Template:M summ Equity Derivatives 12.9

Reminder about the Extraordinary Events

Break these “Extraordinary Events” into four categories:

Corporate events on Issuers: Corporate Events are generally benign but not always expected or even wanted adjustments to the corporate structure and management of specific underlying Shares — Tender Offers, Mergers, management buyouts and events that change the economic proposition represented by those Shares, and not the equity derivative contract. So: Merger Events and Tender Offers;

Index adjustments: For Index trades, unexpected adjustments and changes to methodologies and publishing strategies of underlying Index (as opposed to changes in the composition of the Index according to its pre-existing rules) — collectively call these “Index Adjustment Events”. So:

Index Modification: Changes in the calculation methodology for the Index

Index Cancellation: Where Indexes are discontinued with replacement;

Index Disruption: disruption in the calculation and publication of Index values;

Negative events affecting Issuers: Nationalizations, Insolvency, Delisting of underlying Issuers;

Additional Disruption Events: Events which directly impair performance and risk management of the Transaction itself. These often cross over with market- and Issuer-dependent events above, but the emphasis here is their direct impact on the parties’ abilities to perform and hedge the derivative Transaction itself. So:

The Triple Cocktail: The Triple Cocktail of Change in Law, Hedging Disruption and Increased Cost of Hedging;

Stock borrow events: Specific issues relating to short-selling (Loss of Stock Borrow and Increased Cost of Stock Borrow); and

Random ones that aren’t needed or used: Two random ones that don’t brilliantly fit with this theory, and which people tend to disapply — possibly for that exact reason, but they are fairly well covered by the Triple Cocktail anyway — Failure to Deliver under the Transaction on account of illiquidity and, even more randomly, Insolvency Filing.

Market Disruption Events vs Additional Disruption Events showdown

In a Nutshell™:

• Market Disruption Events (Section 6.3) handle difficulties in valuing ongoing Transactions in a disrupted market — where the parties are happy to carry on with the position, but their practical means of marking-to-market (and therefore margining) their exposures under the Transactions is hampered because of market dislocation;
• Additional Disruption Events (Section 12.9) handle your rights to early-terminate Transactions, usually because their ability to properly risk-manage their positions — i.e., hedge — is undermined by the market dislocation.

So the two are independent: one is where you want to carry on; one where you don’t. So you don't have to wait for a period of Exchange Disruption before invoking a Hedging Disruption, and conversely you could — in theory at any rate — designate an Exchange Disruption even if there were no Hedging Disruption in existence.

Now in point of fact, an Exchange Disruption — especially a long one — usually will count as a Hedging Disruption which might be why the Consequences of Disrupted Days wording in Section 6.6 seems to run out of enthusiasm for its own existence, as if ISDA’s crack drafting squad™ suddenly realised the whole world is futile and threw in the towel. After all, if there have been eight straight Disrupted Days, the likelihood that one or other party hasn’t canned the Transaction on the grounds of Hedging Disruption must be pretty low.

Additional Disruption Events dans une Nutshell™

The important Additional Disruption Events are the Triple Cocktail: Change in Law, Hedging Disruption and Increased Cost of Hedging. They have marginally different play-out rights:

• Change in Law: Either party can terminate on 2 Scheduled Trading Day’s notice, at the Cancellation Amount.
• Hedging Disruption: Hedging Party can terminate on 2 Scheduled Trading Day’s notice, at the Cancellation Amount.
• Increased Cost of Hedging: Hedging Party can present the other guy with a proposed Price Adjustment. Other guy, within 2 Scheduled Trading Days, either accepts the Price Adjustment in an amended trade, pays the PV of the Price Adjustment in full, or the Hedging Party can terminate the trade on the second Scheduled Trading Day, at the Cancellation Amount.

Okay, okay, I hear you — LOSB and ICOSB are important too. For those:

• Loss of Stock Borrow: Hedging Party gives 2 Scheduled Trading Day’s notice of the LOSB. Other guy can either lend the shares itself at the Maximum Stock Loan Rate or lower, or if it doesn’t the Hedging Party can terminate the trade at the Cancellation Amount.
• Increased Cost of Stock Borrow: Hedging Party can present the other guy with a proposed Price Adjustment. Other guy, within 2 Scheduled Trading Days, either accepts the Price Adjustment in an amended trade, pays the PV of the Price Adjustment in full, or lend the Hedging Party the necessary Shares, Failing this, the Hedging Party can terminate the trade on the second Scheduled Trading Day, at the Cancellation Amount.

Insolvency Filing and Failure to Deliver ... well — are they even applied in your confirm?