Cross acceleration - ISDA Provision

ISDA Anatomy™ →Go uptown Grace period be damned. ISDA’s Cross Default clause in a Nutshell™ 5(a)(vi) Cross-Default. If “Cross-Default” applies to a party, it will be an Event of Default if: (1) any agreements it (or its Credit Support Providers or Specified Entities) has for Specified Indebtedness become capable of acceleration; or (2) it (or its Credit Support Providers or Specified Entities) defaults on any payment of Specified Indebtedness (and any grace period expires); And the total of the principal amounts in (1) and (2) exceeds the Threshold Amount. ISDA’s Cross Default clause in full 5(a)(vi) Cross-Default. If “Cross-Default” is specified in the Schedule as applying to the party, the occurrence or existence of:― (1) a default, event of default or other similar condition or event (however described) in respect of such party, any Credit Support Provider of such party or any applicable Specified Entity of such party under one or more agreements or instruments relating to Specified Indebtedness of any of them (individually or collectively) where the aggregate principal amount of such agreements or instruments, either alone or together with the amount, if any, referred to in clause (2) below, is not less than the applicable Threshold Amount (as specified in the Schedule) which has resulted in such Specified Indebtedness becoming, or becoming capable at such time of being declared, due and payable under such agreements or instruments before it would otherwise have been due and payable; or (2) a default by such party, such Credit Support Provider or such Specified Entity (individually or collectively) in making one or more payments under such agreements or instruments on the due date for payment (after giving effect to any applicable notice requirement or grace period) in an aggregate amount, either alone or together with the amount, if any, referred to in clause (1) above, of not less than the applicable Threshold Amount; Index: Click ᐅ to expand: ISDA Navigation See ISDA Comparison for a comparison between the 1992 ISDA and the 2002 ISDA. The Varieties of ISDA Experience Subject 2002 (wikitext) 1992 (wikitext) 1987 (wikitext) Preamble Pre Pre Pre Interpretation 1 1 1 Obligns/Payment 2 2 2 Representations 3 3 3 Agreements 4 4 4 EODs & Term Events 5 Events of Default: FTPD • Breach • CSD • Misrep • DUST • Cross Default • Bankruptcy • MWA Termination Events: Illegality • FM • Tax Event • TEUM • CEUM • ATE 5 Events of Default: FTPD • Breach • CSD • Misrep • DUST • Cross Default • Bankruptcy • MWA Termination Events: Illegality • Tax Event • TEUM • CEUM • ATE 5 Events of Default: FTPD • Breach • CSD • Misrep • DUSS • Cross Default • Bankruptcy • MWA Termination Events: Illegality • Tax Event • TEUM • CEUM Early Termination 6 Early Termination: ET right on EOD • ET right on TE • Effect of Designation • Calculations; Payment Date • Payments on ET • Set-off 6 Early Termination: ET right on EOD • ET right on TE • Effect of Designation • Calculations • Payments on ET • Set-off 6 Early Termination: ET right on EOD • ET right on TE • Effect of Designation • Calculations • Payments on ET Transfer 7 7 7 Contractual Currency 8 8 8 Miscellaneous 9 9 9 Offices; Multibranch Parties 10 10 10 Expenses 11 11 11 Notices 12 12 12 Governing Law 13 13 13 Definitions 14 14 14 Schedule Schedule Schedule Schedule Termination Provisions Part 1 Part 1 Part 1 Tax Representations Part 2 Part 2 Part 2 Documents for Delivery Part 3 Part 3 Part 3 Miscellaneous Part 4 Part 4 Part 4 Other Provisions Part 5 Part 5 Part 5 Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

“Cross acceleration” is not an actual ISDA Event of Default, but it is what happens to an actual ISDA Event of Default — namely, the much-negotiated, seldom-used Section 5(a)(vi), Cross Default, if you can persuade your credit department to water it down to something sensible.

What and how

How to change Cross Default to cross acceleration

You can amend Cross Default to Cross Acceleration by adding the following language:

Section 5(a)(vi) is amended by deleting “, or becoming capable at such time of being declared,” from subsection (1).

Seems so easy, doesn’t it?

Why?

Explain this wondrous drafting to me!

Cross Default, as per the panel to the right, is triggered by two kinds of default:

• General default: a general event of default of any kind at any time during the tenor of any Specified Indebtedness — this could be anything: the borrower’s bankruptcy, a breach of its reps and warranties, a non-payment of interest, any repudiatory breach of the contract of indebtedness, really; or
• Repayment default: the borrower’s failure to fulfil, in full, final repayment of the debt itself when due.

Why draw a distinction between these two general default and repayment default, seeing as both of them are cataclysmic? There is an answer, but it is fussy, word-smithy stuff from the squad, I’m afraid, readers: because a general default entitles the lender to accelerate the debt requiring the borrower to repay it at once, before its scheduled maturity date; a repayment default, logically, falls on that scheduled maturity date, and so can’t be “accelerated” as such. There is nothing to accelerate: the repayment date is already here.

Therefore to convert a cross default to a cross acceleration, you only need to require general defaults to have been accelerated. Repayment defaults can’t be accelerated.

Cross acceleration also avoids the need to muck around allowing for grace periods to expire, granting indulgences for administrative and operational error and all that dreck: if the counterparty has actually accelerated the loan, the grace periods and operational errors are moot. It is too late. The game is up.

Now, to be sure, legal eagles, especially the lesser-spotted buy-side legal eagle, might start hopping up and down, flapping their wings and squawking restively at this point.

“But,” they will say, “what about grace periods and operational errors on that final payment? We must be allowed those before you can close us out!”

You may roll your eyes at this — the JC certainly does — and while it might make you feel better for a moment, it won’t make the problem go away. The short answer is that ordinary grace periods are factored in if you would care to read the language — the event isn’t triggered until they have all expired, and as for contractual affordances that don’t quite count as grace periods (that are, for example, dependent on the borrower providing evidence of operational error to give it some more time to pay) — well, on a fair, large and liberal view these count as grace periods anyway, and if you aren’t persuaded of that am I going to die in a ditch about it? It depends how late it is on a Friday. At the time of writing it is 6:30 pm and the JC is like oh pleeeeease.

But...

Is “downgrading” to cross acceleration wise, though?

There are two schools of thought:

• Yes: The sensible, pragmatic, wise, noble, fearless and brave one you will find in these pages: “Yes. Cross default is misplaced in a modern daily-collateralised ISDA. Anything you can do either to restrict its scope, or simply to avoid being dragged into a tedious argument about its scope, is worth doing.”
• No: The learned one, from the learned author of that terrible FT book about derivatives: “All other things being equal, no. One should only soften cross default reluctantly. Because other counterparts might not be so weak.”

With respect to my learned friend, his reasoning isn’t massively compelling, as it rather mischaracterises what is going on:

With cross acceleration the innocent third party actually has to start proceedings against the defaulting counterparty before you can trigger your transaction termination rights ...

Actually, it doesn’t have to sue your counterparty; just call its debt in.

The downgrading [of cross-default to cross acceleration] therefore affects the timing of your right to terminate, It is no longer automatic but deferred.

I have no idea what the learned author means here by “automatic” here: either way your termination right is optional, not automatic, but in either case it is contingent on a differennt independent event: in one case, the default; in the other, a lender’s acceleration following the default.

If the third party is your counterparty’s main relationship bank it may take some time to review its position...

Indeed it may, and probably will. But while it is doing that it is not accelerating its claim against your counterparty. It is granting its customer, and your counterparty, an indulgence. Your position is, therefore, not worsened in the meantime.

... and may propose a compromise which does not suit you.

You, bear in mind, are the owner of a fully collateralised ISDA Master Agreement which the counterparty has, in the meantime, continued faithfully to perform. If one of your co-creditors has granted an indulgence on outstanding indebtedness — even in return for some other surety or compromise — which avoid that debt being accelerated in full, how can that by itself make your position worse?

I believe such downgrade requests should only be considered favourably if specific foreseeable circumstances justify them [...] or if your counterparty gives written confirmation that cross acceleration applies to all its agreements and will do so in the future. This is because if even one counterparty has Cross Default it would be in pole position to trigger its termination rights.

On this last point, the learned author is, technically, correct: you are marginally worse off if you have conceded cross acceleration and other swap counterparties have not. They can beat you, and your counterparty’s main relationship bank, to the punch, assuming they are cowboys who view a relationship contract like an ISDA Master Agreement as something that it should be a race to close out. Brokers that the JC knows don’t tend to think that way. They have compliance officers who will quail at the thought of not treating their customers fairly. In any case, the fact that this could happen just illustrates how stupid the concept of cross-default is. Especially in our enlightened age of zero-threshold, daily margined non-exotic swap contracts. Especially given the extreme conceptual difficulty of even gathering enough information to work out whether you even can exercise your stupid cross default right.

Just how a third party would ever be able to assess the value of defaulted Specified Indebtedness has never been explained to this old goat.

So this is angel-on-the-head-of-a-pin stuff indeed.

See also

• Cross Default under the ISDA Master Agreement
• Cross default generally