Events of Default - ISDA Provision: Difference between revisions
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{{isdaprov|5(a)(viii)}} {{isdaprov|Merger without Assumption}}<br> | {{isdaprov|5(a)(viii)}} {{isdaprov|Merger without Assumption}}<br> | ||
{{comm}} | {{comm}} | ||
{{eventsofdefault}} | {{eventsofdefault}} | ||
====Types of Events of Default==== | ====Types of Events of Default==== | ||
'''Independently Verifiability''': Some {{isdaprov|Events of Default}} you can independently verify without counterparty's confirmation, for example: | |||
**'''Direct breaches''': direct breaches of the Agreement (eg {{isdaprov|Failure To Pay}}; {{isdaprov|Breach of Agreement}}); | |||
**'''Direct | **'''Public events''': Events which are necessarily public (most of the {{isdaprov|Bankruptcy}} limbs; {{isdaprov|Merger Without Assumption}} | ||
**'''Public | *'''Not independently verifiable''': Some require the counterparty to tell you as they depend on facts which you could not know are not public knowledge, are not breaches of a direct obligation to the counterparty and would not otherwise come to the firm's attention: Particularly: | ||
*'''Not independently verifiable''': | |||
**{{isdaprov|Cross Default}} | **{{isdaprov|Cross Default}} | ||
**other limbs of {{isdaprov|Bankruptcy}} (eg "has a secured party take possession of all or substantially all its assets". | **other limbs of {{isdaprov|Bankruptcy}} (eg "has a secured party take possession of all or substantially all its assets". | ||
| Line 42: | Line 31: | ||
#Impose notification requirement only on "active" termination/default events which are non-public and CP has no excuse for not having monitored them and counterparty has actually exercised; and | #Impose notification requirement only on "active" termination/default events which are non-public and CP has no excuse for not having monitored them and counterparty has actually exercised; and | ||
#If that doesn't work, agree to drop the provision altogether, as in my view its practical utility is limited to "moral" at best (as there is no effective sanction for counterparty breach anyway) | #If that doesn't work, agree to drop the provision altogether, as in my view its practical utility is limited to "moral" at best (as there is no effective sanction for counterparty breach anyway) | ||
===={{isdaprov|Illegality}}==== | |||
{{isdaprov|Illegality}} trumps {{isdaprov|Event of Default}}. Be careful where, for example, a {{isdaprov|Failure to Pay}} is occasioned by a mandatory change in law by a government having jurisdiction over one or other counterparty — see {{isdaprov|Illegality}}. Good example: Greek capital controls of June 2015. | |||
===={{isdaprov|Termination Events}} and {{isdaprov|Events of Default}}==== | |||
{{isdaprov|Termination Events}} and {{isdaprov|Events of Default}} under an {{isdama}} are similar in that when they occur to one party (the {{isdaprov|Affected Party}} or {{isdaprov|Defaulting Party}}) the other may terminate outstanding trades under the agreement. Differences: | |||
*'''Events of Default''': As the word "default" implies EODs are treated as the ''fault'' the defaulting party and may give rise to third-party default rights (where the relevant {{isdaprov|Cross Default}} extends to derivatives and trading documents); | |||
*'''Termination Events''': There is less "moral turpitude" associated with a Termination Event under an {{isdama}}, and they will generally not trigger Cross Defaults (not amounting to "defaults". | |||
{{isdaanatomy}} | {{isdaanatomy}} | ||
*[[Soft Events of Default]] | *[[Soft Events of Default]] | ||
Revision as of 15:52, 10 December 2016
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ISDA Anatomy™
(view template)
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Section 5(a), ISDA Master Agreement
5(a)(i) Failure to Pay or Deliver
5(a)(ii) Breach of Agreement
5(a)(iii) Credit Support Default
5(a)(iv) Misrepresentation
5(a)(v) Default under Specified Transaction
5(a)(vi) Cross Default
5(a)(vii) Bankruptcy
5(a)(viii) Merger without Assumption
Commentary
Types of Events of Default
Independently verifiable
Some Events of Default you can independently verify without counterparty's confirmation, for example:
- Direct breaches: direct breaches of the Agreement (eg Failure to Pay; Breach of Agreement);
- Public events: Events which are necessarily public (most of the Bankruptcy limbs; Merger Without Assumption
Not independently verifiable
Some require the counterparty to tell you as they depend on facts which you could not know are not public knowledge, are not breaches of a direct obligation to the counterparty and would not otherwise come to the firm's attention: Particularly:
- Cross Default
- other limbs of Bankruptcy (eg "has a secured party take possession of all or substantially all its assets".
“Hard” Events of Default
Hard events where some positive action has actually been taken representing a default - such as a Failure to Pay
“Soft” or “Passive” Events of Default
Where a state of affairs has arisen permitting a hard Event of Default to be called, but it has not been designated it happened, such as Cross Default, where person owning the actual "hard" default right against your counterparty may not have triggered (or have any intention of triggering) it.
That said, and for the same reason, such “not independently verifiable” termination/default events are effectively soft anyway, even where we have such an obligation from counterparty to notify us of their occurrence, because we have no means of policing whether or not the Counterparty has in fact notified us, and therefore no practical remedy anyway if it does not. It is a self certification, after all, and all we can rely on is its moral force and the party's competence to monitor its own position and be sufficiently organised to tell us.
Additionally, the obligation on a counterparty to monitor "passive" Events of Default like Cross Default (as opposed to cross acceleration where QED a defaulting party will be notified about the occurrence) is a pretty onerous one particularly for a large entity, and even more so where (as they often are for funds) derivatives are included in definition of Specified Indebtedness.
Given that cross defaults may have artificially low Threshold Amounts (as do some of ours) and are set at levels where actual counterparties owning those rights directly are most unlikely to exercise them, it should not be a surprise to find parties resistant to notifying us about these.
This becomes a credit call but a practical recommendation would be:
- Impose notification requirement only on "active" termination/default events which are non-public and CP has no excuse for not having monitored them and counterparty has actually exercised; and
- If that doesn't work, agree to drop the provision altogether, as in my view its practical utility is limited to "moral" at best (as there is no effective sanction for counterparty breach anyway)
Illegality
Illegality trumps Event of Default. Be careful where, for example, a Failure to Pay is occasioned by a mandatory change in law by a government having jurisdiction over one or other counterparty — see Illegality. Good example: Greek capital controls of June 2015.
Types of Events of Default
Independently Verifiability: Some Events of Default you can independently verify without counterparty's confirmation, for example:
- Direct breaches: direct breaches of the Agreement (eg Failure To Pay; Breach of Agreement);
- Public events: Events which are necessarily public (most of the Bankruptcy limbs; Merger Without Assumption
- Not independently verifiable: Some require the counterparty to tell you as they depend on facts which you could not know are not public knowledge, are not breaches of a direct obligation to the counterparty and would not otherwise come to the firm's attention: Particularly:
- Cross Default
- other limbs of Bankruptcy (eg "has a secured party take possession of all or substantially all its assets".
- "Hard" Events of default: Hard events where some positive action has actually been taken representing a default - such as a Failure to Pay
- "Soft" or "Passive" Events of Default: where a state of affairs has arisen permitting a hard Event of Default to be called, but it has not been designated it happened, such as Cross Default, where person owning the actual "hard" default right against your counterparty may not have triggered (or have any intention of triggering) it.
That said, and for the same reason, such "not independently verifiable" termination/default events are effectively soft anyway, even where we have such an obligation from counterparty to notify us of their occurrence, because we have no means of policing whether or not the Counterparty has in fact notified us, and therefore no practical remedy anyway if it does not. It is a self certification, after all, and all we can rely on is its moral force and the party's competence to monitor its own position and be sufficiently organised to tell us.
Additionally, the obligation on a Counterparty to monitor "passive" Events of Default like Cross Default (as opposed to cross acceleration where QED a defaulting party will be notified about the occurrence) is a pretty onerous one particularly for a large entity, and even more so where (as they often are for funds) derivatives are included in definition of Specified indebtedness.
Given that cross defaults may have artificially low Threshold Amounts (as do some of ours) and are set at levels where actual counterparties owning those rights directly are most unlikely to exercise them, it should not be a surprise to find parties resistant to notifying us about these.
This becomes a credit call but a practical recommendation would be:
- Impose notification requirement only on "active" termination/default events which are non-public and CP has no excuse for not having monitored them and counterparty has actually exercised; and
- If that doesn't work, agree to drop the provision altogether, as in my view its practical utility is limited to "moral" at best (as there is no effective sanction for counterparty breach anyway)
Illegality
Illegality trumps Event of Default. Be careful where, for example, a Failure to Pay is occasioned by a mandatory change in law by a government having jurisdiction over one or other counterparty — see Illegality. Good example: Greek capital controls of June 2015.
Termination Events and Events of Default
Termination Events and Events of Default under an ISDA Master Agreement are similar in that when they occur to one party (the Affected Party or Defaulting Party) the other may terminate outstanding trades under the agreement. Differences:
- Events of Default: As the word "default" implies EODs are treated as the fault the defaulting party and may give rise to third-party default rights (where the relevant Cross Default extends to derivatives and trading documents);
- Termination Events: There is less "moral turpitude" associated with a Termination Event under an ISDA Master Agreement, and they will generally not trigger Cross Defaults (not amounting to "defaults".