Template:Difference between Affected Party and Defaulting Party

The financial difference between an Affected Party and a Defaulting Party

What is the practical, economic difference between being closed out on the same Transaction for an Event of Default and a Termination Event? This is something that all ISDA ninjas know, or sort of intuit, in a sort of semi-conscious, buried-somewhere-deep-in-the-brain-stem kind of way, but they may mutter darkly and try to change the subject if you ask them to articulate it in simple English.

The topic might be chiefly of academic interest were it not for the unfortunate habit of the same “real world” event potentially comprising more than one variety of termination right. This leads to some laboured prioritisation in the ISDA, and sometimes some in the Schedule too. What if my Tax Event upon Merger is also a Credit Event Upon Merger, and also a Force Majeure? that kind of question.

So, with feeling, here it is:

The Definition of Close-out Amount

Remember the way a Determining Party values a Terminated Transaction is calculates its own close-out value — in our nutshell terms, “the losses the Determining Party would incur (positive) or gains it would realise (negative) in replacing the material terms and the option rights of the parties under a Terminated Transaction”. One assesses “the costs one would incur” from ones’ own side of the market. A large party of the question comes down to who the Determining Party is for a given termination event.

Defaulting Party

Under an Event of Default, it is the Non-Defaulting Party at all times (since on the theory of the game, the Defaulting Party is either a miscreant or a smoking hulk of twisted metal, there is no one else around to do this. Therefore, it being an Event of Default is always optimal for the Innocent Party, since it will always be the Determining Party.

One Affected Party

Where the terminating impetus is not so outrageous as to qualify as an Event of Default — i.e., it is only a Termination Event — but it only impacts one party, in most cases it is the same as for an Event of Default. There is one Affected Party, the Non-Affected Party is the sole Determining Party, so it closes out on its own side of the market ... unless the event in question is an Illegality or a Force Majeure Event, in which case there is a rider in Section 6(e)(ii)(3) applies and the Determining Party has to get mid market quotations that don’t take its own creditworthiness into account. But note that the most commonly triggered type of Termination Event is an Additional Termination Event, these tend to have a defaulty, turpidudinous character about them, almost never happen to two people at once, and therefore behave exactly like Events of Default.

Two Affected Parties

When both parties are affected — a scenario the ISDA only contemplates for Termination Events; Events of Default being more of a “she who draws first wins” sort of affair, where the first in time prevails — then each party is a “Determining Party” calculates its own close-out value — in our nutshell terms, “the losses the Determining Party would incur (positive) or gains it would realise (negative) in replacing the material terms and the option rights of the parties under a Terminated Transaction” — throws it into the ring and the Calculation Agent splits the difference. Assuming both parties calculate so the end result is necessarily a mid-market

JC’s cut-out-and-keep™ guide to terminating Transactions

Event	How many affected	What happens
Events of Default Q.E.D. there is only one Defaulting Party: 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	Defaulting Party only	Non-defaulting Party calculates on its own side of market.
Termination Events where there is only one Affected Party And this odd rider in Section 6(e)(ii)(3) requiring a midmarket price does not apply: 5(b)(iii) Tax Event 5(b)(iv) Tax Event Upon Merger 5(b)(v) Credit Event Upon Merger 5(b)(vi) Additional Termination Event	One Affected Party only	Non-Affected Party calculates on its own side of market.
Termination Events where there is only one Affected Party but ... This odd rider in Section 6(e)(ii)(3) requiring a midmarket price does apply: 5(b)(i) Illegality 5(b)(ii) Force Majeure Event	One Affected Party only	Non-Affected Party seeks prices by reference to mid-market values and which do not reflect its own credit.
Termination Events where there are two Affected Parties 5(b)(i) Illegality 5(b)(ii) Force Majeure Event 5(b)(iii) Tax Event 5(b)(iv) Tax Event Upon Merger	Each party is an Affected Party	Both parties are Determining Parties, and Calculation Agent splits the difference ergo it is a midmarket rate.