Template:M summ 2002 ISDA 5(a)(vi)
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.