Dividends - Equity Derivatives Provision

2002 ISDA Equity Derivatives Definitions A Jolly Contrarian owner’s manual™ 10 in a Nutshell™ The JC’s Nutshell™ summary of this term has moved uptown to the subscription-only ninja tier. For the cost of ½ a weekly 🍺 you can get it here. Sign up at Substack. You can even ask questions! Ask about it here. 10 in all its glory Article 10 Dividends Section 10.1. Dividend Amount. “Dividend Amount” means, in respect of the relevant Share, the related Dividend Period and the related Dividend Payment Date, the Record Amount, the Ex Amount or the Paid Amount, as specified in the related Confirmation, or any other amount determined as provided in the related Confirmation or included as part of an adjustment pursuant to Section 11.2. 10.1(a) Record Amount. “Record Amount” means, in relation to a Dividend Amount, 100% of the gross cash dividend per Share declared by the Issuer to holders of record of a Share on any record date occurring during the relevant Dividend Period. 10.1(b) Ex Amount. “Ex Amount” means, in relation to a Dividend Amount, 100% of the gross cash dividend per Share declared by the Issuer to holders of record of a Share where the date that the Shares have commenced trading “ex-dividend” on the Exchange occurs during the relevant Dividend Period. 10.1(c) Paid Amount. “Paid Amount” means, in relation to a Dividend Amount, 100% of the gross cash dividend per Share paid by the Issuer during the relevant Dividend Period to holders of record of a Share. Any “gross cash dividend” shall represent a sum before the withholding or deduction of taxes at the source by or on behalf of any applicable authority having power to tax in respect of such a dividend, and shall exclude any imputation or other credits, refunds or deductions granted by any applicable authority having power to tax in respect of such dividend and any taxes, credits, refunds or benefits imposed, withheld, assessed or levied thereon. In addition, “gross cash dividends” shall exclude Extraordinary Dividends and Excess Dividend Amounts, if any, unless otherwise provided in the related Confirmation. Section 10.2. Dividend Payment Date. “Dividend Payment Date” means, in respect of a Dividend Period, each date specified or otherwise determined as provided in the related Confirmation or, if such date is not a Currency Business Day, the next following Currency Business Day. If no such date is specified in the related Confirmation, the Dividend Payment Date shall be the Cash Settlement Payment Date or Settlement Date, as the case may be, relating to the end of the relevant Dividend Period. Section 10.3. Dividend Period. “Dividend Period” means the First Period or the Second Period, as specified in the related Confirmation, or such other period determined as provided in the related Confirmation. If no Dividend Period is specified in the related Confirmation, the Dividend Period will be the Second Period. 10.3(a) First Period. “First Period” means each period from, and including, one Cash Settlement Payment Date or Settlement Date, as the case may be, to, but excluding, the next following Cash Settlement Payment Date or Settlement Date, as the case may be, except that (i) the initial Dividend Period will commence on, and include, the Clearance System Business Day that is one Settlement Cycle following the Trade Date and (ii) the final Dividend Period will end on, but exclude, the final Cash Settlement Payment Date or Settlement Date, as the case may be. 10.3(b) Second Period. “Second Period” means each period from, but excluding, one Valuation Date to, and including, the next Valuation Date, except that (i) the initial Dividend Period will commence on, but exclude, the Trade Date and (ii) the final Dividend Period will end on, and include, the final Valuation Date or, in respect of a Physically-settled Forward Transaction to which Variable Obligation is not applicable, the date that is one Settlement Cycle prior to the Settlement Date. Section 10.4. Re-investment of Dividends. If “Re-investment of Dividends” is specified as applicable in the related Confirmation in respect of an Equity Amount Payer in relation to each relevant Dividend Payment Date, the Calculation Agent shall, for purposes of each subsequent Cash Settlement Payment Date, adjust the Equity Notional Amount relating to that Equity Amount Payer by adding to the Equity Notional Amount the Dividend Amount relating to that Equity Amount Payer and that Dividend Payment Date. Section 10.5. Dividend Payment Obligations Relating to Physically-settled Option Transactions. All dividends on Shares to be delivered under a Physically-settled Option Transaction will be payable to the party that would receive such dividends according to market practice for a sale of such Shares to be settled through the relevant Clearance System on the relevant Exercise Date. Section 10.6. Extraordinary Dividend. “Extraordinary Dividend” means an amount per Share specified or otherwise determined as provided in the related Confirmation. If no Extraordinary Dividend is specified in or otherwise determined as provided in the related Confirmation, the characterization of a dividend or portion thereof as an Extraordinary Dividend shall be determined by the Calculation Agent. Section 10.7. Excess Dividend Amount. “Excess Dividend Amount” means, in respect of a Dividend Period, the Record Amount, the Ex Amount or the Paid Amount, as specified in the related Confirmation, or any other amount determined as provided in the related Confirmation. 10.7(a) Record Amount. “Record Amount” means, in relation to an Excess Dividend Amount, 100% of the Extraordinary Dividend per Share declared by the Issuer to holders of record of a Share on any record date occurring during the relevant Dividend Period. 10.7(b) Ex Amount. “Ex Amount” means, in relation to an Excess Dividend Amount, 100% of the Extraordinary Dividend per Share declared by the Issuer to holders of record of a Share where the date that the Shares have commenced trading ex-dividend on the Exchange occurs during the relevant Dividend Period. 10.7(c) Paid Amount. “Paid Amount” means, in relation to an Excess Dividend Amount, 100% of the Extraordinary Dividend per Share paid by the Issuer during the relevant Dividend Period to holders of record of a Share. edit Resources and Navigation Resources About the Equity Derivatives Definitions | (full wikitext) | (nutshell wikitext) | Equity v credit derivatives showdown Hot topics Synthetic Prime Brokerage Anatomy | The Triple Cocktail | Cancellation and Payment | Calculation Agent Resources About the Equity Derivatives Definitions | (full wikitext) | (nutshell wikitext) | Equity v credit derivatives showdown Hot topics Synthetic Prime Brokerage Anatomy | The Triple Cocktail | Cancellation and Payment | Calculation Agent TOC | 1 General Definitions | 2 Option Transactions | 3 Exercise of Options | 4 Forward Transactions | 5 Equity Swap Transactions | 6 Valuation | 7 Settlement | 8 Cash Settlement | 9 Physical Settlement | 10 Dividends | 11 Adjustments and Modifications | 12 Extraordinary Events · 12.8 Cancellation Amount · 12.9 Additional Disruption Events · 12.9 List of ADEs · 12.9(b) Consequences of ADEs | 13 Miscellaneous Index: Click ᐅ to expand: Equity Derivatives - Premium Synthetic Prime Brokerage Premium version of this page

Overview

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Article 10 Dividends
Section 10.1. Dividend Amount

10.1(a) Record Amount

10.1(b) Ex Amount

10.1(c) Paid Amount

Section 10.2. Dividend Payment Date
Section 10.3. Dividend Period

10.3(a) First Period

10.3(b) Second Period

Section 10.4. Re-investment of Dividends
Section 10.5. Dividend Payment Obligations Relating to Physically-settled Option Transactions
Section 10.6. Extraordinary Dividend
Section 10.7. Excess Dividend Amount

10.7(a) Record Amount (Excess Dividend Amount)

10.7(b) Ex Amount (Excess Dividend Amount)

10.7(c) Paid Amount (Excess Dividend Amount)

Summary

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What is a “dividend”?

ISDA’s crack drafting squad™, usually so unquenchable in their yen to define the living daylights out of any concept, however quotidian, is strangely mute on the question of what exactly a dividend is. A dividend is just — you know, a dividend.

The ’squad also threw in the concept of an “Extraordinary Dividend”, but — rest a while before heading in that direction — that definition, truthfully, will leave you none the wiser.

What of cash distributions to Shareholders that aren’t described as, or generally in the nature of, dividends? Is there such a thing? By the lights of the 2002 ISDA Equity Derivatives Definitions you would be inclined to conclude there is not. In any case, you are in your Calculation Agent’s hands.

What about some court-ordered compensation payment a Share issuer is obliged to pay to a class of its shareholders as a result of some ignominy perpetrated on the company’s behalf at some point in the past (a panicked, and ultimately negligent misstatement about its the real extent of its exposure to Russia/Argentina/The Millennium Bug/The Sub-Prime Market/LIBOR/Archegos/Russia (again) which induced panicky investors not to sell, and which turned out to be a mistake for which those investors were entitled to compensation? This one we feel more confident about: this is not a dividend, for reasons which we go into in greater detail when discussing the parallel concept of Income under the 2010 GMSLA.

Manufacturing dividends under an equity swap

You will quickly come to realise that the equity derivatives definitions regarding payment of dividends might as well have come from a dungeon deep in the brain of MC Esher. ISDA’s crack drafting squad™, with its yen for infinite particularity and optionality, has formulated alternate mechanisms to manufacture dividends by reference to three key stages in the dividend distribution process in an underlying security:

• The record date (being the date on which a holder of record becomes entitled to a dividend payment);
• The ex date (being the date on which the underlying shares trade clean of the dividend payment in the market, which will be one settlement cycle before the record date), and
• The dividend payment date itself (being the date on which the underlying dividend distributions actually hit holders’ bank accounts).

None of them, in the JC’s purblind view, works.

The only one you should ever need is the Paid Amount, as it references the date of actual payment of the underlying dividend, and no Equity Amount Payer with a sensible idea in its head will want to pay you sooner than that — but even that misses the significance to its payability of the earlier record date. You only are entitled to a dividend on the dividend payment date at all if you were the holder of record on the record date.

Much of the fear, loathing and confusion in these definitions arises from sloppy drafting in relation to this and the other two options, which don’t make sense anyway.

Also, note this: the ex date and the record date logically come before the dividend payment date. They will usually precede it by weeks, or even months. So if your Dividend Periods are short (e.g., monthly), it is quite likely that the ex date and record date will fall in an earlier Dividend Period than the dividend payment date.

If you elect Ex Amount or Record Amount, this would mean your equity swap would pay its Dividend Amount before the underlying share paid its actual dividend.

Spoiler: that’s stupid.

If you elect Paid Amount, it is conceivable you could be expected to manufacture a dividend payment for a dividend whose record date fell before the Trade Date of your equity swap Transaction.

Spoiler: that’s even stupider.

The point of a derivative is to replicate, as closely as possible, the economics of its reference asset. Not only does electing Ex Amount or Record Amount introduce arbitrary timing “basis” between the derivative and its underlying security, it also potentially introduces credit “basis”, because an underlying issuer which has declared a dividend may not ultimately be able to pay it — if it has become insolvent in the meantime, which could be a period of months. Now some timing basis between a derivative and its underlying is inevitable — the derivative payment will lag the underlying payment — but credit basis is certainly not. Derivatives are not meant to guarantee the performance of the underlying securities they reference. In fact, that is utterly antithetical to the very definition of the word “derivative”.

The timing of dividends

There are four crucial dates: in order, these are the “declaration date”, the “ex-dividend date”, the “record date”, and the “Dividend Payment Date”.

• Declaration date: The declaration date (also called an announcement date is the date on which the issuer announces there will be a dividend. They usually happen quarterly, for those stocks which are regular dividend payers. This comes first. The dividend declaration will include the size of the dividend (the Dividend Amount), the ex-dividend date (being the last date on which, if you buy the stock, you get the dividend), and the Dividend Payment Date — the date on which a dividend is actually paid. Timings are likely to be (these are indicative — I just made them up okay):

• Declaration date = D
• Ex-dividend date = D+9
• Record date = D+10
• Dividend payment date = D+30

• Ex-dividend date actually keys off the record date, and is set based on stock exchange rules — usually a business day before the record date. If you buy a stock on or after its ex-dividend date, you won’t get the dividend because the trade won’t settle until after the ...
• Record date, being the date you actually have to be on the register of shareholders to qualify for the dividend, which will be paid to whoever was the holder of record on the record date, whether or not they have subsequently sold the share, on the
• Dividend payment date which may be as much as a month or more after the original dividend declaration date.

Interest and accruals

While the definitions provide that the Equity Amount Payer must manufacture Dividend Amounts on the Cash Settlement Payment Date, (typically at the end of a Dividend Period) and therefore structures in a period between receipt of underlying and payment on the swap, the definitions do not provide for any interest accrual over that period.

In practice, users tend to “pay when paid”, settling Dividend Amounts the business day following receipt on the underlying, notwithstanding the text of the 2002 ISDA Equity Derivatives Definitions. No-one complains about this. Indeed, we imagine no-one is any the wiser. If you are anything like the JC, you will quietly wonder why we bother negotiating contracts in the first place, if operations personnel are just going to ignore them in practice. If you are an operations person, you may quietly wonder exactly the same thing.

Dividends on Index Transactions? No, sir. But yes, sir.

We shouldn’t really need to say it, but we will: You don’t — well ~ cough ~ shouldn’t — get dividend payments on an Index Transaction. The Index calculation methodology will either replicate the effect of dividend reinvestment on Index constituents, by proportionately re-weighting constituents when they pay dividends — in which case you will get the effect of those dividends just through “price return” of the Index level — or it won’t, in which case you won’t get the effect of those dividends, BECAUSE YOU BOUGHT A DERIVATIVE OF AN INDEX THAT DOESN’T REPLICATE THE EFFECT OF ANY DIVIDENDS.

Either way, the dividend provisions of the 2002 ISDA Equity Derivatives Definitions aren’t — well ~ cough ~ shouldn’t be — relevant to Index and Index Basket Swap Transactions. So they don’t really countenance the idea of an Index paying through dividends. While, in the Russian-doll defined terms schema confected by ISDA’s crack drafting squad™ an Index Swap Transaction is a kind of Equity Swap Transaction, and therefore can have a Type of Return applied to it, when you dive down the rabbit hole, through the Total Return star-gate, along the Re-investment of Dividends axis and into the Dividend Amount portal, you hit the hard black nothingness of dark energy: A Dividend Amount is defined, of course, by reference to a Share’s Record Amount, Ex Amount or Paid Amount, and not that of an Index, for the compellingly straightforward reason that Indices are abstract numbers. They don’t pay dividends.

Now ISDA’s crack drafting squad™ made a half-hearted swipe — actually, it a was more like a full-blooded, half-hour long drubbing — in one of the Pan-Asia MCAs to build in manufactured dividends to Japanese index products, but it is fiendishly complicated, not to mention wrong-headed, and no-one uses it as far as we know.

However.

There is a fairly common market practice, for indices that don’t re-weight to replicate dividend reinvestment, for dealers to manufacture dividends on the Index constituents anyway. This is because a common means of hedging indices is by buying the underlying stocks, so since the dealer is getting the cashflows in and can pay them out. This is hard to reconcile with the drafting of the 2002 ISDA Equity Derivatives Definitions, unless either (i) for Index transactions, you rather wilfully deem “Shares” to mean “constituents of the Index”, or (ii) you treat the Index Transaction as really a dynamic custom Share Basket Swap Transaction. Your front office guys won’t like that suggestion, so do you know what the JC’s approach is? Just leave it. This is one of those beautiful places where the lawyers — who have only the faintest grasp of that the front office does at the best of times — do one thing, and the business — which broadly could not care a row of buttons what legal contracts say until it suddenly all goes Pete Tong — does another, ne’er the twain meet, and the respective groups carry on in blissful ignorance of the a gaping conceptual chasm between them.

And speaking of gaping chasms, you know what I’m going to say now, don’t you?

Clause-by-clause

Section 10.1(a) Record Amount

Referencing the Ex Amount or the Record Amount for a manufactured distribution under an equity derivative doesn’t make much sense. Referencing the Paid Amount would, had ISDA’s crack drafting squad™ drafted it properly. The JC has a proposed fix.

Section 10.1(b) Ex Amount

A key part of the Kafkaesque labyrinth you must navigate to work out how much, and when, your Dividend Amount (or, if you’re looking at paragraph 10.7(b), Extraordinary Dividend) will be paid.

Spoiler: referencing the Ex Amount or the Record Amount for a manufactured distribution under an equity derivative doesn’t make much sense. Referencing the Paid Amount would, had ISDA’s crack drafting squad™ drafted it properly. The JC has a proposed fix.

Note how an unexpected cessation of all non-essential economic activity in the western world has threatened to reveal embedded snafu drafting in the Equity Derivatives Definitions. See the “For completists” section below for more.

Section 10.1(c) Paid Amount

The Paid Amount problem. So we have two problems: what to do if the record date for a Dividend Amount falls before the trade date for a Transaction, and what to do if the dividend payment date falls after the Transaction terminates.

Neither of these contingencies, predictable though they seem to be, is addressed in the 2002 ISDA Equity Derivatives Definitions. But help is at hand: the JC — errors and omissions excepted, all usual disclaimers applying — humbly offers the following corrective for your Master Confirmation Agreement:

“Paid Amount” will apply, provided that:

(a) where the Share was trading “ex-dividend” as of the Effective Date, the Paid Amount will be zero; and

(b) where the Transaction terminates after the Share commenced trading “ex-dividend” but before the scheduled Dividend Payment Date, the Equity Amount Payer will pay any Paid Amount one settlement cycle following payment of the corresponding dividend by the Issuer to holders of record of the Share.

Section 10.2 Dividend Payment Date

Just part of the monster truck motorway pile-up that was ISDA’s crack drafting squad™s’ attempt to provide for manufactured dividends on equity derivatives. Total disaster. See Dividend Amount for the full enormity of the situation.

The only relevance of the Cash Settlement Payment Date or Settlement Date is that the former relates to money payments and therefore cash dividends, the latter to physical delivery of securities, (i.e. scrip dividends), which are more fraught with disruptions.

So your cash payments will usually get paid on the intended Currency Business Day; scrip dividends might not get to you for a few days if the market is a bit salty.

Section 10.3 Dividend Period

Somewhat muffs what you do with a Paid Amount dividend that became due (i.e., had a record date before the termination date, but is not paid until after the termination date.

Section 10.4 Reinvestment of Dividends

This adds the value of declared and paid dividends to the value of the Equity Notional Amount. It references the Cash Settlement Payment Date which assumes a cash dividend and not a scrip dividend) because if you aren’t actually settling the dividend at all, you don’t have to worry about there being some kind of disruption, which worry is implied in the definition of Settlement Amount - being the date you get physical settlement of a scrip dividend — but not in the Cash Settlement Payment Amount, which is the date for a cash dividend. I don't think I explained that very well. But hopefully you can see what I mean. Sort of.

Section 10.5 Dividend Payment Obligations Relating to Physically-settled Option Transactions

There are some provisions of the 2002 ISDA Equity Derivatives Definitions that will cause extended, heated negotiation and a degree of enmity between even mild-mannered negotiators. This is not one of them.

Section 10.6 Extraordinary Dividend

You would be forgiven for thinking this definition a little circular, especially if you haven’t specified what an Extraordinary Dividend will be in the Confirmation. This is because — we venture — ISDA’s crack drafting squad™ felt it was all a bit hard.

“Because,” said they, “of the difficulties of determining in advance in any formulaic way what would constitute an Extraordinary Dividend, the details of this are left to parties to state in their Confirmations.”

Of course, the point about an Extraordinary Dividend is that it is extraordinary. Out of the ordinary; off the beaten track; beyond the mortal comprehension, and powers of prediction, not just of the sainted ISDA drafting committee, but of those poor saps, too, grinding out your equity derivative trade confirms in some mice-invested operations depot in suburban Almaty. How are they supposed to know what an Extraordinary Dividend is?

But look on the bright side: “Dividend” is not defined in the 2002 ISDA Equity Derivatives Definitions at all!

Anyway, the definition boils down, as best as I can fathom, to this:

“An Extraordinary Dividend is whatever the Calculation Agent jolly well says it is.”

Which, in its way, is fine, especially if you happen to be acting for the Calculation Agent, but if you are the Calculation Agent and the question before you is “is this really weird thing that’s just happened to the voting stock of some obscure trucking company in Panama an Extraordinary Dividend or not?” you might feel anchored a little high up the beach as the tide goes out.

Look, I don’t make the rules, folks.

Section 10.7 Excess Dividend Amount

See paragraph 10.1(b) Ex Amount, which applies to normal, unremarkable dividends and 10.7(b) Ex Amount which applies to Extraordinary Dividends (or you could really go to town and compare them).

Most of the time you’ll be using the normal one under paragraph 10.1(b), but (except for the reference to “gross cash dividend” on one hand and “extraordinary dividend” on the other.

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• The JC’s famous Nutshell™ summary of this clause
• Note it’s about timings, not amounts. Sone fun JC diagrams
• “Paid” dividends, or “declared”.
• Dividend clawbacks and the user’s guide
• The JC house view: situation normal.

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See also

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• Dividend Payment Date.
• Dividend Recovery which isn’t 2002 ISDA Equity Derivatives Definitions canon, as such, but more apocrypha or officially endorsed fan fiction. Something like that.