Template:M summ 2002 ISDA 5(a)(vi): Difference between revisions

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{{isdaprov|Cross Default}} is intended to cover off the unique risks associated with ''lending money to counterparties who have also borrowed heavily from other people''. If you try to apply it to contractual relationships which aren't debtor/creditor in nature — as starry-eyed young [[credit officer]]s in the thrall of the moment like to — it will give cause trouble. This will not stop credit officers doing that. Note also that it is, as are most ISDA provisions, bilateral. If you are a regulated financial institution, the boon of having a {{isdaprov|Cross Default}} right against your counterparty may be a lot smaller than the bane of having given away a {{isdaprov|Cross Default}} right against yourself.  
{{isdaprov|Cross Default}} is intended to cover off the unique risks associated with ''lending money to counterparties who have also borrowed heavily from other people''. If you try to apply it to contractual relationships which aren't debtor/creditor in nature — as starry-eyed young [[credit officer]]s in the thrall of the moment like to — it will give cause trouble. This will not stop credit officers doing that. Note also that it is, as are most ISDA provisions, bilateral. If you are a regulated financial institution, the boon of having a {{isdaprov|Cross Default}} right against your counterparty may be a lot smaller than the bane of having given away a {{isdaprov|Cross Default}} right against yourself.  


Under the {{isdama}}, if the cross default applies, default by a party under a contract for “{{isdaprov|Specified Indebtedness}}” with a third party in an amount above the “{{isdaprov|Threshold Amount}}” is an {{isdaprov|Event of Default}} under the {{isdama}}.  
Under the {{isdama}}, default by a swap counterparty for “{{isdaprov|Specified Indebtedness}}” with a third party in an amount above the “{{isdaprov|Threshold Amount}}” is an {{isdaprov|Event of Default}} under the {{isdama}}. {{isdaprov|Cross Default}} thus imports all the default rights from the {{isdaprov|Specified Indebtedness}} in question into your {{isdama}}. For example, if you breach a financial covenant in your [[revolving credit facility]] with some other [[bank]], an entirely different swap counterparty could close you out '''even if your bank lender didn’t'''.
==={{isdaprov|Specified Indebtedness}}===
 
{{isdaprov|Cross Default}} is, therefore, theoretically at least, a very dangerous provision. [[Financial reporting]] dudes get quite worked up about it. Yet, it is very rarely triggered<ref>That is to say, it is practically useless.</ref>: It is inherently nebulous. [[Credit officer|credit officers]] disdain nebulosity and, rightly, will always prefer to act on a clean {{isdaprov|Failure to Pay}} or a {{isdaprov|Bankruptcy}}. Generally, if you have a daily-margined {{isdama}}, one of those will be along soon enough.
 
“Okay, so why do we even ''have'' a {{isdaprov|Cross Default}} in an {{isdama}}?” I hear you ask. ''Great'' question. Go ask {{icds}}. The best [[JC|we]] can figure is when they put it into the document, back in the 1980s, swaps were new, they hadn't really thought them through, no-one realised how they would explode<ref>Ahhh, sometimes ''literally''.</ref> and in any case folks back then held lots of opinions we would now regard as quaint. I mean, just look at the music they listened to.
===={{isdaprov|Specified Indebtedness}}====
{{isdaprov|Specified Indebtedness}} is generally any [[borrowed money|money borrowed]] from any third party (e.g. bank debt; [[deposits]], loan facilities etc.). Some parties will try to widen this: do your best to resist the temptation.  
{{isdaprov|Specified Indebtedness}} is generally any [[borrowed money|money borrowed]] from any third party (e.g. bank debt; [[deposits]], loan facilities etc.). Some parties will try to widen this: do your best to resist the temptation.  


===={{isdaprov|Threshold Amount}}====
The {{isdaprov|Threshold Amount}} is usually defined as a cash amount or a percentage of shareholder funds, or both, in which case — [[Trick for young players|schoolboy error]] hazard alert — be careful to say whether it is the greater or lesser of the two. It should be big: like, life-threateningly big - because the consequences of triggering it are dire. Expect to see 2-3% of shareholder funds, or (for banks) sums in the order of hundreds of millions of dollars. For funds it could be a lot lower — like, ten million dollars — and, of course, will reflect [[NAV]] not shareholder funds.
The {{isdaprov|Threshold Amount}} is usually defined as a cash amount or a percentage of shareholder funds, or both, in which case — [[Trick for young players|schoolboy error]] hazard alert — be careful to say whether it is the greater or lesser of the two. It should be big: like, life-threateningly big - because the consequences of triggering it are dire. Expect to see 2-3% of shareholder funds, or (for banks) sums in the order of hundreds of millions of dollars. For funds it could be a lot lower — like, ten million dollars — and, of course, will reflect [[NAV]] not shareholder funds.
{{isdaprov|Cross default}} imports all the default rights from the {{isdaprov|Specified Indebtedness}} into the {{isdama}}. For example, if you breach a financial covenant in your Specified Indebtedness, your swap counterparty could close you out '''even if the lender of the facility took no action on the breach'''. Cross default is, therefore, theoretically at least, a very dangerous provision. Financial reporting dudes get quite worked up about it. Oddly enough, it is very rarely triggered: It is actually very nebulous, and most credit officers would prefer to act on a clean {{isdaprov|Failure to Pay}} or a {{isdaprov|Bankruptcy}} event. Generally one will be along presently.
===Cross Aggregation===
The {{2002ma}} updates the {{1992ma}} cross-default so that if the combined amount outstanding under the two limbs of {{isdaprov|Cross Default}} exceed the {{isdaprov|Threshold Amount}}, then it will be an {{isdaprov|Event of Default}}. Normally, under the {{1992ma}}, {{isdaprov|Cross Default}} requires one ''or'' the other limbs to be satisfied — you can’t add them together.
As per the above, the two limbs are:
*a default under a financial agreement that would allow a creditor to [[accelerate]] any [[indebtedness]] that party owes it;
*a [[failure to pay]] on the due date under such agreements after the expiry of a [[grace period]].

Revision as of 14:00, 20 March 2020

General

Cross Default is intended to cover off the unique risks associated with lending money to counterparties who have also borrowed heavily from other people. If you try to apply it to contractual relationships which aren't debtor/creditor in nature — as starry-eyed young credit officers in the thrall of the moment like to — it will give cause trouble. This will not stop credit officers doing that. Note also that it is, as are most ISDA provisions, bilateral. If you are a regulated financial institution, the boon of having a Cross Default right against your counterparty may be a lot smaller than the bane of having given away a Cross Default right against yourself.

Under the ISDA Master Agreement, default by a swap counterparty for “Specified Indebtedness” with a third party in an amount above the “Threshold Amount” is an Event of Default under the ISDA Master Agreement. Cross Default thus imports all the default rights from the Specified Indebtedness in question into your ISDA Master Agreement. For example, if you breach a financial covenant in your revolving credit facility with some other bank, an entirely different swap counterparty could close you out even if your bank lender didn’t.

Cross Default is, therefore, theoretically at least, a very dangerous provision. Financial reporting dudes get quite worked up about it. Yet, it is very rarely triggered[1]: It is inherently nebulous. credit officers disdain nebulosity and, rightly, will always prefer to act on a clean Failure to Pay or a Bankruptcy. Generally, if you have a daily-margined ISDA Master Agreement, one of those will be along soon enough.

“Okay, so why do we even have a Cross Default in an ISDA Master Agreement?” I hear you ask. Great question. Go ask ISDA’s crack drafting squad™. The best we can figure is when they put it into the document, back in the 1980s, swaps were new, they hadn't really thought them through, no-one realised how they would explode[2] and in any case folks back then held lots of opinions we would now regard as quaint. I mean, just look at the music they listened to.

Specified Indebtedness

Specified Indebtedness is generally any money borrowed from any third party (e.g. bank debt; deposits, loan facilities etc.). Some parties will try to widen this: do your best to resist the temptation.

Threshold Amount

The Threshold Amount is usually defined as a cash amount or a percentage of shareholder funds, or both, in which case — schoolboy error hazard alert — be careful to say whether it is the greater or lesser of the two. It should be big: like, life-threateningly big - because the consequences of triggering it are dire. Expect to see 2-3% of shareholder funds, or (for banks) sums in the order of hundreds of millions of dollars. For funds it could be a lot lower — like, ten million dollars — and, of course, will reflect NAV not shareholder funds.

  1. ↑ That is to say, it is practically useless.
  2. ↑ Ahhh, sometimes literally.
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