Template:M summ Equity Derivatives 11.1

Typically, your master confirmation will set out the resolution method for each type of Index Adjustment Event separately — this figures, since depending on the type of Index Adjustment Event, the range of possibilities open to even the most imaginative Calculation Agent will differ. If the underlying Index has been cancelled, you can’t very just well make an adjustment and carry on, because there is nothing left to pay the performance of. It might have been nice had ISDA’s crack drafting squad™ programmed some of this into the definitions, but bless them, they didn’t, so let us speculate.

Cancellation and Payment

Note that “Cancellation and Payment” means different things for different Index Adjustment Events. In the unlikely event it applies to Index Disruption, the transaction is cancelled on the Valuation Date; if an Index Cancellation, then immediately before the cancellation goes live — unless the Index Sponsor didn’t announce it, in which case, as soon as it does (this protects a hedging counterparty). For an Index Modification, there is an odd lacuna: either side can cancel it, neither has to, but cancellation must take place before the adjustment event. We imagine this gets to be self-policing: if both sides are happy not to cancel, the modification is probably not that material. Customers can generally close out their risk on any day in any case.

Likely elections

Three things can happen to an index which are beyond the control of the parties: it can be disrupted, it can be materially changed, or it can be cancelled altogether by the Index Sponsor. In any of these cases the bargain represented by an index transaction will no longer be the one anticipated by the parties on execution, and they may wish to take some action. The possible actions are:

• Index Cancellation: This one, we humbly submit, is likely to be Cancellation and Payment, seeing as there is nothing left to modify or, really, negotiate about.
• Index Modification: Here Calculation Agent Adjustment doesn’t really make sense (as it implies a one-off adjustment), which falls to Negotiated Close-out, which is really a wishy-washy way of saying Cancellation and Payment, which, for Index Modifications, gives both parties the option to cancel the trade, but not the obligation to.
• Index Disruption: Index disruption is likely to be transitory — just a temporary failure to publish an index level — and seeing as the Calculation Agent will be hedging by transacting in the underliers of the Index, so it ought to be able to calculate, near enough, an estimated Index level by reference to the closing prices of the constituents. Here, expect Calculation Agent Adjustment, for the Calculation Agent to have a bash at figuring out what the Index would have paid had it not been altered, disrupted or cancelled.. Should things become permanent, it is likely to be an Index Calculation or Index Modification, so the disruption terms no longer would be in play.

In all cases, remember: generally the swap dealer (who is Calculation Agent) does not have a dog in the fight. It will accommodate its customer’s wishes as far as it can — that is only good business — as long as those wishes reflect genuinely hedgeable positions. If the dealer can hedge, it will, and will pass on those economics. If it can’t, it won’t, and will account for the liquidation value of its hedges.

The default option here is “Cancellation and Payment”. Negotiated Close-out is just an agreement to agree, and it would be a brave Calculation Agent indeed who volunteered to continue calculating a cancelled Index based on previous rules once it has been disestablished by the actual Index sponsor, which is what Calculation Agent Adjustment appears to require — but we have seen hopeful counterparties ask. They always seem so disappointed when you let them down.