assets]] methodology.
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| With the effluxion of time some of the heat seems to have gone out of the debate, and new policies, or market-led solutions, have taken hold.
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| ===Litigation===
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| There is a (generous) handful of important authorities on the effect under [[English law]] or [[New York law]] of the suspension of obligations under Section {{isdaprov|2(a)(iii)}} of the {{isdama}}, and whether [[flawed asset]] provision amounts to an “[[ipso facto]] clause” under the [[US Bankruptcy Code]] or violates the “[[anti-deprivation]]” principle under [[English law]]. These are amusing, as they are conducted in front of judges and between litigators none of whom has spent more than a fleeting morning in their professional careers considering the legal complications, let alone commercial implications, of derivative contracts. Thus, expect some random results<ref>For example, {{casenote|Greenclose|National Westminster Bank plc}} albeit not related to [[flawed asset]]s.</ref>.
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| {{Casenote|Enron|TXU}} upheld the validity of Section {{isdaprov|2(a)(iii)}}<ref>You wonder how much of that was influenced by what a bunch of odious jerks Enron were in their derivative trading history, mind you.</ref> {{casenote|Metavante|Lehman}} considered Section 2(a)(iii) of the {{isdama}} and reached more or less the opposite conclusion.
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| Also of interest in the back issues of the {{jclr}} are:
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| *{{casenote|Lomas|Firth Rixson}}
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| *{{casenote|Marine Trade|Pioneer}}
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| *{{casenote|Pioneer|Cosco}}
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| *{{casenote|Pioneer|TMT}}
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