Template:Isda Automatic Early Termination summ

{{{{{1}}}|Automatic Early Termination}} is an odd and misunderstood concept which exists in Section {{{{{1}}}|6(a)}} {{{{{1}}}|Right to Terminate Following Event of Default}} of the ISDA Master Agreement. As is so much in the ISDA Master Agreement, it’s all about close-out netting as it is about credit protection per se. Where a jurisdiction suspends terms of contracts in a period of formal insolvency, the idea is to have the ISDA break before that suspension kicks in — so close-out netting works. It was introduced in the 1987 ISDA, but was not labelled “{{{{{1}}}|Automatic Early Termination}}” in that agreement, possibly because it was not conceived as an optional election to be used with caution where needed: it just sat there and applied across the board.

{{{{{1}}}|AET}} is thus only triggered by certain events under the {{{{{1}}}|Bankruptcy}} event of default — formal bankruptcy procedures — and not by economic events that tend to indicate insolvency (such as an inability to pay debts as they fall due, technical insolvency or the exercise of security. Though, interestingly, those events (limbs (2) and (7) of the {{{{{1}}}|Bankruptcy}} definition) were in the 1987 ISDA version. This is just one more reason not to use that edition, if there are any Burmese Junglers out there looking for one.

Nor does it apply to other {{{{{1}}}|Events of Default}}.

Automatic early termination (“{{{{{1}}}|AET}}”) protects in jurisdictions (e.g., Germany and Switzerland) where certain bankruptcy events would allow a liquidator to “cherry-pick” those {{{{{1}}}|transaction}}s it wishes to honour (those which are in-the-money to the defaulting party) and avoid those where the {{{{{1}}}|defaulting party}} is out-of-the-money.

It only has limited use

{{{{{1}}}|AET}} is only really useful:

(1) to a regulated financial institution, which
(2) would incur a capital charge if it doesn’t have a netting opinion, and
(3) where it wouldn’t get that netting opinion for a particular counterparty without {{{{{1}}}|AET}} being switched on in its ISDA Master Agreement.

There are only a few counterparty types where these conditions prevail: the German and Swiss corporates mentioned above, for example. There may be others, but not many, because {{{{{1}}}|AET}} is a good-old-days, regulators-really-are-dopey-if-they-fall-for-this kind of tactic. It only really survives these days because it is so part of the furniture no-one has the chutzpah to question it, despite the trail of destruction and confusion it has left across the commercial courts of the US an the UK.

I mean, really? Deeming your ISDA to have magically terminated, without anyone’s knowledge or action, the instant before that termination would become problematic as a result of your insolvency? Come on. Is any sophisticated insolvency regime going to buy that kind of magical thinking? (No slight meant on Germany or Switzerland here: the “Teutonic” AET does not deliver netting where unequivocally it would otherwise be forbidden, but rather buttresses residual doubt about the effectiveness of netting during insolvency as a result of looseness in insolvency regulations that aren’t categorical that you can net. The view is generally it should be okay in insolvency, but there are just some freaky discretions that may make life awkward if used maliciously. This is not legal advice.)