Default Under Specified Transaction - ISDA Provision: Difference between revisions
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Revision as of 11:19, 18 January 2020
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ISDA Anatomy™
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Often confused with Cross Default. In fact, they’re meant to be mutually exclusive. That won’t stop folks conflating them, though. Look, we all do it.
This is like Cross Default, but for non “borrowing” style transactions - for example swap agreements agreements and repos, but only transactions between the two counterparties and their referenced Credit Support Providers and Specified Entities.
If a Counterparty (or — sigh — its Credit Support Provider or Specified Entity) experiences an Event of Default under a swap agreement (or other transaction falling within the definition of Specified Transaction[1] with you, this will be an Event of Default under the ISDA Master Agreement.
Acceleration, not Default
DUST is triggered by an acceleration following an event of default under the Specified Transaction, not upon the default itself[2]. Since the Specified Transaction is between you and the other party to the ISDA Master Agreement, there is no great loss — it is within your gift to accelerate the other contract — and to achieve set-off you would have to do so anyway.
This is less drastic than the corresponding Cross Default provision, which imports all the Events of Default from all Specified Indebtedness into the present one[3], even if the counterparty to the defaulted contract has itself waived its rights to exercise.
Drafting oddities
Payment acceleration versus delivery acceleration — mini close-out
Upon a payment default under 5(a)(v)(1), only that particular transaction must be accelerated (it doesn’t require full close out of the relevant Master Agreement. But a delivery default under 5(a)(v)(3), is only triggered if the whole Master Agreement is closed out.
Why would that be? Oh! Yes, Stock loan ninja at the back, with your hand up!
- Stock loan ninja (for it is he): Sir! Sir! Please sir, is this to stop the mini-closeout of a single Loan under a 2010 GMSLA?
- The JC (beaming inscrutably): Yeeeees — Go on — ?
- SLN: Sir, please sir, settlement failures under a stock loan are often a function of market illiquidity (the asset to be delivered isn’t available) and aren’t necessarily indicative of credit deterioration, sir, so should not necessarily trigger a DUST under the ISDA. But this situation would never apply to a simple cash payment. On the other hand, if the whole 2010 GMSLA is closed out as a result of a delivery fail, you clearly are in a credit-stress situation.
- JC: Excellent!
Final payments
The reason for the second limb of the definition is to catch final payments, which can’t be accelerated, since they’re already due.
What if I “jump the gun”?
Could a wrongfully submitted notice of default be treated as a repudiation/anticipatory breach by the “non-defaulting party” giving the other party at least the right to withhold payments on the basis that this would constitute a Potential Event of Default by the party submitting the notice? There’s not much law on point, but the starting point is “no” - it would simply be an ineffective notice. However, a non-payment on the basis of an ineffective notice would be impermissible and may itself amount to a Failure to Pay. But as to the mere dispatch of the notice itself, there is relatively recent case law[4] (albeit in the bond world) stating that an acceleration notice that is submitted wrongfully, i.e. when no actual event of default, is merely ineffective and does not give rise to a claim for breach of contract or damages from “defaulting party”. Clearly this has not been considered in context of ISDA per se (and may be nuances here that would lead to different result) but at it is a start.
Differences between cross default and DUST
Ideally, cross default and DUST should be mutually exclusive. They are meant to dovetail with each other, not cross over. This will not stop mission creep from over-zealous credit departments, who will try to expand the scope of each, leading to all kinds of cognitive dissonances and righteous[5] indignation from the counterparty’s negotiator. As ammunition for your fruitless attempts to persuade the credit department to live in the real world for once, try these:
- Cross default generally references indebtedness where the exercising counterparty has significant loan-type exposure to the defaulter; DUST references bilateral derivative and trading transactions which tend not to be in the nature of indebtedness (it is true to say that the line between these can be gray, especially in the case of uncollateralised derivative relationships;
- Cross default is only triggered once a certain threshold amount of indebtedness is defaulted upon; DUST is triggered upon any breach;
- Cross default references your Counterparty owes to a third party outside your control; DUST references other obligations your counterparty owes you or an affiliate you can reasonably be expected to be in league with. (ie you can't generally trigger if your counterparty defaults on Specified Transactions it has on with third parties)
- DUST only comes about if the Specified Transaction in question has been actually accelerated, whereas cross default is available whether the primary creditor has accelerated or not. (A cross default which requires acceleration is called “cross acceleration”.)
See also
References
- ↑ This is typically wide, though it excludes borrowed money - but check the Agreement!
- ↑ Except where that happens on maturity: see drafting point below.
- ↑ I should say I am grateful to my correspondent Nick for his helpful suggestion here. I don’t get many correspondents so it is extra special when one writes in with actual useful feedback. Thanks Nick! (To my other correspondents: hi, nice to hear from you too, but no I have not been in a car accident recently.)
- ↑ Concord Trust v The Law Debenture Trust Corporation plc
- ↑ And, to be candid, rightful.