Template:M summ Equity Derivatives 12.8(a)

Cancellation Amount is a beast of a definition. But when you boil it down, it’s pretty straightforward. It applies when terminating a Transaction following an Extraordinary Event or an Additional Disruption Event.

Importantly, by dint of Section 12.8(e), the Determining Party may pass through hedge breakage costs and losses.

Geopolitical events

Now, what gains or losses might the Determining Party incur in replacing the material terms of the Transaction if, due to wars, sanctions and other miscellaneous geopolitical hanky-panky, a market gets totally shut down? If, for example, the outside world has imposed economic sanctions on the jurisdiction in which your Shares trade (as, at the time of writing, seems far possible for Russia), of if the Shares’ jurisdiction itself imposes sanctions on money coming in from or going out to the outside world (as did Greece, for a brief moment, in 2015)?

Well, worst case, the holder of a long swap position might get a doughnut. The holder of a short position could, conceivably, lose even more, were the value of affected Shares to spike during the sanctions, but that seems practically unlikely: the nature of economic sanctions and geopolitical turmoil tends not to boost local equity markets and, we imagine, generally would make affected shares go down in price. Here the problem might instead be that the holder of the short position can’t close out, despite desperately wanting to.

In either case, the dealer’s attitude is likely to be the same: “I can’t see a bid-ask to do what I need to do to [keep a long position going/close a short position out] (delete as applicable). If you can find me such a bid or ask I can trade on I will, but if not, I regret to say you may get bupkis.”

Now the nature of geopolitical events is to be unpredictable. They may manifest themselves in different and unexpected ways, so — while no-one likes to rag on ISDA’s crack drafting squad™ more than the JC does, readers, you know that — you can’t really blame the ’squad for not setting out the myriad of unintended knock-on consequences there might be to your equity derivative portfolio as a result of an unwarranted military incursion in the Urals.

That said, it is all about managing expectations. The other typical characteristic of geopolitical hanky-panky is that it rarely comes out of the blue: it brews, there is posturing, brinkspersonship, manoeuvering before anything happens. This is a good time to get out and talk to your clients. Remember the name of the game is to manage client expectations: a client who didn’t know it had some risk, even though it should have known (or, in fact did know) is more likely to be upset when that risk materialises than one who did know, because you reminded it. Your goal is not to win litigation over boilerplate terms in your contracts, but avoid it.