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, if the cross default applies, default by a party under a contract for “Specified Indebtedness” with a third party in an amount above the “Threshold Amount” is an Event of Default under the ISDA Master Agreement.

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.

The Threshold Amount is usually defined as a cash amount or a percentage of shareholder funds. It should be big: be a life-threatening failure - because the consequences of triggering it are dire. Expect to see 2-3% of shareholder funds, or sums in the order of hundreds of millions of dollars.

Cross default imports all the default rights from the Specified Indebtedness into the ISDA Master Agreement. For example, if you breach a financial covenant in your Specified Indebtedness, your swap counterparty could close you out even if the lender of the facility took no action on the breach. Cross default is, therefore, theoretically at least, a very dangerous provision. Financial reporting dudes get quite worked up about it. Oddly enough, it is very rarely triggered: It is actually very nebulous, and most credit officers would prefer to act on a clean Failure to Pay or a Bankruptcy event. Generally one will be along presently.

Cross Aggregation

The 2002 ISDA updates the 1992 ISDA cross-default so that if the combined amount outstanding under the two limbs of Cross Default exceed the Threshold Amount, then it will be an Event of Default. Normally, under the 1992 ISDA, Cross Default requires one or the other limbs to be satisfied — you can’t add them together.

As per the above, the two limbs are:

• a default under a financial agreement that would allow a creditor to accelerate any indebtedness that party owes it;
• a failure to pay on the due date under such agreements after the expiry of a grace period.