Automatic Early Termination - ISDA Provision
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2002 ISDA Master Agreement
Section 6(a) in a Nutshell™ Use at your own risk, campers!
Full text of Section 6(a)
Related agreements and comparisons
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Content and comparisons
Redlines
- 1987 ⇒ 1992: Redline of the ’92 vs. the ’87: comparison (and in reverse)
- 1992 ⇒ 2002: Redline of the ’02 vs. the ’92: comparison (and in reverse)
- 1987 ⇒ 2002: Redline of the ’92 vs. the ’87: comparison (and in reverse)
Discussion
No change in the Early Termination Date definition from 1992 ISDA to 2002 ISDA (no real surprise there) but the close-out methodology between the two versions, by which one works out what must be paid and by whom on an Early Termination Date, and which you are encouraged to follow in all its gory detail starting at Section 6(a), is really quite different, and notwithstanding the fact that the 2002 ISDA version was meant to address the many and varied complaints levelled by market practitioners at the 1992 ISDA we still find the 1992 version in use in the occasional market centred in unsophisticated rural backwaters like, oooh, I don’t know, New York.
Those with a keen eye will notice that, but for the title, Section 6(a) of the 2002 ISDA is the same as Section 6(a) of the 1992 ISDA and, really, not a million miles away from the svelte form of Section 6(a) in the 1987 ISDA — look on that as the Broadcaster to the 1992’s Telecaster. There is one key difference, though: the evolution of the Automatic Early Termination provision. And the 1987 ISDA saw no call to have a “Non-Defaulting Party”.
It has its own entire page — Automatic Early Termination — so we have refrained from discussing it here.
Summary
Automatic Early Termination
There is an entire, long-winded page about AET, so we have refrained from blathering on about it here.
Everyone’s hair will be on fire
This is likely to be a time where the market is dislocated, your credit officer is running around with her hair on fire, your normally affable counterparty is suddenly diffident, evasive, or strangely just not picking up the phone, and your online master agreement database has crashed because everyone in the firm is interrogating it at once. The sense of dreary quietude in which your Master Agreement was negotiated will certainly not prevail. Bear this in mind when negotiating. For example, the elaborate steps your counterparty insists on for your sending close-out notices, to fifteen different addresses, in five different formats and with magic words in the heading, will really trip your gears, especially if some of those methods are no longer possible. There is an argument that some buy-side counterparties complicate the formal process of closing out specifically to buy time and deter their dealers from pulling the trigger. It is a pretty neat trick, if so: you can expect the dealer’s credit department to puke all over a margin lockup, but a bit of fiddling around the edges of a Notices section? Sure, whatever.
Bear in mind, too: this is one time the commercial imperative will count for nothing. This is it: literally, the end game. If you close out there is no business: you are terminating your trading relationship altogether with extreme prejudice. The normal iterated game of prisoner’s dilemma has turned into a single round game. Game theorists will realise at once that the calculus is very different, and much, much less appealing.
So: good luck keeping your head while all around you are losing theirs.
Close-out sequence
Once you have designated an Early Termination Date for your ISDA Master Agreement, proceed to 6(c) to understand the Effect of Designation. Or learn about it in one place with the NC.’s handy cribsheet, “closing out an ISDA”.
The Notices provisions in Section 12 are relevant to how you may serve this notice. In a nutshell, in writing, by hand. Don’t email it, fax it, telex it, or send it by any kind of pony express or carrier pigeon unless your pigeon/pony is willing to provide an affidavit of service.
Defaulting Party
The key thing to notice here is that — in an uncharacteristically rather neat, understated bit of drafting — Defaulting Party encapsulates a party who has itself defaulted, or whose Credit Support Provider or Specified Entity has committed an act which amounts to an Event of Default for that counterparty to this ISDA Master Agreement. I know, I know, this doesn’t seem that big of a deal: this sort of thing that should be plain, obvious and go without saying — but it saves you a job when, in your peregrinations round the party’s Confirmation, you come to talk of pending Events of Default and Termination Events against that party.
Instead of saying, laboriously, “if there is an Event of Default or Termination Event with respect to a party or its Credit Support Providers or Specified Entities, as the case may be” you can speak of a Defaulting Party or an Affected Party.
Of course, it would be nice if there was a catch-all for a party who has committed an Event of Default or suffered a Termination Event, so you didn’t need to go “Defaulting Party or Affected Party, as the case may be” — cheekily we suggest “Innocent Party” and “Implicated Party” (“Guilty Party”, though fun, isn’t quite right, seeing as Termination Events aren’t meant to impute any kind of culpability).
Non-defaulting Party
To be compared with - well, Defaulting Party. Of all things. And Non-affected Party, as well. The difference between a Non-defaulting Party and a Non-affected Party, and the linguistic torture that distinction as inflicted on the race of ISDA lawyers ever since, says everything you need to know about the absurdity of modern commercial law.
- Do say: “the Non-defaulting Party or the non-Affected Party, as the case may be” over and over again.
- Don’t say: “Is there really no other way you could get across this concept, for crying out loud?”
General discussion
See also
References
Automatic Early Termination is an odd and misunderstood concept which exists in Section 6(a) Right to Terminate Following Event of Default of the ISDA Master Agreement. As is so much in the ISDA Master Agreement, it’s all about Netting. Where a jurisdiction suspends terms of contracts in a period of formal insolvency, the idea is to have the ISDA break before that suspension kicks in — so close-out netting works.
AET is thus only triggered by certain events under the Bankruptcy event of default — formal bankruptcy procedures — and not by economic events that tend to indicate insolvency (such as an inability to pay debts as they fall due, technical insolvency or the exercise of security. Nor does it apply to other Events of Default. Template:Automaticearlytermination
Tedious but harmless drafting tweaks
Even for the Non-Defaulting Party, AET is a necessary evil. It leaves the Non-Defaulting Party at risk of being un-hedged on a portfolio of Transactions that automatically terminated effective as of a Bankruptcy event without the NDP knowing that the Bankruptcy event had happened[1]. The NDP may want to capture the market risk between the Bankruptcy event and the date on which they should have known about it, and factor that into the Close-out Amount. If they do, expect to see language like the below.
If you are an AET counterparty, your credit officer may bridle at the sight of this, but you can reassure her that at any point where this language comes into play she will be wandering around outside in a daze clutching an Iron Mountain box full of gonks, comedy pencils and deal tomb-stones, and contemplating a career reboot as a maths teacher, so she shouldn’t really care anyway.
- Adjustment for Automatic Early Termination: If an Early Termination Date occurs following an Automatic Early Termination event, the Early Termination Amount will adjusted to reflect movements in rates or prices between that Early Termination Date and the date on which the Non Defaulting Party should reasonably have become aware of the occurrence of the Automatic Early Termination.
Switzerland
Switzerland is — isn’t it always? — different, and a good place to go right now would be the Swiss bankruptcy language page. Switzerland itself is also a good place to go, especially in the skiing season. The JC loves Wengen.
AET under the 1987 ISDA
Note the somewhat difficult position for AET under the 1987 ISDA - a fuller discussion at that article - which was part of the reason for the move to the 1992 ISDA in the first place.
See also
References
- ↑ Unless credit department is constantly monitoring the regulatory newswires of all AET counterparties to check whether they go bankrupt each day, and they won’t be.