Undead ISDA

ISDA Anatomy™ →Go uptown →intro →prem →sa 💥🆕💥 Audio version of this article 🎧 Listen to this podcast — on Spotify — on Substack Index: Click ᐅ to expand: Audio Essays Uh-oh: honey — did I check the residual Cross Default risk on that old 87 ISDA? Index: Click ᐅ to expand: ISDA Navigation See ISDA Comparison for a comparison between the 1992 ISDA and the 2002 ISDA. The Varieties of ISDA Experience Subject 2002 (wikitext) 1992 (wikitext) 1987 (wikitext) Preamble Pre Pre Pre Interpretation 1 1 1 Obligns/Payment 2 2 2 Representations 3 3 3 Agreements 4 4 4 EODs & Term Events 5 Events of Default: FTPD • Breach • CSD • Misrep • DUST • Cross Default • Bankruptcy • MWA Termination Events: Illegality • FM • Tax Event • TEUM • CEUM • ATE 5 Events of Default: FTPD • Breach • CSD • Misrep • DUST • Cross Default • Bankruptcy • MWA Termination Events: Illegality • Tax Event • TEUM • CEUM • ATE 5 Events of Default: FTPD • Breach • CSD • Misrep • DUSS • Cross Default • Bankruptcy • MWA Termination Events: Illegality • Tax Event • TEUM • CEUM Early Termination 6 Early Termination: ET right on EOD • ET right on TE • Effect of Designation • Calculations; Payment Date • Payments on ET • Set-off 6 Early Termination: ET right on EOD • ET right on TE • Effect of Designation • Calculations • Payments on ET • Set-off 6 Early Termination: ET right on EOD • ET right on TE • Effect of Designation • Calculations • Payments on ET Transfer 7 7 7 Contractual Currency 8 8 8 Miscellaneous 9 9 9 Offices; Multibranch Parties 10 10 10 Expenses 11 11 11 Notices 12 12 12 Governing Law 13 13 13 Definitions 14 14 14 Schedule Schedule Schedule Schedule Termination Provisions Part 1 Part 1 Part 1 Tax Representations Part 2 Part 2 Part 2 Documents for Delivery Part 3 Part 3 Part 3 Miscellaneous Part 4 Part 4 Part 4 Other Provisions Part 5 Part 5 Part 5 Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

Undead
ˌʌnˈdɛd (n.)

A mythological being that occupies the netherworld between death and life; neither of the vital plane nor beyond the Styx; inert but yet not impotent: Nosferatu: an existence beyond the forest; of spectral but not corporeal energy.

The status of every defunct ISDA master agreement, once all Transactions have terminated. Neither alive nor dead but in a suspended inanimate state; disengaged but yet blooming with bacterial potential.

An ISDA reaches the same purgatorial state however its end time comes about: whether that be through the exigencies of a stressed close-out, or the beckoning lassitudinal entropy of our modern life or just a peculiar frame in which we grow bored, adversely regulated or we just lose interest and thereby give up on swaps.

Perhaps the attention simply wanders: we just let the last remaining Transactions roll off and scamper, free, into the fragrant meadows of oblivion and never set about planting any new ones.

But when our Transacting does come to an end — however it does — it leaves behind an extant rusting hulk: a dilapidating Master Agreement that attracts weeds, vermin, dope smokers, adolescents and other undesirables while at the same time leaching caustic toxins, salting the ground into a barren, desolate badland of financial misadventure.

No no-fault termination

There is no termination without fault on notice clause in the ISDA. It has no mechanism for a party unilaterally to finally close an ISDA Master Agreement down just because.

Now and then someone like Parsons, that pedantic oik from the credit department, will stop by your desk, eyes a-glitter, drop a sheaf upon it and casually impose upon you the burden of disposing of it. If, like JC, you find the credit department’s penchant for stupid notices irksome, you may be equally nonchalant in reply.

Parsons: I say, Molesworth, the H.O.D. asked if you would kindly do the honours to terminate this defunct ISDA.

Molesworth: What do you mean, “terminate this defunct ISDA”?

Parsons: (Affecting shock at the brazen display of ignorance) You know, send out a Section 6(g) notice or something. Whatever verbiage it is that you legal eagles do.

Molesworth: No.

Parsons: I beg your pardon?

Molesworth: Well, no. I’m afraid the answer is no.

For while you can terminate a Transaction under an ISDA Master Agreement — and all of them at once, if things come to that — none of the ISDA’s printed forms envisages the parties terminating the Master Agreement itself. Not even following a close-out. There are reasons for this, at least while the closeout process is on foot, and it is notoriously open-ended: If you terminate the whole agreement, not just the Transactions under it, then how are all those clever close out mechanics meant to work?

But these don’t apply to a non-stressed termination. You know, the nice, friendly, “well, I guess I’ll be on my way,” hasta mañana, parting-is-such-sweet-sorrow sort of staple of every finance contract.

ISDA is unique

Alone in the firmament of finance relationship contracts the ISDA Master Agreement has no general no-fault termination provisions. It cannot be unilaterally killed off. So, unless you and your counterparty can confect a means between you of putting the old bag down — and for that you will need the communion wine, garlic, wooden stakes and so on of consensus — a discarded ISDA arrangement will just lie there, locked-in, mute, transfixed, plastered to the infinite like some ghostly apparition, frozen at the event horizon of financial probity for ever — surviving, indefinitely, some say even beyond the mortal existence of they whose trading relationship it once described.

Some would say this is a trifle; a curio, sure, but ultimately a non-point: as unalive as the ISDA that presents it.

But it still unnerves those of delicate or superstitious mien. Like Parsons. For if it is still there, however immobile, can it not cause mass destruction through inattention?

Normally it does not matter

Mainly, no. For an ISDA Master Agreement under which there are no extant Transactions carries of itself no financial obligations or liabilities (we will get to Independent Amounts presently). An ISDA, without a Transaction, presents no risk''. It is as safe as a rusty Luger with the firing pin removed.

If no Transactions remain, there is nothing left one can close out or be closed out on, so what earthly concern is it, for either party, if notional non-payment obligations go unfulfilled?

What kind of paranoid weirdo would take the point that one’s continuing covenants — to send annual reports within three months of their publication, for example — are being broken? And what of those financial meta-obligations? That two-edged Cross Default clause? Could it ... ?

You may laugh, but note only this: they who so haughtily wave such trifles away yet still go quiet and dare not speak of the Dark Lord of the Swaps.

Premium content Here the free bit runs out. Subscribers click 👉 here. New readers sign up 👉 here and, for ½ a weekly 🍺 go full ninja about all these juicy topics👇 When it sort of does matter Can you make your dealer give it back? Practically, yes Theoretically, no Peril-sensitive sunglasses corner: JC gets deep and dark with terrifying hypotheticals

See also

• Early Termination under the ISDA Master Agreement
• No-fault termination
• The Good Man
• The Dark Lord of the Swaps

References

Undead
ˌʌnˈdɛd (n.)

A mythological being that occupies the netherworld between death and life; neither of the vital plane nor beyond the Styx; inert but yet not impotent: Nosferatu: an existence beyond the forest; of spectral but not corporeal energy.

The status of every defunct ISDA master agreement, once all Transactions have terminated. Neither alive nor dead but in a suspended inanimate state; disengaged but yet blooming with bacterial potential.

An ISDA reaches the same purgatorial state however its end time comes about: whether that be through the exigencies of a stressed close-out, or the beckoning lassitudinal entropy of our modern life or just a peculiar frame in which we grow bored, adversely regulated or we just lose interest and thereby give up on swaps.

Perhaps the attention simply wanders: we just let the last remaining Transactions roll off and scamper, free, into the fragrant meadows of oblivion and never set about planting any new ones.

But when our Transacting does come to an end — however it does — it leaves behind an extant rusting hulk: a dilapidating Master Agreement that attracts weeds, vermin, dope smokers, adolescents and other undesirables while at the same time leaching caustic toxins, salting the ground into a barren, desolate badland of financial misadventure.

No no-fault termination

There is no termination without fault on notice clause in the ISDA. It has no mechanism for a party unilaterally to finally close an ISDA Master Agreement down just because.

Now and then someone like Parsons, that pedantic oik from the credit department, will stop by your desk, eyes a-glitter, drop a sheaf upon it and casually impose upon you the burden of disposing of it. If, like JC, you find the credit department’s penchant for stupid notices irksome, you may be equally nonchalant in reply.

Parsons: I say, Molesworth, the H.O.D. asked if you would kindly do the honours to terminate this defunct ISDA.

Molesworth: What do you mean, “terminate this defunct ISDA”?

Parsons: (Affecting shock at the brazen display of ignorance) You know, send out a Section 6(g) notice or something. Whatever verbiage it is that you legal eagles do.

Molesworth: No.

Parsons: I beg your pardon?

Molesworth: Well, no. I’m afraid the answer is no.

For while you can terminate a Transaction under an ISDA Master Agreement — and all of them at once, if things come to that — none of the ISDA’s printed forms envisages the parties terminating the Master Agreement itself. Not even following a close-out. There are reasons for this, at least while the closeout process is on foot, and it is notoriously open-ended: If you terminate the whole agreement, not just the Transactions under it, then how are all those clever close out mechanics meant to work?

But these don’t apply to a non-stressed termination. You know, the nice, friendly, “well, I guess I’ll be on my way,” hasta mañana, parting-is-such-sweet-sorrow sort of staple of every finance contract.

ISDA is unique

Alone in the firmament of finance relationship contracts the ISDA Master Agreement has no general no-fault termination provisions. It cannot be unilaterally killed off. So, unless you and your counterparty can confect a means between you of putting the old bag down — and for that you will need the communion wine, garlic, wooden stakes and so on of consensus — a discarded ISDA arrangement will just lie there, locked-in, mute, transfixed, plastered to the infinite like some ghostly apparition, frozen at the event horizon of financial probity for ever — surviving, indefinitely, some say even beyond the mortal existence of they whose trading relationship it once described.

Some would say this is a trifle; a curio, sure, but ultimately a non-point: as unalive as the ISDA that presents it.

But it still unnerves those of delicate or superstitious mien. Like Parsons. For if it is still there, however immobile, can it not cause mass destruction through inattention?

Normally it does not matter

Mainly, no. For an ISDA Master Agreement under which there are no extant Transactions carries of itself no financial obligations or liabilities (we will get to Independent Amounts presently). An ISDA, without a Transaction, presents no risk''. It is as safe as a rusty Luger with the firing pin removed.

If no Transactions remain, there is nothing left one can close out or be closed out on, so what earthly concern is it, for either party, if notional non-payment obligations go unfulfilled?

What kind of paranoid weirdo would take the point that one’s continuing covenants — to send annual reports within three months of their publication, for example — are being broken? And what of those financial meta-obligations? That two-edged Cross Default clause? Could it ... ?

You may laugh, but note only this: they who so haughtily wave such trifles away yet still go quiet and dare not speak of the Dark Lord of the Swaps.

When it sort of does matter

JC is blessed with inquisitive, thoughtful and voluminous correspondents. He relies on them to keep the old goat on his toes and plugged into the finer points of swappery. One recently raised this juicy hypothetical:

What if I have posted a static, upfront Independent Amount under a Credit Support Annex, but in the traditional fashion? That is, not an amount specifically tied to a Transaction, but a genuinely independent Independent Amount paid as the price of entering the ISDA Master Agreement in the first place. Say all my Transactions have terminated and I’m not expecting to enter any more, how do I get my IA back, if I can’t terminate the ISDA)?

This is a very good, if theoretical, point. Well — JC thought it was theoretical: surely, no-one in this day and age demands genuinely independent Independent Amounts, do they? — but apparently, they do. Swap dealers may, as consideration for even opening a credit line, let alone trading upon it, ask prospective customers to deposit a wodge of cash or securities as general collateral. Particularly, we hear, corporate and non-financial end users whose bona fides the dealer has difficulty assessing. But it may also come in use for programme traders and those who can put a dealer into a swap position by give up before the dealer even knows it’s happened. This is common in the equity derivatives market. Still, it seems perverse — a reversal of the natural order of things in which it is typically dealers who provide finance to their customers and not the other way round — but there we have it: as a price of entering the derivatives trading game you might have to stump up half a mill in hard folding stuff to your dealer.

Strictly, that cash is deposited under the CSA and not the ISDA proper — though that is a fine distinction indeed if the CSA counts as a Transaction under the ISDA Master Agreement — and in any case it is academic, as the CSA doesn’t have any termination provisions in it either.

So, questions: firstly if all my existing business has rolled off and I don’t intend to trade again, can I get my Independent Amount back?

There is a theoretical answer to this and a practical one.

Practically, yes

Practically, yes, of course, you can get your IA back. just ask for it. If you notify your dealer that you intend to shut up shop, it will close down your credit line and set about offboarding you as a client and as part of that process return any Independent Amounts, letters of credit and any other sums or sureties it happens to be holding against your obligations under the trading relationship.

It is well incentivised to do this: not only must the holder of an Independent Amount manufacture income or pay interest at market rates on whatever is deposited but, as a regulated financial institution it must keep laborious and expensive KYC processes in place for all legal entities with which it has a current business relationship. The cost of this will merrily outweigh any value to be had by clinging onto an Independent Amount.

If your relationship is at an end, that is to say, your dealer will be highly motivated to extract itself from the KYC process. It will gladly give you your Independent Amount back and be done with it.

Theoretically, no

But that is not to say it has to. For the theoretical answer is difficult: there is an odd lacuna in the drafting of the Credit Support Annex which in thirty years the ’squad has not seen fit to fix.

Clearly, the Independent Amount is designed as an input into the “Exposure” calculation, and that is only relevant if a party has any Exposure, which it will only do if there are any outstanding Transactions.

You can see this from the mechanics of original payment: while the Independent Amount is designated in the Elections paragraph, you wouldn’t be required to actually pay it until you executed your first Transaction. Thereafter, the Transfer Amounts that flow back and forth to reflect changes in Exposure under the CSA do so over the threshold effectively established by the Independent Amount.

As the last Transaction terminates, the Transfer Amount required to be sent back to the customer will be only the excess of its Credit Support Balance less that Independent Amount, which thereafter is just trapped with the dealer and with no means — beyond falling upon the good graces of the dealer to be a good egg and do the right thing — to recover it.

But still, note: in theory this is a highly counterintuitive proposition: effectively a dealer who holds IA has a perpetual, somewhat subordinated financing facility from its counterparties.

The thing about theoretical risks is they have a habit of becoming practical ones at exactly the moment you at least want them to. So let us put on our peril-sensitive sunglasses.

Peril-sensitive sunglasses corner

Let us put on our peril-sensitive sunglasses for a moment and imagine a worst-possible-case scenario.

In most circumstances, basic financial incentives would strongly favour the dealer returning posted IA on demand, for the reasons given above: It is somewhat expensive to service, and the implied commitment to KYC is a pain. But let’s imagine a portfolio of corporate counterparties who maintain IA with the dealer just to cover the contingency that they will want to trade in the future, even if they aren’t presently doing so. A given dealer might have dozens of such counterparties. Possibly hundreds. They might have posted half a million each. Perhaps 5 million. Together, they represents a decent chunk of change to the dealer.

Then there is a sudden market dislocation: a 2007-style credit crunch. A full-blown 2008 meltdown. The sort of lockup that happened after Silicon Valley Bank and Credit Suisse went to Vanillesoße. All, or substantially all, hell breaks loose.

Suddenly, every bugger on the street is calling its dealers for cash. Hedge funds want their excess margin back. No one’s rolling commercial paper. The discount window has slammed shut.

Suddenly that portfolio of dormant Independent Amounts represents a fairly handy wodge of working capital. At any rate, it would be better than not having it. It would definitely be better than having to return it at that precise moment.

And the point at which a dealer might suddenly be disinclined to wire “rainy day” money back to its customers on request is precisely the point at which those customers might suddenly be inclined to ask for it.

It would make a great play.

See also

• Early Termination under the ISDA Master Agreement
• No-fault termination
• The Good Man
• The Dark Lord of the Swaps