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Section Preamble

Section Preamble in a nutshell

2002 ISDA Master Agreement

between

[SPECIFY] and [SPECIFY]

will be entering into “Transactions” governed by this 2002 Master Agreement and its “Schedule”, and a “Confirmation” evidencing those Transactions. The 2002 Master Agreement with its Schedule are the “Master Agreement”.
So:―

Comparison between versions

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)

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Discussion

The Preamble to the 1987 ISDA had an extra feature: the single agreement provision. By 1992, this had been moved to its own little subclause in Section 1(c), and there it has stayed ever since.

As for the modern ISDAs, there is little material difference between the 1992 ISDA and the 2002 ISDA here. By 2002, ISDA’s crack drafting squad™ was a more world-weary, battle-hardened unit than it was in 1992, and was more alive to the idea that one might document Transactions other than via a full-blown Confirmation. Particularly in the equity derivatives world, because the asset class tends to be fairly vanilla, the market was starting to generate Master Confirmation Agreements for certain markets and regions, meaning that commoditised swap transactions could be fully automated and electronically completed through online trade matching systems without any faxed bits of paper saying “Dear Ladies and Gentlemen” and similarly genteel things that are so archaic as to seem, in these snow-flecked days, mildly offensive.

Discussion

Chekhov’s gun
Russian: Чеховское ружьё (n.)

A narrative principle that states that every element in a story must be necessary, and irrelevant elements should be removed.

“If there is a rifle hanging on the wall in the first act, it must go off in the third.”

A preamble is he legal eagle’s opportunity to set a scene, a juridical version of “once upon a time”: an integrated passage that may or may not start with “whereas”, “background” or something like that and is meant to prime you for the meat of contract.

The ISDA Master Agreement needs just such a scene-setter: everyone, once, stares at that gnomic title and thinks, “okay, what on earth is this all about?” That is the Preamble. There is not much to see but, casually, it calls the reader’s attention to things that will later become important — the proverbial rifle hanging above the fireplace that goes off in the third act. That is where the similarities with Chekhov end, though: before long, it will go full Dostoyevsky on us.

The ISDA Master Agreement is the basic framework that applies to anyone who touches down on planet ISDA. The preamble tells us about its tri-partite form: the Pre-printed Master, a Schedule of elections and amendments, and Confirmations setting out the terms of Transactions.

ISDAs, Ancient and Modern

There are two versions of the ISDA still widely in use — the 2002 ISDA Master Agreement and the ISDA Master Agreement (Multicurrency — Cross Border) which is known to all who love her as the 1992 ISDA Master Agreement. These we call the “Modern ISDAs”.

There are two more or less fully retired versions: the ISDA Interest Rate and Currency Exchange Agreement of 1987 (the 1987 ISDA) and the ISDA Code of Standard Wording, Assumptions and Provisions for Swaps of 1985 (let’s call this the 1985 Code, though few people have ever even seen one). These we call the “Ancient ISDAs”.

There is one, the 2008 ISDA Decentralised Automomous Organisation-as-an-Agreement that died tragically during conception and never made it to the market but yet exists as an apocryphal testament to the enduring, wishful optimism of derivatives lawyers the world over. We call this the “Atlantis Variation”.

2002 ISDA

The still, after all these years, state-of-the-art 2002 ISDA. This is the most popular version — it took industry participants an awfully long time to get comfortable with it, despite its innovations being largely sensible but, twenty-two years into its life, most of the European and Asian markets trade on the 2002 ISDA, and we sense even those camelesque Americans are coming to begrudging terms with it. If you are ever not sure, on this wiki, the JC will generally have the 2002 ISDA in mind, though there is a fully scoped user manual and comparative discussions relating to the 1992 ISDA as well. Speaking of which —

1992 ISDA

The 1992 ISDA was the first global, pan-transactional, earth-shaking version of the ISDA Master Agreement. It was the first one to be actually called a “Master Agreement”. It is still popular with traditionalists, those who can’t abide a one-day grace period for Failure to Pay or Deliver, and Americans.

Until quite recently much of the American market was still on the 1992 ISDA, although most users heavily modified it to take in most of the innovations of the 2002 ISDA. But the anecdotal sense we have is that even in New York, these days, the 2002 ISDA is the master agreement of choice for the discerning ninja.

The fact that there was so much institutional reluctance to update to a new and better agreement should tell us a good deal, both good and bad, about how people in established businesses behave — in brief, they like what they know — and how quickly things really change: not very.

Perhaps had the 2002 ISDA been more radical it might have stood a greater chance quick of adoption. On the other hand, the further the fruit falls from the tree, the greater the chance of outright failure. Just ask “Flight 19”, the poor, doomed Linklaters team who drafted the 2011 Equity Derivatives Definitions.

1987 ISDA

The 1987 ISDA Interest Rate and Currency Exchange Agreement — it wasn’t, by name, a comprehensive “master agreement” — is all but a dead letter now. But, we sense, not quite.

Just as there are still soldiers in the Burmese jungle fighting the Second World War, through inattention or truculence there may be pockets, embedded deep in the impassable hinterlands of structured finance who still cling to the 1987 ISDA, notwithstanding its well-recognised shortcomings. If you come across one of these, proceed with caution: 1987 ISDAs don’t have a lot of safety features a modern derivatives counterparty relies on, so are only for real die-hard vinyl junkies and weirdos.

1985 ISDA Code

These days interesting only for its place in the fossil record — and a witty acrostic that points to a playfulness among the First Men that has long since vanished, the 1985 ISDA Code was out of use well before the millennium. The JC only found out about it when visiting a retired ninja in a care home in 2015, and at first assumed it was some sort of urban myth or in-joke. But apparently not.

2008 ISDA — “Atlantis”

The 2008 ISDA Decentralised Autonomous Organisation-as-an-Agreement — a “this-fixes-everything, on-chain, smart, artificially intelligent” was introduced during, and tragically destroyed by, the Global Financial Crisis.

Oh, all right there isn’t a 2008 ISDA. Never was. This one is a running JC in-joke. Talking to yourself might not be the first sign of madness, but having in-jokes with yourself might be. From the blurb to Hunter Barkley’s 2026 novel The Atlantis Variation:

… the 2008 ISDA would be a definitive, final, flawless self-aware edition of the ISDA Master Agreement. Short, plainly worded, future-proofed and agile, it would allow counterparties to agree robust trading terms with little fuss and only the cursory clerical management delivered through unskilled personnel in low-cost jurisdictions and, eventually, chatbots.

It promised to be the long-lost missing use-case for distributed ledger technology, natively negotiated “on-chain” between arrays of dematerialised large language models housed, for the sense of theatre, in a single giant data centre in the outskirts of Bucharest.

Had it been implemented, the Atlantis would have addressed the financial, infrastructural and regulatory challenges which would dog the financial derivatives market in the early 21st century, eventually bringing to the brink of an abyss the rolling countryside of Aïessdiyé, a verdant wetlands in whose folded hills, nooks and crannies peaceable, hobbity little swapsfolk had for generations made their comfortable burrows.

While they romped wealthily about their sun-drenched meadows, the ’08 would silently, effectively consolidate all documentation across a wide range of products and asset classes (including, but not limited to, repo, stock lending, prime brokerage, exchange traded derivatives, commodities and emissions), finally moving the financial world into a stable utopian state in which all risks are known, all eventualities experienced and contingencies accounted for. Risk would finally be banished for ever.

That was the theory: the reality was infinitely darker.

Schedule

All usable versions of the ISDA Master Agreement have a Schedule with a semi-rigid structure:

Part 1: Termination Provisions
Part 2: Tax Representations
Part 3: Documents for Delivery
Part 4: Miscellaneous (Schedule)
Part 5: Other Provisions

The first four parts of the Schedule fine-tune various Events of Default and Termination Events, letting the parties make certain elections and representations, setting out their tax and financial disclosures and specifying names, addresses, contact details, agents, friends and relations and so on.

Part 5 is a free-form “any other business” where your credit team can indulge its fantasies, gild the lily and you can set out agreed amendments to the pre-printed form.

A quick word on etiquette: one would never inline amend an ISDA Master Agreement — mostly they pass around the market in .pdf form, so you couldn’t anyway, but even if you could it would be unspeakably bad form to try — if you do want to make amendments to the legal or economic terms you put them in the Schedule. There are prudent legal design reasons for this, though over the years the amount of freestyle “Part 5” amendment has grown to the point where the Schedule is often longer than the Master Agreement proper.

Much of this is quite unnecessary and, for lovers of clarity and documentary elegance, a cause for great regret.

Transactions

Because the range of things you could conceivably write a swap about is unlimited, and having only ten fingers and toes, JC will have less to say about “Transactions” generally — except for Equity Derivatives, because they tend to be generic, delta-one and they are popular in the equity prime brokerage world, which is JC’s old stamping ground.

The I.S.D.A.

ISDA, which publishes the ISDA, was the “International Swap Dealers Associations, Inc.” — interesting plural, that — but in any case, outwardly a sell-side industry association.

JC’s extensive research has not yielded an explanation for why ISDA ever considered itself a plural, and the chatbots he consulted all came up with absurd reasons like — and I kid you not — inclusivity, collectivity, and global representation:

“using Associations”, speculated NiGEL, “might have aimed to convey a broader representation of various swap dealers across the globe, even though it wasn’t a merger of multiple entities”. Perhaps, it continues, “founders anticipated incorporating other regions or types of swap dealers in the future, which never materialised”.

Perhaps. Or maybe it was a typo. Who knows?

In any weather, in 1993, ISDA rebranded itself as the “International Swaps and Derivatives Association, Inc.”: singular, at the same time more unitary and sounding more inclusive of buy-siders, but still in spirit the same old ISDA, stake-held predominantly by the largest swap dealers on the face of the Earth.

It may aspire to conquer the world — it encroaches on the commodities, carbon, securities financing and crypto domains — but for now, ISDA remains a “dealer-community” association, largely devoted to the swap.

Buy-side representation

These days the “buy-side lobby” is bigger, more organised and better represented than it used to be, with the following associations representing its interests:

AIMA (the Alternative Investment Management Association)
EFAMA (the European Fund and Asset Management Association)
The MFA (the Managed Funds Association) and
The AI (the Investment Association).

ISDA architecture

The legal documentation for an ISDA swap transaction comes in three main parts, but — of course — there are complications for the legal eagles to get their iatrogenic talons into. But for now, let’s start at the beginning.

The ISDA Master Agreement

The ISDA Master Agreement is the basic framework which applies to anyone who touches down on planet ISDA. There are three existing versions:

• the state-of-the-art 2002 ISDA;
• the still-popular-with-traditionalists-and-Americans 1992 ISDA, and
• the all-but-retired-but-don’t-forget-there-are-still-soldiers-in-the-Burmese-jungle 1987 ISDA
• the interesting-only-for-its-place-in-the-fossil-record-and-witty-acrostic 1985 ISDA Code; and
• there isn’t a 2008 ISDA. That’s a little running JC in-joke.

All three versions have a tri-partite form: Pre-printed Master, Schedule and — well, this is controversial: for is it, or is it not, part of the ISDA Master Agreement? — Credit Support Annex. Template:M detail 2002 ISDA Preamble

Section 1

Section 1 in a nutshell

1 Interpretation
1(a) Definitions. Most of the definitions are in Section 14 but some are scattered throughout the Master Agreement.
1(b) Inconsistency. Where they conflict, each Confirmation overrides the Schedule, and the Schedule overrides the Master Agreement.
1(c) Single Agreement. When they enter each Transaction the parties are relying on the Master Agreement and all outstanding Confirmations being a single agreement. They would not otherwise enter into any Transaction.

Comparison between versions

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)

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Discussion

The 2002 ISDA does the reader the service of acknowledging there might be terms defined in the schedule and not just Section 14 — as indeed there must — party-specific things like Party A, Party B, Credit Support Provider, Credit Support Document, and no doubt you can think of others — but beyond this, the text of Section 1 in the 2002 ISDA is the same as Section 1 in the 1992 ISDA.

The 1987 ISDA was broadly the same, though there was no “single agreement” subclause (c) — that is built instead into the Preamble. By 1992 ISDA’s crack drafting squad™ deemed this important enough to deserve its own place in Section 1(c), and there it stayed for the 2002 ISDA.

Discussion

Section 1 is a gentle introduction indeed to the dappled world of the ISDA Master Agreement.

In a nutshell, unless you are doing repackagings — and even then, don’t get carried away — make sure you understand what Section 1 is there for and what it does, but don’t fiddle with it.

Section 1(a)

The large slew of definitions are set out in Section 14. JC considers each in its own write in Section 14, so not much more to say here.

Section 1(b)

It wouldn’t be ISDA if there weren’t a hierarchy clause; like all hierarchy clauses, this one states what ought to be obvious: the pre-printed ISDA Master Agreement itself sits at the bottom of the hierarchy, is modified by the Schedule; once that is negotiated and stuck into the netting database, the Schedule sits there, ungainly, unloved and unregarded until the Great King of Terror comes down from the sky and may be (but generally isn’t) modified as needs be for each Transaction by the Confirmation.

In point of fact the Confirmations don’t tend to modify anything in the Master or Schedule, but rather builds on them, but if there is inconsistency — and with a document as pedantic and overwrought as the ISDA Master Agreement you never know — then the most specific, recently edited document will be the one that prevails.

All of this follows from general principles of contractual interpretation and common sense communication, of course.

A message to internal audit and quality control teams

One quick point that only needs saying when busy-bodies from internal audit come on their biannual trip hunting for worms and earwigs under rocks in your neighbourhood: you — and by that we mean one — never, never, never “inline” amends the form of ISDA Master Agreement. It is sacred. Never to be edited. If, er, one wants to amend its terms — of course one does, one is a legal eagle and one’s client is special — you do that remotely by setting out the amendment in Part 5 of the Schedule.

Why labour this obvious point? Because JC has had to explain to a disbelieving external audit consultancy, retained to ensure quality control over a portfolio of tens of thousands of master trading agreements, that there was no need for a control measuring the number of agreements that had been inline amended; no need for a core-sample test, a gap analysis or a nine-month all-points operational risk deep dive to be sure that this was the case — and it was an argument that ran for three weeks and which JC almost lost.

No-one, ever, inline amends the ISDA.

The ISDA Master Agreement is shot through with unimaginative design, unnecessary verbiage and conceptual convolution, but this is one design principle the ’squad got perfectly right: “offboarding” amendments to the Schedule does several smart things: it creates a neutral standard for all participants offering no scope for interrogation by sancimonious quality controllers, it makes very clear at a glance what has changed from the standard and most importantly it disincentivises formalistic fiddling: it is a rare — though by no means unknown — kind of pedant who insists on insertions like, “Section 2(a)(i) is amended by adding, “, as the case may be” before the full stop on the third line.”

Section 1(c)

Section 1(c) starts getting a bit tastier in that it comprises the Single Agreement. This is deep ISDA lore, from which all the close-out netting that gives the ISDA Master Agreement its capital efficiency flows.

The “single agreement” concept

Here several pieces of magic come together to create the capital foundation of the modern master trading agreement. The challenge, originally solved by the First Men, was to create an architecture that allowed discrete, unitary, complete Transactions, such that creating a new one or terminating an old one didn’t upset the economic or legal integrity of other Transactions that were currently on foot — no untoward tax consequences, that is to say — while at the same time creating an umbrella framework so that, should something regrettable happen to either party, all Transactions can be quickly rounded up, evaluated, stopped and then collapsed down — “netted” — to a single payment, payable by one party to the other.

This involved some canny financial engineering. The general rules of set-off require not just a mutuality of parties to the off-setting debts, but also amounts falling due on the same day and in the same currency — neither of which was necessarily true of the independent Transactions executed under a multi-currency, cross-border ISDA Master Agreement.

Their solution was this concept of the “Single Agreement”: the over-arching agreement that, however independent and self-contained Transactions are for any other purpose, when it comes to their early termination, they transmogrify into the single host agreement, in the process reduced to mere calculation inputs to the final amount which one party must pay the other. Thereby the process is not one of “set-off” at all, but of calculating a single net amount, the payment of which would sort out all matters outstanding under the relationship.

The JC once had the idea of doing a “boring talk” about the history of the ISDA Master, and actually pitched it to the BBC for their podcast series. It was rejected, on account of being too boring. True story.

Section 1(c): the Single Agreement

Most of Section 1 may be theatrical throat-clearing, but section 1(c) is important — by some lights, the main reason one even has an ISDA Master Agreement: it vouchsafes your close-out netting analysis, purporting to inextricably bind together all Transactions under the ISDA Master Agreement as part of a single, concerted, nettable whole. Should (God forbid) your counterparty have imploded, an unthinking administrator might feel the three-year jet fuel swap you traded in July 2012 had nothing really to do with your six-month interest rate swap from February last year and when it comes to considering who owes who what, the two should be treated as separate, unitary transactions. It might think this quite enthusiastically if one of those transactions happens out-of-the-money to you, and the other one in-the-money. This, at any rate, has been the dominant fear of the Basel Committee on Bank Supervision since it hit upon the idea of capital relief for master netting agreements in 1986.

“Why, that’s dashed bad luck, old man! You have to pay me that out-of-the-money exposure and while this dead parrot owes you on the other trade, the end of the creditors’ queue is that one you can see over there in the far distance, should you have a telescope on you.”

You might be inclined to say, “but wait: we should be able to set these off surely! This is all the same stuff, right! Swaps! They all go together! They’re not unitary transactions at all!”

Well, Section 1(c) — the one that says “it is all a single agreement, and we would never have done any of this if we had thought for a moment it might not be, and to prove it we are saying this out loud at the very inception of our derivatives relationship” is your friend in making that argument. There are similar provisions in other agreements, but none is so classic or elegant as the ISDA Master Agreement’s.

Section 2

Section 2 in a nutshell

2. Obligations
2(a) General Conditions

2(a)(i) Each party must perform its obligations under each Transaction Confirmation.

2(a)(ii) Parties must make:

(a) Payments for value the specified due date, in freely transferable funds and in the regular fashion for making payments in the currency in question.

(b) Deliveries for receipt on the due date and in the regular fashion for making deliveries of the asset in question.

2(a)(iii) Each party’s obligations under each Transaction are conditional upon:

(1) there being no uncured Event of Default or Potential Event of Default against the other party.

(2) no Early Termination Date having been designated for the Transaction.

(3) each other condition precedent in this Agreement being met.

2(b) Change of Account. Either party may change its standard settlement instructions by five Local Business Days’ notice before any Scheduled Settlement Date but the other party may make reasonable objections to such a change.
2(c) Netting of Payments . If on any date amounts would otherwise be payable by each party to the other

(i) in the same currency; and

(ii) under the same Transaction,

then those obligations will be satisfied and replaced by an obligation on the party owing the larger amount to pay the difference. The parties may net payments across multiple specified Transactions by applying “Multiple Transaction Payment Netting” (and clause 2(c)(ii) will therefore not apply). Multiple Transaction Payment Netting arrangements may apply to different groups of Transactions, will apply separately to each pairing of specified Offices and will take effect as agreed between the parties.
2(d) Deduction or Withholding for Tax

2(d)(i) Gross-Up. The parties must pay without withholding unless required by law. Where a payer has to withhold, it must:—

(1) promptly tell the recipient;

(2) promptly pay the withheld amount to the relevant authorities (including the withholding on any required gross-up);

(3) give the recipient a receipt for the tax payment; and

(4) gross up any Indemnifiable Tax, so that the recipient receives the amount it would otherwise have received (free of Indemnifiable Taxes). However, the payer need not gross up any withholding that arose only because:—

(A) the recipient did not provide Section 4(a) tax information, or breached its Payee Tax Representations; or

(B) the recipient's Payee Tax Representations were not true (other than because of regulatory action taken after execution of the Transaction or a Change in Tax Law.

2(d)(ii) Liability. If the payer :—

(1) is required by law to withhold a non-Indemnifiable Tax;

(2) nonetheless does not do so; and

(3) suffers by direct assessment a liability for that Tax,

then, unless the recipient has satisfied the Tax liability directly, it must reimburse the payer for that liability (plus interest, but not penalties unless it failed to provide tax information required under Section 4(a), or breached any Payee Tax Representations.

Comparison between versions

Readers looking for significant differences between the 1992 ISDA and 2002 ISDA will find their socks resolutely still on by the time they get to the end of section 2. Other than some new Multiple Transaction Payment Netting wording designed to untangle a cat’s cradle of language that, in this commentator opinion, didn’t need to be there in the first place, the only significant change in Section 2 is that the Default Interest provision has been removed and now appears, in a gruesomely reorganised format, in Section 9(h) of the 2002 ISDA.

Section 2(a)

The 1987 ISDA, being concerned only with interest rates and currency exchange, does not contemplate delivery, as such. Delivery implies non-cash assets. Therefore portions of 2(a)(i) and 2(a)(ii) were augmented in the 1992 ISDA to cater for this contingency. The 1992 ISDA also added a condition precedent to the flawed asset clause (Section 2(a)(iii)) that no Early Termination Date had been designated.

Thereafter Section 2(a) is identical in the 1992 ISDA and the 2002 ISDA. However the subsidiary definition of Scheduled Settlement Date — a date in which any Section 2(a)(i) obligations fall due — is a new and frankly uncalled-for innovation in the 2002 ISDA.

We have a special page dedicated to Section 2(a)(iii), by the way. That is a brute, and one of the most litigationey parts of the Agreement.

Section 2(b)

But for the new definition of Scheduled Settlement Date in the 2002 ISDA, the 1992 ISDA text is formally the same.

Section 2(c)

The 2002 ISDA introduces the concept of Multiple Transaction Payment Netting, thereby correcting a curiously backward way of applying settlement netting.

Section 2(d)

Other than an “on or after the date on which” embellishment towards the end of the clause, exactly the same text in the 1992 ISDA and the 2002 ISDA.

Section 2(e)

Section 2(e), dealing with default interest, was removed in the 2002 ISDA, and replaced with a spikier, more fulsome Section 9(h) (Interest and Compensation).

A new and different Section 2(e) for the 2002 ISDA was almost revived after the global financial crisis as a tool for imposing a “use it or lose it” trigger on Section 2(a)(iii), but the moment passed. See Condition End Date for more information.

Discussion

Section 2(a) contains the fundamental payment and delivery obligations under the ISDA Master Agreement; the remainder of the section is a random collection of harmless and uncontroversial, or even unnecessary, bits of housekeeping such as how one changes settlement instructions (Section 2(b)), under what circumstances the parties can net down offsetting payments in the ordinary course (Section 2(c) — though, spoiler, it is whenever they both feel like it), and arrangements for where and when one grosses up for withholding tax is (Section 2(d)).

Section 2(a)

Section 2 contains the basic nuts and bolts of your obligations under the Transactions you execute. Pay or deliver what you’ve promised to pay or deliver, when you’ve promised to pay it or deliver it, and all will be well.

“Scheduled Settlement Date”

Though it doesn’t say so, at least in the 2002 ISDA the date on which you are obliged to pay or deliver an amount is the “Scheduled Settlement Date”. The ’02 definition only shows up only in Section 2(b) (relating to the time by which you must have notified any change of account details) and then, later, in the tax-related Termination Events (Tax Event and Tax Event Upon Merger). That said, “Scheduled Settlement Date” isn’t defined at all in the 1992 ISDA.

Section 2(a)(iii): the flawed asset provision

And then there’s the mighty flawed asset provision of Section 2(a)(iii). This won’t trouble ISDA negotiators on the way into a swap trading relationship — few enough people understand it sufficiently well to argue about it — but if, as it surely will, the great day of judgment should visit upon the financial markets again some time in the future, expect plenty of tasty argument, between highly-paid King’s Counsel who have spent exactly none of their careers considering derivative contracts, about what it means.

We have some thoughts on that topic, should you be interested, at Section 2(a)(iii).

Section 2(b)

ISDA’s crack drafting squad™ phoning it in, we are obliged to say, and not minded to make any better a job of it when given the opportunity to in 2002. On the other hand, in this time of constant change, it is reassuring to know some things just stay the same.

Section 2(c)

Section 2(c) is about “settlement” or “payment” netting — that is, the operational settlement of offsetting payments due on any day under the normal operation of the Agreement — and not the more drastic close-out netting, which is the Early Termination of all Transactions under Section 6.

If you want to know more about close-out netting, see Single Agreement and Early Termination Amount.

We wonder what the point of this section is, since settlement netting is a factual operational process for performing existing legal obligations, rather than any kind of variation of the parties’ rights and obligations. If you owe me ten pounds and I owe you ten pounds, and we agree to both keep our tenners, what cause of action arises? What loss is there? We have settled our existing obligations differently.

To be sure, if I pay you your tenner and you don’t pay me mine, that’s a different story — but then there is no settlement netting at all. The only time one would wish to enforce settlement netting it must, ipso facto, have happened, so what do you think you’re going to court to enforce?

Section 2(d)

Section 2(d) does the following:

• Net obligation: if a counterparty suffers withholding it generally doesn’t have to gross up – it just remits tax to the revenue and pays net.
• Refund obligation where tax subsequently levied: if a counterparty pays gross and subsequently is levied the tax, the recipient must refund an equivalent amount to the tax.
• Indemnifiable Tax: the one exception is “Indemnifiable Tax” - this is tax arises as a result of the payer’s own status vis-à-vis the withholding jurisdiction. In that case the payer has to gross up, courtesy of a magnificent quintuple negative.

Stamp Tax reimbursement obligations are covered at 4(e), not here.

News from the pedantry front

Happy news, readers: we have a report from the front lines in the battle between substance and form. The JC asked no lesser a tax ninja than Dan Neidle — quietly, the JC is a bit of a fan — the following question:

In the statement, “X may make a deduction or withholding from any payment for or on account of any tax” is there any difference between “deducting” and “withholding”?

They seem to be exact synonyms.

Likewise, “for” vs. “on account of”?

We are pleased to report Mr N opined replied:

I don’t think there’s a difference. Arguably it’s done for clarity, because people normally say “withholding tax” but technically there’s no such thing — it’s a deduction of income tax.

Which is good enough for me. So all of that “shall be entitled to make a deduction or withholding from any payment which it makes pursuant to this agreement for or on account of any Tax” can be scattered to the four winds. Henceforth the JC is going with:

X may deduct Tax from any payment it makes under this Agreement.

Subsection 2(a)

Comparison between versions

The 1987 ISDA, being concerned only with interest rates and currency exchange, does not contemplate delivery, as such. Delivery implies non-cash assets. Therefore portions of 2(a)(i) and 2(a)(ii) were augmented in the 1992 ISDA to cater for this contingency. The 1992 ISDA also added a condition precedent to the flawed asset clause (Section 2(a)(iii)) that no Early Termination Date had been designated.

Thereafter Section 2(a) is identical in the 1992 ISDA and the 2002 ISDA. However the subsidiary definition of Scheduled Settlement Date — a date in which any Section 2(a)(i) obligations fall due — is a new and frankly uncalled-for innovation in the 2002 ISDA.

We have a special page dedicated to Section 2(a)(iii), by the way. That is a brute, and one of the most litigationey parts of the Agreement.

Discussion

Section 2 contains the basic nuts and bolts of your obligations under the Transactions you execute. Pay or deliver what you’ve promised to pay or deliver, when you’ve promised to pay it or deliver it, and all will be well.

“Scheduled Settlement Date”

Though it doesn’t say so, at least in the 2002 ISDA the date on which you are obliged to pay or deliver an amount is the “Scheduled Settlement Date”. The ’02 definition only shows up only in Section 2(b) (relating to the time by which you must have notified any change of account details) and then, later, in the tax-related Termination Events (Tax Event and Tax Event Upon Merger). That said, “Scheduled Settlement Date” isn’t defined at all in the 1992 ISDA.

Section 2(a)(iii): the flawed asset provision

And then there’s the mighty flawed asset provision of Section 2(a)(iii). This won’t trouble ISDA negotiators on the way into a swap trading relationship — few enough people understand it sufficiently well to argue about it — but if, as it surely will, the great day of judgment should visit upon the financial markets again some time in the future, expect plenty of tasty argument, between highly-paid King’s Counsel who have spent exactly none of their careers considering derivative contracts, about what it means.

We have some thoughts on that topic, should you be interested, at Section 2(a)(iii).

Flawed assets

Section 2(a)(iii): Of these provisions, the one that generates the most controversy (chiefly among academics and scholars, it must be said) is Section 2(a)(iii). It generates a lot less debate between negotiators, precisely because its legal effect is nuanced, so its terms are more or less inviolate. Thus, should your counterparty take a pen to Section 2(a)(iii), a clinching argument against that inclination is “just don’t go there, girlfriend”.

Payments and deliveries

In a rare case of leaving things to practitioners’ common sense, ISDA’s crack drafting squad™ deigned not to say what it meant by “payment” or “delivery”.

Payments

Payments are straightforward enough, we suppose — especially since they are stipulated to be made in “freely transferable funds and in the manner customary for payments in the required currency”: beyond that, money being money, you either pay or you don’t: there are not too many shades of meaning left for legal eagles to snuggle into.

Deliveries

Deliveries, though, open up more scope for confecting doubts one can then set about avoiding. what does it mean to deliver? What of assets in which another actor might have some claim, title or colour of interest? In financing documents you might expect at least a representation that “the delivering party beneficially owns and has absolute rights to deliver any required assets free from any competing interests other than customary liens and those arising under security documents”.

What better cue could there be for opposing combatants leap into their trenches, and thrash out this kind of language?

Less patient types — like yours truly — might wish to read all of that into the still, small voice of calm of the word “deliver” in the first place.

What else could it realistically mean, but to deliver outright, and free of competing claims? It is bound up with implications about what you are delivering, and whose the thing is that you are delivering. It would be absurd to suppose one could discharge a physical delivery obligation under a swap by “delivering” an item to which one had no title at all: it is surely implicit in the commercial rationale that one is transferring, outright, the value implicit in an asset and not just the formal husk of the asset itself, on terms that it may be whisked away at any moment at the whim of a bystander.

Swaps are exchanges in value, not pantomimes: one surrenders the value of the asset for whatever value one’s counterparty has agreed to provide in return. Delivery is not just some kind of performative exercise in virtue signalling. You have to give up what you got. As the bailiffs take leave of your counterparty with the asset you gave it strapped to their wagon, it would hardly do to say, “oh, well, I did deliver you that asset: it never said anywhere it had to be my asset, or that I was meant to be transferring any legal interest in it to you. It is all about my act of delivery, I handed something to you, and that is that.”

We think one could read that into the question of whether a delivery has been made at all. Should a third party assert title to or some claim over an asset delivered to you, your best tactic is not a vain appeal to representations your counterparty as to the terms of delivery, but to deny that it has “delivered” anything at all. “I was meant to have the asset. This chap has repossessed it; therefore I do not have it. If I don’t have it, it follows that you have failed to deliver it.”

Modern security as practical control

In any weather, nowadays much of this is made moot by the realities of how financial assets are transferred: that is, electronically, fungibly, in book-entry systems, and therefore, by definition, freely: a creditor takes security over accounts to which assets for the time being are credited, or by way of physical pledge where the surety resides in the pledgee holding and therefore controlling the securities for itself. It is presumed that, to come about, any transfer of assets naturally comes electronically and without strings attached. It would be difficult for such a security holder to mount a claim for an asset transferred electronically to a bona fide third party recipient for value and without notice: the practicalities of its security interest lie in its control over the asset in the first place: holding it, or at the least being entitled to stop a third party security trustee or escrow custodian delivering away the asset without the security holder’s prior consent. Template:M detail 2002 ISDA 2(a)

Subsection 2(a)(iii)

Comparison between versions

Section 2(a)(iii) is the world-famous, notorious, much-feared “flawed asset” provision in the ISDA Master Agreement. The text was mostly unchanged between the 1992 ISDA and the 2002 ISDA, bar a single clarification in Section 2(a)(iii)(3). There was a change from the 1987 ISDA which did not have the middle condition precedent that “no Early Termination Date in respect of the relevant Transaction has occurred or been effectively designated”. As to what all this means, or achieved, we speculate below.

Discussion

Herculio: I have a thought. This meagre tract: not ninety words
Wrapp’d about with preliminal nicety and
Stamp’d as for affixation to a servic’d boiler —
Conceals a clever trick.
Ser Jaramey: What kind of onion’d witchery is this?

—Otto Büchstein, Ser Jaramey Slizzard

Assets, and flawed assets

What is the big deal about this, then? Well, it turns your ISDA into a “flawed asset”.

Flawed asset
/flɔːd ˈæsɛt/ (n.)

A financial asset that looks good, but thanks to a carefully buried conditions precedent, is not there when you, and more importantly, your insolvency administrator, most wants it.

In the language of financial obligations, the right to future payments under a contract is an asset. The creditor owns that right and, all other things being equal, can deal with it — that is, sell or raise money against it — the same way it can sell or mortgage a house, car, a portfolio of equities, or some decentralised cryptographic tokens representing abstract capital.

Assets have certain “ontological” properties, such as continuity in time and space. They might rust, depreciate, go out of fashion or stop working properly but they are nevertheless, existentially, still there. While you own them they therefore have some value to you, however parlous the state of your affairs might otherwise be.

Should your stars line up so that some official comes to be drawing up a closing account of your earthly financial existence — should you become bankrupt, heaven forfend — your assets can reliably be popped onto the “plus” side of the ledger. The difficulty subsists in working out what they are worth, but at least they are there.

This continuity is important to the administration of failing enterprises wherever they are based. It is a rude shock to find the assets you thought were there have without good explanation, gone. Many countries have rules preventing company managers from selling or giving away assets at an undervalue or otherwise granting unfair preferences as impending disaster looms. And nor can they enter contracts, even in times of fair weather, which would have the effect of granting unfair preferences, or depriving other creditors, should the clouds roll in.

An asset that doesn’t have that quality of continuity: that suddenly isn’t there, or that has the unnerving quality of winking in and out of sight at inopportune moments — is thus somehow imperfect: “flawed”.

Section 2(a)(iii) seems to have that effect on a Defaulting Party’s claims under an ISDA — its asset. Just when the Defaulting Party goes insolvent or fails to perform, the Non-defaulting Party is entitled to suspend the performance of its obligations without terminating the Transaction. Not entitled, even — as we will see, it just happens.

Should the Defaulting Party then cure the default, the Transaction resumes and the Non-defaulting Party must resume all its obligations, including the suspended ones. But for so long as the default is not cured, the Non-defaulting Party does not have to do anything. The Defaulting Party is left hanging there, with this “flawed asset”.

Insolvency regimes: not keen.

The United States Bankruptcy Code renders unenforceable terms terminating or modifying a contract that are triggered by the simple fact of insolvency proceedings. These are known as “ipso facto” clauses, because the simple fact of bankruptcy “in itself” triggers the clause.

If Section 2(a)(iii) were an ipso facto clause, it would not be enforceable. Whether it is an ipso facto clause is a subject of vigorous but tiresome debate. For our purposes, that people don’t easily agree about it is all you need to know.

The UK has no statutory equivalent of America’s ipso facto rule, but hundreds of years ago resourceful common law judges “discovered” an “anti‑deprivation” rule to the effect that, in the honeyed words of Sir William Page Wood V.C., in Whitmore v Mason (1861) 2J&H 204:

“no person possessed of property can reserve that property to himself until he shall become bankrupt, and then provide that, in the event of his becoming bankrupt, it shall pass to another and not his creditors”.

This required some wilfulness on the bankrupt’s part and not just inadvertence or lucky hap, but still: if you set out to defeat the standing bankruptcy laws do not expect easily to get away with it.

It seems, at any rate, that Section 2(a)(iii), might resemble some kind of intended deprivation; merely crystallising one’s existing position and stopping it from going further down the Swanee, as one might do by closing out altogether, seems less likely to.

Anyway: be aware: Section 2(a)(iii) attracts insolvency lawyers.

Rationale: avoiding a cleft stick

We can have a fine time rabbiting away about the ontology of assets, but isn’t there a more basic question: why would a Non-defaulting Party, presented with a counterparty in default, ever not want to just close out?

It all comes down to moneyness.

The “bilaterality” of a swap transaction means that either party may, net, be “out of the money” — that is, it would have to pay a net sum of money were the Transaction terminated — at any time. Unless something dramatic happens, this “moneyness” is only a “notional” debt: it only becomes “due” if an Early Termination Date is designated under the Master Agreement.

So an out-of-the-money, Non-defaulting Party has a good reason not to close out the ISDA. Doing so would oblige it to crystallise and pay out a mark-to-market loss. Why should it have to do that just because a Defaulting Party has failed to perform its end of the bargain?

On the other hand, the Defaulting Party is, er, ipso facto, not holding up its end of the bargain. Just as our innocent Non-defaulting Party does not wish to realise a loss by terminating, nor does it want to have to stoically pay good money away to a Defaulting Party who isn’t paying anything back.

A cleft stick, therefore.

Section 2(a)(iii) allows our Non-defaulting Party the best of both worlds. The conditions precedent to payment not being satisfied, it can just stop performing and sit on its hands — thereby neither crystallising its ugly mark-to-market position nor pouring perfectly good money away (which is a form of drip-feeding away that mark-to-market position, if you think about it).

So much so good for the Non-defaulting Party.

But the Defaulting Party’s “asset” — its contingent claim for its in-the-money position against the Non-defaulting Party — is compromised. This, for an insolvency administrator and all the Defaulting Party’s other creditors, is a bummer. It deprives them of the “asset” represented by the Transaction.

Which events?

Exactly which default events can trigger the suspension? Under the ISDA, Events of Default and even Potential Events of Default do, but Termination Events and Additional Termination Event do not. This is because most Termination Events are softer, “Hey look, it’s no one’s fault, it’s just one of those things” kind of events. This is not usually true of Additional Termination Events, though: they tend to be credit-driven, and girded with more “culpability” and “event-of-defaulty-ness”. So this is a bit dissonant, but there are far greater dissonances, so we park this one and carry on.

JC has seen valiant efforts to insert Additional Termination Events to section 2(a)(iii), and Potential Additional Termination Event, a class of things that does not exist outside the laboratory, and must therefore be defined. All this for the joy of invoking a clause that is highly unlikely to ever come into play, and which makes little sense in the first place.

Why the ISDA?

Herculio: All well-meant, good Triago. Be not sour —
These are not grapes.
Triago: Indeed not sir: rather, scrapes.
And scars and knocks — the job-lot doggedly sustained.
Herculio: (Aside) Some more than others. The odd one feigned.
But come, Sir Tig: what unrests you here?
Triago (waving paper): A tract from a brother clerk in America.
Herculio: Cripes abroad. Grim tidings?
Triago: Forsooth: it wears the colours of a fight.
A word-scape stain’d with tightly kernèd face
And girded round with fontish weaponry.
Herculio (inspecting the document): Verily, convenantry this dark
Speaks of litiginous untrust.
—Otto Büchstein, Die Schweizer Heulsuse

Why, then, is this flawed assets business special to ISDA? Is it special to ISDA?

Normal financing contracts are, by nature, one-sided. Loans, for example. One party — the dealer, broker, bank: we lump these various financial service providers together as The Man — provides services, lends money and “manufactures” risk outcomes; the other — the customer — consumes them.

So, generally, the customer presents risks to The Man, and not vice versa. If the customer fails, it can’t repay its loan. All the “fontish weaponry” is therefore pointed at the customer.

Though the ISDA is also a “risk creation contract” with these same characteristics, it is not designed like one. Either party can be out of the money, and either party can blow up. The fontish weaponry points both ways.

This presented dealers with an unusual scenario: what happens if you blow up when I owe you money? That could not happen in a loan. It is less likely to happen under a swap these days, too, thanks to the arrival of mandatory variation margin — that is one of JC’s main objections — but the ISDA Master Agreement was forged well before this modern era.

There is an argument the flawed asset clause wasn’t a good idea even then, but a better one that it is a bad idea now, but like so many parts of this sacred, blessed form it is there and, for hundreds and thousands of ISDA trading arrangements, we are stuck with it.

Developments between editions

“...a condition precedent for the purpose of this Section 2(a)(iii) ...”

The 2002 ISDA trims back the third limb of Section 2(a)(iii) from “all other conditions precedent” to just those that specifically say they mean to be caught by Section 2(a)(iii). This a sensible restriction in scope as far as it goes (but JC would go further and remove Section 2(a)(iii) altogether).

We have heard the argument advanced — apparently on the authority of that FT book about derivatives — that this restricted third limb somehow conditions the other conditions precedent in the clause (i.e., that there is no ongoing PEOD or EOD and that the Transaction has not already been terminated):

Section 2(a)(iii)(3) makes clear that if people want to stipulate any condition precedent other than the standard ones in Section 2(a)(iii)(1) and (2) they must clearly add the wording that the relevant condition will be “a condition precedent for the purposes of Section 2(a)(iii)”. ... Effectively this narrows the scope of the corresponding provision of the 1992 Agreement where no such statement was necessary.

It plainly does not, and nor do we see how you could read the FT book as making that argument. The extreme looseness of 2(a)(iii) imported by any notified breach of the agreement, however technical, being a Potential Event of Default, remains.

“No Early Termination Date ... has occurred”...

New in the 1992 ISDA was the second condition precedent, that “...no Early Termination Date in respect of the relevant Transaction has occurred or been effectively designated”.

This is tidy-up material to bring triggered Termination Events into scope. There is a period between notice of termination and when the Early Termination Date is actually designated to happen — and in a busy ISDA it could be a pretty long period — during which time the Transaction is still on foot and going, albeit headed inexorably at a brick wall. Template:Isda 2(a)(iii) gen Template:Isda 2(a)(iii) detail

Subsection 2(b)

Comparison between versions

But for the new definition of Scheduled Settlement Date in the 2002 ISDA, the 1992 ISDA text is formally the same.

Discussion

ISDA’s crack drafting squad™ phoning it in, we are obliged to say, and not minded to make any better a job of it when given the opportunity to in 2002. On the other hand, in this time of constant change, it is reassuring to know some things just stay the same. Template:M gen 2002 ISDA 2(b) Template:M detail 2002 ISDA 2(b)

Subsection 2(c)

Comparison between versions

The 2002 ISDA introduces the concept of Multiple Transaction Payment Netting, thereby correcting a curiously backward way of applying settlement netting.

Discussion

Section 2(c) is about “settlement” or “payment” netting — that is, the operational settlement of offsetting payments due on any day under the normal operation of the Agreement — and not the more drastic close-out netting, which is the Early Termination of all Transactions under Section 6.

If you want to know more about close-out netting, see Single Agreement and Early Termination Amount.

We wonder what the point of this section is, since settlement netting is a factual operational process for performing existing legal obligations, rather than any kind of variation of the parties’ rights and obligations. If you owe me ten pounds and I owe you ten pounds, and we agree to both keep our tenners, what cause of action arises? What loss is there? We have settled our existing obligations differently.

To be sure, if I pay you your tenner and you don’t pay me mine, that’s a different story — but then there is no settlement netting at all. The only time one would wish to enforce settlement netting it must, ipso facto, have happened, so what do you think you’re going to court to enforce?

Transaction flows and collateral flows

In a fully margined ISDA Master Agreement, all other things being equal, the termination of a Transaction will lead to two equal and opposite effects:

• A final payment or exchange under the Transaction having a value more or less equal to the present value of that Transaction;
• A offsetting change in the Exposure under the CSA in exactly the same value.

The strict sequence of these payments ought to be that the Transaction termination payment goes first, and the collateral return follows, since it can only really be calculated and called once the termination payment has been made.

I know what you’re thinking. Hang on! that means the termination payer pays knowing this will increase its Exposure for the couple of days it will take for that collateral return to find its way back. That’s stupid!

What with the regulators’ obsession minimise systemic counterparty credit risk, wouldn’t it be better to apply some kind of settlement netting in anticipation, to keep the credit exposure down?

Now, dear reader, have you learned nothing? It might be better, but “better” is not how ISDA documentation rolls. The theory of the ISDA and CSA settlement flows puts the Transaction payment egg before the variation margin chicken so, at the moment, Transaction flows and collateral flows tend to be handled by different operations teams, and their systems don’t talk. Currently, the payer of a terminating transaction has its heart in its mouth for a day or so.

Industry efforts to date have been targeting at shortening the period between the Exposure calculation and the final payment of the collateral transfer.
Template:M detail 2002 ISDA 2(c)

Subsection 2(d)

Comparison between versions

Other than an “on or after the date on which” embellishment towards the end of the clause, exactly the same text in the 1992 ISDA and the 2002 ISDA.

Discussion

Section 2(d) does the following:

• Net obligation: if a counterparty suffers withholding it generally doesn’t have to gross up – it just remits tax to the revenue and pays net.
• Refund obligation where tax subsequently levied: if a counterparty pays gross and subsequently is levied the tax, the recipient must refund an equivalent amount to the tax.
• Indemnifiable Tax: the one exception is “Indemnifiable Tax” - this is tax arises as a result of the payer’s own status vis-à-vis the withholding jurisdiction. In that case the payer has to gross up, courtesy of a magnificent quintuple negative.

Stamp Tax reimbursement obligations are covered at 4(e), not here.

News from the pedantry front

Happy news, readers: we have a report from the front lines in the battle between substance and form. The JC asked no lesser a tax ninja than Dan Neidle — quietly, the JC is a bit of a fan — the following question:

In the statement, “X may make a deduction or withholding from any payment for or on account of any tax” is there any difference between “deducting” and “withholding”?

They seem to be exact synonyms.

Likewise, “for” vs. “on account of”?

We are pleased to report Mr N opined replied:

I don’t think there’s a difference. Arguably it’s done for clarity, because people normally say “withholding tax” but technically there’s no such thing — it’s a deduction of income tax.

Which is good enough for me. So all of that “shall be entitled to make a deduction or withholding from any payment which it makes pursuant to this agreement for or on account of any Tax” can be scattered to the four winds. Henceforth the JC is going with:

X may deduct Tax from any payment it makes under this Agreement.

Section 3

Section 3 in a nutshell

3. Representations
Each party makes the representations below (with Section 3(g) representations only if specified in the Schedule) and repeats them on the date it enters into each Transaction and, for Section 3(f) representations, at all times until they terminate this Agreement). Any “Additional Representations” will be made and repeated as specified.
3(a) Basic Representations

3(a)(i) Status. It is duly organised and validly existing under the laws of its jurisdiction and is, where relevant, in good standing;

3(a)(ii) Powers. It has the power to execute, deliver and perform this Agreement and any Credit Support Document to which it is a party and has done everything needed to do so;

3(a)(iii) No Violation or Conflict. Its entry into and performance of this Agreement is not contrary to law, its constitutional documents, or any court or government order or contractual restriction affecting it or its assets;

3(a)(iv) Consents. It has all regulatory approvals needed to enter and perform this Agreement and any Credit Support Document to which it is a party and they remain unconditional and in full force; and

3(a)(v) Obligations Binding. Its obligations under this Agreement and any Credit Support Document to which it is a party are its legal, valid and binding obligations, enforceable in accordance with their terms (subject to general laws affecting creditors’ rights and equitable principles).

3(b) Absence of Certain Events. No Event of Default or Potential Event of Default or, to its knowledge, Termination Event is in existence for that party or would happen if it entered or performed this Agreement or any Credit Support Document.
3(c) Absence of Litigation. There is no pending or threatened litigation against it, any Credit Support Providers or any Specified Entities before any court or government agency that could affect the legality, enforceability or its ability to perform this Agreement or any Credit Support Document.
3(d) Accuracy of Specified Information. The Specified Information designated as being subject to this Section 3(d) representation is, as at its stated date, materially accurate and complete.
3(e) Payer Tax Representation. Each of its Payer Tax Representations specified in the Schedule is true.
3(f) Payee Tax Representation. Each Payee Tax Representation it has made to which this Section 3(f) applies (as specified in the Schedule) is true.
3(g) No Agency. It is a principal and not an agent under this Agreement.

Comparison between versions

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

As the comparisons above illustrate the Representations have remained largely intact since the 1987 ISDA.

There is no “No Agency” representation in the 1992 ISDA or the 1987 ISDA. A fun part of the ritual of negotiating a 1992 ISDA always was — in America, we imagine, still is — to put one in, so when those kill-joys on ISDA’s crack drafting squad™ shunted one into the 2002 ISDA it will have ruined a few people’s days — so much so that, in some quarters, they still use the 1992 ISDA as a standard. Americans, for example.

A JC digression, if I may. The 2002 ISDA was published now over two decades ago. Since 1992, a great deal has happened which the derivatives industry has learned from: the Internet; email; Enron, LTCM, the Russian Crisis, the GFC, the LIBOR scandal, COVID, the rise and fall of asset classes, cryptocurrencies and artificial intelligence (... yes and they are sure to rise again, and crush us all. Keep holding your breath). Nevertheless, we are stuck in our ways. Not only has the 2002 ISDA not been updated, or even had an update proposed, large parts of the derivatives market — and the most sophisticated, heavy-hitting parts of that market, what is more: the American parts — still trade on the 1992 Master Agreement.

We mention this not to make fun of Americans, or the derivatives industry more generally, however they richly deserve it — we do plenty enough of that in these pages as it is — but to temper the expectations of those who think anything is going to change any time soon. There are far too many vested, rent-seeking interests in things chuntering along just how they are for anyone to be seriously confronted with the idea of having to adopt anything new. Allen Farrington might claim that Bitcoin fixes a lot of things: it does not fix this.

Discussion

If you want any special extra Representations over and above the boring ones in Section 3, stick them in Part 5 of the Schedule, or maybe a master confirmation, be sure to label them “Additional Representations” and, if the fancy catches you, have the representor deem them repeated on the commencement of any new Transaction, the anniversary of the ISDA Master Agreement or whenever, in a moment of weakness, insecurity or indolence, your operations team feels like reaching out to the counterparty and asking it to say them again. They’ll love you for it.

Yes, Misrepresentation is an Event of Default

A breach of any of these Representations when made (or deemed repeated) (except a Payer or Payee Tax Representation, but including any Additional Representation is an Event of Default. Eventually.

Additional Representations as Additional Termination Events

In the case of Additional Representations this can be somewhat drastic, especially if your Additional Representation is Transaction-specific (for example India, China and Taiwan investor status reps for equity derivatives), and it would seem churlish to close out a whole ISDA Master Agreement on their account.

Then again, show me a swap dealer who would detonate an entire swap trading relationship with a solvent counterparty and I’ll show you a moron — but, as we know, opposing legal eagles operate on the presumption that everyone else is a moron and thus tend to be immune to such grand rhetorical flourishes, and regard such appeals to basic common sense as precisely such flourishes, so don’t expect that argument to carry the day, however practically true it may be.

Instead, expect to encounter leagues of agonising drafting, but there are easier roads to travel. Try:

These representations will be Additional Representations, except that where they prove to be materially incorrect or misleading when made or repeated it will not be an Event of Default but an Additional Termination Event, where the Transactions in question are the Affected Transactions and the misrepresenting party is the sole Affected Party.

Subsection 3(a)

Comparison between versions

The Section 3(a) Basic Representations survived intact, to the last punctuation mark, between the 1992 ISDA and the 2002 ISDA. They were that excellent.

Discussion

An observant negotiator (is there any other kind?) handling a 1992 ISDA might wish to add a new agency rep as Section 3(a)(vi). In 2002, ISDA’s crack drafting squad™ obviously thought this was such a good idea that they added a brand-new “no-agency” rep to the 2002 ISDA, only they can’t have felt it was basic enough to go in the Basic Representations, so they put it in a new clause all by itself at Section 3(g).

But you don’t need a bespoke “no-agency” rep if you’re on a 2002 ISDA, if that’s what you’re wondering.

3(a)(v) Obligations Binding

“any Credit Support Document to which it is a party”: Business at the front; party at the back.

Now given that a Credit Support Document will generally be a deed of guarantee, letter of credit or some other third party form of credit assurance from a, you know, third party to which a Party in whose favour it is provided will not be a “party” — and no, an 1995 CSA is not a Credit Support Document, however much it might sound like one, one might wonder what the point would be of mentioning, in this sub-section, Credit Support Documents to which a Party is party.

Well — and this might come as a surprise if you’re an ISDA ingénue; old lags won’t bat an eyelid — there isn’t much point.

But does anyone, other than the most insufferable pedant, really care? I mean why would you write a snippy wiki article about some fluffy but fundamentally harmless language unless you were a stone-cold bore?

Hang on: Why are you looking at me like that?

Subsection 3(b)

Comparison between versions

No change from 1992 ISDA to 2002 ISDA.

Discussion

Can you understand the rationale for this representation? Sure.

Does it do any practical good? No.

It is a warranty, not a representation

A standard, but useless, contractual warranty. It can’t be a pre-contractual representation, of course, because the very idea of an “event of default” depends for its intellectual existence on the conclusion of the contract in which it is embedded. So, it won’t really do to argue there should be no contract, on grounds of the false representation that a contract that does not exist has not been breached.

It is paradoxes all the way down

A No EOD rep is a classic loo paper rep: soft, durable, comfy, absorbent — super cute when a wee Labrador pub grabs one end of the streamer and charges round your Italian sunken garden with it — but as a credit mitigant or a genuine contractual protection, only good for wiping your behind on.

Bear in mind you are asking someone — on pain of them being found in fundamental breach of contract — to swear to you they are not already in fundamental breach of contract. Now, how much comfort can you genuinely draw from such promise? Wouldn’t it be better if your credit team did some cursory due diligence to establish, independently of the say-so of the prisoner in question, whether there are grounds to suppose it might be in fundamental breach of contract?

Presuming there are not — folks tend not to publicise their own defaults on private contracts, after all — the real question here is, “do I trust my counterparty?” And to that question, any answer provided by the person whose trustworthiness is in question, carries exactly no informational value. All cretins are liars.

So, let’s say it turns out your counterparty is lying; there is a pending private event of default it knew about and you didn’t. Now what are you going to do? Righteously detonate your contract on account of something of which by definition you are ignorant?

Have fun, counsellor.

“...or potential event of default”

Adding potential events of default is onerous, especially if it is a continuous representation, as it deprives the representor of grace periods it has carefully negotiated into its other payment obligations. Yes, it is in the ISDA Master Agreement.

“... or would occur as a result of entering into this agreement”

A curious confection, you might think: what sort of event of default could a fellow trigger merely by entering into an ISDA Master Agreement with me? Well, remember the ISDA’s lineage. It was crafted, before the alliance of men and elves, by the Children of the Woods. They were a species of pre-derivative, banking people. It is possible they had in mind the sort of restrictive covenants a banker might demand of a borrower with a look of softness about its credit standing: perhaps a promise not to create material indebtedness to another lender, though in these enlightened times that would be a great constriction indeed on a fledgling enterprise chasing the world of opportunity that lies beyond its door.

So, does a swap mark-to-market exposure count as indebtedness? Many will recognise this tedious question as one addressed at great length when contemplating a Cross Default: Suffice, here, to say that an ISDA isn’t “borrowed money” as such, but a material swap exposure would have the same credit characteristics as indebtedness. But in these days of compulsory variation margin you wouldn’t expect one’s mark-to-market exposure to be material, unless something truly cataclysmic was going on intra-day in the markets.

Much more likely is a negative pledge, and while an unsecured, title-transfer, close-out netted ISDA might not offend one of those, a Pledge GMSLA might, and a prime brokerage agreement may well do.

But still, nonetheless, see above: if it does, and your counterparty has fibbed about it, all you can do is get out your tiny violin. Template:M detail 2002 ISDA 3(b)

Subsection 3(c)

Comparison between versions

Section 3(c) was one of the bits of the 1992 ISDA that ISDA’s crack drafting squad™ “got mostly right” at the first time of asking. But still, some bright sparks on the ’Squad took it upon themselves, in the 2002 ISDA, to switch out reference to “Affiliates” which — I don’t know, might take in some distant half-bred cousin you don’t enormously care about and who doesn’t cast any real shadow on your creditworthiness — with “Credit Support Providers” and “Specified Entities” who no doubt more keenly do, but this leads to just more fiddliness in the Schedule over-stuffed with fiddliness, since one must then go to the trouble of specifying, and then arguing with your counterparties about, who should count as a Specified Entity for this remote and rather vacuous purpose.

Keeps the home fires burning in the hobbity shires where ISDA negotiators make their homes, we suppose.

Discussion

Reference to Affiliates can be controversial, particularly for hedge fund managers.

More generally, absence of litigation is a roundly pointless representation, but seeing as (other than unaffiliated hedge fund managers) no-one complains about it, it is best to just leave well alone.

Absence of litigation generally

An absence of litigation representation seeks to address litigation carrying two particular risks:

• Enforceability: Litigation that could somehow undermine or prejudice the very enforceability of life was we know it (a.k.a the agreement you are presently negotiating);
• Credit deterioration: Litigation that is so monstrous in scope that it threatens to wipe your counterparty from the face of the earth altogether, while it still owes you under the agreement you’re negotiating.

Enforceability-threatening litigation

Firstly, Earth to Planet ISDA: what kind of litigation or regulatory action — we presume about something unrelated to this agreement since, by your theory, it doesn’t damn well exist yet — could adversely impact in the enforceability of this future private legal contract between one of the litigants and an unrelated, and ignorant, third party?

Search me. But still, I rest assured there will an ISDA boxwallah out there somewhere who could think of something.

Existentially apocalyptic litigation

Look, if your counterparty is banged up in court proceedings so awful to behold that an adverse finding might bankrupt it altogether, and your credit sanctioning team hasn’t got wind of it independently then, friend, you have way, way bigger problems than whether you have this feeble covenant in your docs. And, if you are only catching it at all thanks to a carelessly given absence of litigation rep, by the time said litigation makes itself known to you. won’t it be a bit late?

Deemed repetition

Ah, you might say, but what about the deemed repetition of this representation? Doesn’t that change everything?

Deemed repetition

What of this idea that one not only represents and warrants as of the moment one inks the paper, but also is deemed to repeat itself an the execution of each trade, on any day, or whenever a butterfly flaps its wings on Fitzcarraldo’s steamer? Do we think it works? Do we? Given how practically useless even explicit representations are, does it really matter?

And, having given it, how are you supposed to stop a continuing representation once it has marched off into the unknowable future, like one of those conjured brooms from the Sorcerer’s Apprentice? If you don’t stop it, what then? This may seem fanciful to you, but what are buyside lawyers if not creatures of unlimited, gruesome imagination? Are their dreams not full with flights of just this sort of fancy? Rest assured that, as you do, they will be chewing their nails to the quick in insomniac fever about this precise contingency.

For which reason — it being a faintly pointless representation in the first place and everything — it might be best just to concede this point when it arises, as inevitably it will.

Pick your battles

All that said, and probably for all of the above reasons, parties tend not to care less about this representation, so your practical course is most likely to leave it where you find it. Template:M detail 2002 ISDA 3(c)

Subsection 3(d)

Comparison between versions

ISDA’s crack drafting squad™ must have got this spot-on in their first attempt in 1992, because their successors in 2002 could not find so much as an inverted comma to change.

Discussion

The fabulous Section 3(d) representation, giving one’s counterparty the right to close out should any so-designated representations turn out not to be true. This is sure to occupy an inordinate amount of your negotiation time — in that it occupies any time at all — because you are as likely to be hit in the face by a live starfish in the Gobi Desert as you are to close out an ISDA Master Agreement because your counterparty is late in preparing its annual accounts. But that’s a personal view and you may not rely on it.

The 3(d) representation, in the documents for delivery table in the Schedule, therefore covers only the accuracy and completeness of Specified Information and not (for example) whether Specified Information is delivered at all. For that, see Section 4(a) - Furnish Specified Information.

“Covered by the Section 3(d) Representation”

If one is required to “furnish” Specified Information under Section 4, two things can go wrong:

No show: One can fail to provide it, at all, in which case there is a Breach of Agreement, but be warned: the period before one can enforce such a failure, judged by the yardstick of modern financial contracts, is long enough for a whole kingdom of dinosaurs to evolve and be wiped out; or

It’s cobblers: One can provide the Specified Information, on time, but it can be a total pile of horse ordure. Now, here is a trick for young players: if your Specified Information is, or turns out to be, false, you have no remedy unless you have designated that it is “subject to the Section 3(d) representation”. That is the one that promises it is accurate and not misleading.

Might Section 3(d) not cover a representation?

Now you might ask what good an item of Specified Information can possibly be, if Section 3(d) didn’t apply and it could be just made up on the spot without fear of retribution — as a youngster, the JC certainly asked that question, and has repeated it over many years, and is yet to hear a good answer — but all we can presume is that in its tireless quest to cater for the unguessable predilections of the negotiating community, ISDA’s crack drafting squad™ left this preposterous option open just in case. It wouldn’t be the first time.

Legal opinions, and Credit Support Documents

A trawl through the SEC’s “Edgar” archive reveals that the sorts of things to which “Covered by Section 3(d) Representation” results in a “No” outcome are rare — but not non-existent. It is things like “Legal opinion from counsel concerning due authorization, enforceability and related matters, addressed to the other party and reasonably acceptable to such other party”, or “Credit Support Documents”.
See further discussion in the sections below.

Annual reports

The other little fiddle — and it is a little fidgety fiddle — is to remark of annual reports that, yes, they are covered by that Section 3(d) representation, but with a proviso:

“Yes; provided that the phrase “is, as of the date of the information, true, accurate and complete in every material respect” in Section 3(d) shall be deleted and the phrase “fairly presents, in all material respects, the financial condition and results of operations as of their respective dates and for the respective periods covered thereby” shall be inserted in lieu thereof.”

More on “covered by the Section 3(d) Representation”

We went digging a little deeper. These are the only examples we could find before we got bored looking. In each case we are not persuaded these caveats accommodate anyone other than our value-adding learned friends:

Legal opinions

Should a legal opinion issued by a third party who is not party to the agreement, or even affiliated with it, have to be true in the Section 3(d) sense?

The predictable response is for the counterparty to say, “look: I’m not a lawyer, okay, so it can hardly be on me if the legal advice I get in good faith happens to be wrong?” We suppose this is excluded because the Party to the ISDA is not the author of the legal opinion, nor professionally competent to pass on its contents (hence the need for the legal opinion in the first place), so should hardly be expected to be held to account for it.

This may be expressed to you, dissonantly, in the honeyed prose of a private practice lawyer — a vernacular foreign to most ISDA negotiators. You may wonder whether it has not been disingenuously spoon-fed to your counterpart by just such a fellow. We will not speculate. But we will observe that, while it may seem compelling at first, it is bad logic. It presumes that what matters is the probity with which a counterparty conducts itself; that it acts in good faith and with a benign disposition; that its “good chapness” —the basic honesty it shows when dealing with its market counterparties — is beyond reproach.

But this, we submit, is to misunderstand in a profound way the point of a commercial contract. There are no ethicists in a foxhole. Unlike criminal or even tort law, the law of contract is not an instrument of moral judgment. It cares only about economics: that one does, or does not, do what one has promised or — as in this case — that what one has represented to you is, or is not, true. The law of contract is broadly incurious about why.

What matters is the economic consequence of a falsity — the actus reus, not one’s mens rea. The object of a legal opinion is to confirm the accuracy of a legal representation. Instead of simply representing that, for example, you have the regulatory permission to act as a swap dealer, you have a legal opinion to confirms that fact, from one who should know.

Now, if I have engaged in a trading arrangement with you on the presumption that you are appropriately permissioned, licenced, and constitutionally able to enter into valid and binding swap contracts, and you satisfy my qualms by proffering the legal opinion of some respectable attorney-about-town you have found who will say it is so, and that attorney turns out to be wrong, my commercial position is no less parlous just because you weren’t to know your legal advisor was a clot. Regardless of whose fault it was, or how egregious was her negligence in being at fault, if the required regulatory permission does not exist, the comfort I seek is misplaced. I now have a portfolio of swaps which may not be enforceable. My claims may be suspended at any minute.

I want out before that can happen. I might wish you well, and bitterly regret it were not otherwise, but it is not otherwise. I need out. If that causes you some embarrassment, inconvenience or financial loss, then the person to whom you should look for redress is your lawyer.

Not for the first time, the “market standard,” for no reason other than it is a legal question and there is no-one else around qualified to gainsay it, is crafted to suit the personal interests of the opining legal community. Have no truck with this, fellows.

Credit Support Documents

We imagine here the perceived fear is that a Credit Support Document, being an executed legal contract, does not have a truth or falsity independent of itself the bargain it represents and evidences, so cannot really be a misrepresentation. But in a funny sense a legal contract constitutes the agreement it evidences: sure; the legal accord is an immaterial, intellectual thing, a consensus ad idem that inhabits the incarcerated space that separates us, and it cannot be fully delimited by mortal, combustible paper. But all the same, its written form can hardly contradict it. If the written agreement incontrovertibly says “I must go up” our legal compact can hardly require me to go down; the paper format surely constrains what one can take from, or give to, a contract.

That being the case, there is not really a meaningful sense in which a contract can “misrepresent” the actual accord it represents. or be “false”. There is something faintly, but elusively, paradoxical about this.

What might happen is that a counterparty submits a form that has been superseded, or terminated and thus is but a husk of an ex-contract; one that once existed but now does not. Alternatively, a truly mendacious counterparty might offer up a form that is not really a contract, or even evidence of one, at all: a forgery, or a fraud.

But in those cases, the operating cause of the falsehood is the party submitting the document, not the document offered by way of representation itself, and in each an innocent party is better protected if Section 3(d) Representation does apply.

Audited financial statements

Your adversary may try to crowbar in something like this, to satisfy her yen to make a difference and please her clients with her acumen and commercial fortitude:

“or, in the case of financial information, a fair representation of the financial condition of the relevant party, provided that the other party may rely on any such information when determining whether an Additional Termination Event has occurred.”

This is predicated on the following reasoning: “In publishing the audit, the auditor itself is not making any greater representation than that the statements are a fair representation of the financial conditions. I’m no accountant. I didn’t even write the stupid audit. How am I supposed to know? Why should I give any representation about the content of the audit at all, let alone a stronger representation than the expert? I am not underwriting the work of some bean-counter at Deloitte.”

Fair questions, but they misapprehend what is being asked. The riposte is this: The Part 3 information you must supply is “Party B’s annual audited financial statements.” So the representation we are after is that you have handed over a fair, accurate and complete copy of those audited statements, not that the statements themselves, as prepared by the auditor, are necessarily fair, accurate and complete. To get that comfort, we have the auditor’s own representation of the company’s financial condition, and we don’t need yours.

Not providing documents for delivery is an Event of Default ... eventually

The importance of promptly sending required documents for delivery goes as follows:

• By dint of Section 4(a) you agree to furnish each other Specified Information set out in Part 3 of the Schedule.
• By dint of Section 5(a)(ii) if you don’t then that can be a Breach of Agreement Event of Default (Section 5(a)(ii)). Be warned: you must pursue a tortured chain of nested double negatives and carefully parse the interplay between Sections 4(a) and 5(a)(ii) to grasp this, but it is true.
• But, Section 5(a)(ii) imposes a thirty freaking day grace period following notice before a Breach of Agreement counts as an Event of Default allowing termination. (A Failure to Pay or Deliver is excluded from that definition, by the way, because it has its own EOD with a much tighter grace period).
• So if you need a document “furnished” urgently and can’t wait a month for it (you might not, if you are a credit officer and it is a monthly NAV statement, for example) then you must upgrade a simple 5(a)(ii) Breach of Agreement to a full-blown Additional Termination Event.
  

Subsection 3(e)

Comparison between versions

No change between Section 3(e) of the 1992 ISDA and Section 3(e) of the 2002 ISDA. To be fair, what’s there to change?

Discussion

You’ll find the usual form of the Payer Tax Representations in Part 2(a) of the Schedule. They aren’t usually amended.

Withholding under the ISDA

TL;DR: The basic rationale is this:

• if the tax relates to the underlying instrument, rather than the Payer’s residence or tax status, the Payer does not have to gross up.
• if the tax relates to the Payer’s residence or tax status, then the Payer does have to gross up unless the Payee should have provided information to the Payer which would have entitled the Payer to avoid the tax.
• if you’ve agreed the FATCA Amendment, the Payer doesn’t have to gross up any FATCA Withholding Taxes.

The combination of the Payer Tax Representations and the Gross-Up clause of the ISDA Master Agreement has the following effect:

• Section 3(e): I promise you that I do not have to withhold on my payments to you (as long as all your Payee Tax Representations are correct and you have, under Section 4(a), given me everything I need to pay free of withholding);
• Section 2(d): I will not withhold on any payments to you. Unless I am required to by law. Which I kind of told you I wasn’t... If I have to withhold, I'll pay the tax the authorities and give you the receipt. If I only had to withhold because of my connection to the taxing jurisdiction (that is, if the withholding is an Indemnifiable Tax), I’ll gross you up. (You should look at the drafting of Indemnifiable Tax, by the way. It's quite a marvel). ...
• Gross-Up: Unless the tax could have been avoided if the Payee had taken made all its 3(f) representations, delivered all its 4(a) material, or had its 3(f) representations been, like, true).
• Stamp Tax is a whole other thing.
• As is FATCA, which (as long as you’ve made your FATCA Amendment or signed up to a FATCA Protocol, provides that FATCA Withholding Taxes are excluded from the Section 3(e) Payer Tax Representations, and also from the definition of Indemnifiable Tax. Meaning one doesn't have to rep, or gross up, FATCA payments.

Subsection 3(f)

Comparison between versions

No change between the 1992 ISDA and the 2002 ISDA.

Discussion

US Payee Tax Representations

The required Payee Tax Representations depend on the nature of the Counterparty.

• US Person: Counterparty is a “U.S. person” for the purposes of the Internal Revenue Code of 1986 as amended.
• US Corporation: It is classified as a US Corporation for United States federal income tax purposes.
• Foreign Person: It is a “foreign person” for United States federal income tax purposes.
• Non-US Branch of Foreign Person: Each branch is a non-US branch of a foreign person for US federal income tax purposes
• Non-Withholding Partnership:It is classified as a “non-withholding foreign partnership” for United States federal income tax purposes.
• Connected Payments: Each payment received or to be received by it under this Agreement will be effectively connected with its conduct of a trade or business within the United States.
• Non-Connected Payments: Each such payment received or to be received by it in connection with this Agreement will not be effectively connected with its conduct of a trade or business in the United States
• Tax Treaty Benefits: It is fully eligible for the benefits of the “Business Profits” or “Industrial and Commercial Profits” provision, the “Interest” provision or any “Other Income” provision of the Income Tax Convention between the United States and Counterparty’s Jurisdiction* with respect to any payment described in such provisions and received or to be received by it in connection with this Agreement and no such payment is attributable to a trade or business carried on by it through a permanent establishment in the United States.
• Public International Organisation: It is a public international organization that enjoys the privileges, exemptions and immunities as an international organization under the International Organizations Immunities Act (22 U.S.C. 288-288f).
• Withholding and Reporting: It will assume withholding and reporting for any payments (or portions of any payments) determined to be non-Effectively Connected income for United States federal income tax purposes.
• Monetary Policy: Its primary purpose for entering into this Agreement is to implement or effectuate its governmental, financial or monetary policy.

Subsection 3(g)

Comparison between versions

Section 3(g) is the spiritual successor to Section 3(a)(vi), the added representation that parties habitually tack on to the end of Section 3(a). ISDA’s crack drafting squad™ kind of made an honest clause out of it in the 2002 ISDA.

Discussion

If you like a bit of agency chat, you might like our articles about principals and agents, undisclosed agents, undisclosed principals and all that good stuff.

Investment managers as agents

In practice, many ISDA Master Agreements are entered by agents — investment managers and asset managers (so-called “real money” managers) — on behalf of underlying principals — investment funds, and institutional clients who have appointed them as discretionary investment advisers.

These managers often enter transactions in aggregate and only allocate them to their underlying principals later in the day. This means that the broker will have a nervous few hours before it knows whom it is expected to sue if the principal doesn’t pony up on time. General principles of agency — in particular liability for an undisclosed principal —mean agents are not quite so footloose and fancy-free as many of them seem to believe.

Look, it is not the end of the world if your counterpart refuses to renounce all agency, as long as you set up the accounts correctly with the underlying principals, and the firm has a robust approach to trade allocation. Ultimately — and notwithstanding the nervous few hours pending allocation — the person against whom you are, long term, booking the trade is the principal.

Internal agency model

It is not beyond the paranoid fantasies of a US tax attorney — a rich, baroque tapestry indeed — to want to “deem” a swap counterparty to be an agent for one of its affiliates for certain — you know, tax — purposes, even though the affiliate is not mentioned in the contract and the other side has not the first clue that this affiliate even exists.

How does this bear on your Section no agency representation? As far as your counterparty is concerned, not at all: a fellow acting under an agency he has not disclosed to his counterpart is called a “principal”. This is all the no agency representation is meant to confirm: for the avoidance of doubt — of which there wasn’t much anyway — you are not acting on behalf of someone else. Therefore, should you not perform our contract, I can bring my claim against you; you cannot slip out of the tackle by pointing to some under-capitalised espievie in a banana republic I didn’t know about whom you suddenly claim to be representing. I can therefore safely instruct my credit officer that the only commercial bona fides she needs to have in mind, as she slips on her rubber gloves, are yours.

It doesn’t matter whether the agency arrangement exists or not: either way, you are liable, as a principal, to me, it is your problem to recover any money you may be owed by your man in Havana.

Now whether such a representation undermines the fantastical aspirations of your tax attorney, on the other hand, is a question only he can answer. Template:M detail 2002 ISDA 3(g)

Section 4

Section 4 in a nutshell

4. Agreements
While either party has any obligation under this Agreement or any Credit Support Document:—
4(a) Furnish Specified Information. It will deliver to the other party (or to such government or taxing authority as it reasonably directs):—

(i) any tax documents specified in the Schedule or any Confirmation;

(ii) any other documents specified in the Schedule or any Confirmation; and

(iii) any other document the other party reasonably requests to minimise withholding tax on any payment (and which would not materially prejudice the provider’s position), if need be accurately completed and executed and delivered as specified in the Schedule or such Confirmation or, otherwise as soon as reasonably practicable.

4(b) Maintain Authorisations. It will use all reasonable efforts to maintain all regulatory consents and licences it needs to perform this Agreement or any Credit Support Document and will use all reasonable efforts to obtain any it may need in the future.
4(c) Comply With Laws. It will comply with all applicable laws if not doing so would materially impair its performance of this Agreement or any Credit Support Document.
4(d) Tax Agreement. It will tell the other party promptly after learning that any of its Section 3(f) representations have ceased to be accurate.
4(e) Payment of Stamp Tax. Unless incurred closing out a Transaction against a Defaulting Party (as to that, see Section 11), it will pay any Stamp Tax it incurs performing this Agreement by reason of it being in a Stamp Tax Jurisdiction, and will indemnify the other party against any such Stamp Tax that that party suffers, unless the jurisdiction in question also happens to be a Stamp Tax Jurisdiction for that other party.

Comparison between versions

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

The 1992 ISDA introduced a new 4(a)(iii) to cover such tax representations as are needed to allow Credit Support Providers to pay without withholding. Beyond that there were minimal changes between the versions, down to punctuation changes, though in Section 4(e) a clearer reference to offices and branches. So that is nice.

Discussion

A hodge-podge of “state the bleeding obvious” rules, breach of some of which justifies (eventual) close-out as a “breach of agreement” — agreeing to provide the credit information you have patiently listed in your schedule, flagrantly breaking the law, carelessly losing one’s regulatory authorisations — and random tax provisions and indemnities (providing the necessary tax forms to minimise tax, and pay tax if you don’t).

These are the dull agreements — which by and large don’t justify close-out.

Section 5

Section 5 in a nutshell

5. Events of Default and Termination Events
5(a) Events of Default
Any of the following events occurring to a party or its Credit Support Provider or Specified Entity will (subject to Sections 5(c) and 6(e)(iv)) be an “Event of Default”) for that such party:—

5(a)(i). Failure to Pay or Deliver. Failure by a party to make any payment or delivery when due under this Agreement which is not remedied by the first Local Business Day or Local Delivery Day after the party receives notice of the failure;

5(a)(ii) “Breach of Agreement” means:

(1) a party breaches any of its obligations under the Agreement and doesn’t remedy the breach within 30 days of the other party’s notice other than the following:

(a) a Failure to Pay or Deliver;

(b) owning up to a Termination Event;

(c) not providing any necessary tax documents;

(d) any of its tax representations not being true; or

(2) a party repudiates this ISDA Master Agreement or any Transaction.

5(a)(iii) Credit Support Default.

(1) The party or its Credit Support Provider defaults under any Credit Support Document after any grace period has expired;

(2) Any Credit Support Document (or any security interest granted under one) terminates or becomes ineffective (except according to its terms) while any covered Transaction without the other party’s written consent; or

(3) the party or its Credit Support Provider repudiates any obligations under Credit Support Document;

5(a)(iv) Misrepresentation. A representation (other than a Payee or Payer Tax Representation) made under this Agreement or a Credit Support Document was materially incorrect or misleading when it was made;

5(a)(v) Default Under Specified Transaction. The party or one of its Credit Support Providers or Specified Entities:―

(1) defaults on any payment due under a Specified Transaction (or any related credit support arrangement) and as a result that Specified Transaction is validly accelerated;

(2) defaults on any final payment due under a Specified Transaction after one Local Business Day;

(3) defaults on any delivery due under a Specified Transaction (or any related credit support arrangement) and, all Transactions under the relevant Master Agreement are validly accelerated; or

(4) repudiates any Specified Transaction (or any related credit support arrangement);

5(a)(vi) Cross-Default. If “Cross-Default” applies to a party, it will be an Event of Default if:

(1) any agreements it (or its Credit Support Providers or Specified Entities) has for Specified Indebtedness become capable of acceleration; or

(2) it (or its Credit Support Providers or Specified Entities) defaults on any payment of Specified Indebtedness (and any grace period expires);

And the total of the principal amounts in (1) and (2) exceeds the Threshold Amount.

5(a)(vii). Bankruptcy. A party of its Credit Support Provider or Specified Entity:―

(1) Dissolved: is dissolved (other than by merger);

(2) Insolvent: becomes insolvent, unable to pay its debts, or admits it in writing;

(3) Composition with Creditors: makes a composition with its creditors;

(4) Insolvency Proceedings: suffers insolvency proceedings instituted by:

(A) a regulator; or

(B) anyone other than a regulator, and

(I) it results in a winding up order; or

(II) those proceedings are not discharged within 15 days;

(5) Voluntary Winding Up: resolves to wind itself up (other than by merger);

(6) Put in Administration: has an administrator, provisional liquidator, or similar appointed for it or for substantially all its assets;

(7) Security Exercised: has a secured party take possession of, or a legal process is enforced against, substantially all its assets for at 15 days without a court dismissing it;

(8) Analogous events: suffers any event which, under the laws of any jurisdiction, has the same effect as any of the above events; or

(9) Action in furtherance: takes any action towards any of the above events.

5(a)(viii) Merger Without Assumption. The party (or a Credit Support Provider) merges with or transfers or all or substantially all its assets to another entity and:―

(1) the resulting entity does not assume all the original party’s obligations under this Agreement (or Credit Support Document); or

(2) the Credit Support Document does cover the resulting party’s obligations under this Agreement.

5(b) Termination Events
The events below occur to a party or its Credit Support Provider or Specified Entity (subject to Section 5(c)) it will be an Illegality (5(b)(i)); a Force Majeure Event (5(b)(ii)), a Tax Event (5(b)(iii)), a Tax Event Upon Merger (5(b)(iv)) and Credit Event Upon Merger (5(b)(v)):

5(b)(i) Illegality. Taking account of any fallbacks and remedies in the Transaction, for reasons beyond the Affected Party’s control, (not counting a lack of authorisation required under Section 4(b)), it would be illegal in any relevant jurisdiction to comply with any material term of a Transaction or Credit Support Document.

5(b)(ii) Force Majeure Event. A force majeure occurring after any Transaction is executed means:―

(1) the Affected Party’s relevant Office cannot practicably perform any obligation under the Transaction; or

(2) the Affected Party or its Credit Support Provider cannot practicably perform any obligation under the Transaction;

if the force majeure is outside the Affected Party’s control and it could not, using all reasonable efforts (without incurring more than incidental expenses by way of loss), overcome the necessary prevention;

5(b)(iii) Tax Event It will be a Termination Event when, following a change in tax law or practice after any trade date, an Affected Party is likely to have to either:

(1) Gross up an Indemnifiable Tax deduction (other than for interest under Section 9(h)); or

(2) receive a payment net of Tax which the Non-Affected Party is not required to gross up (other than where it is caused by the Non-Affected Party’s own omission or breach).

5(b)(iv) Tax Event Upon Merger. A party (the “Burdened Party”) on the next Scheduled Settlement Date will have to:

(1) Gross up an Indemnifiable Tax deduction (other than for interest under Section 9(h)); or

(2) receive payments net of Tax which are not required to be grossed up (other than where that is caused by the Non-Affected Party’s own omission or breach);

because a party has merged with, transferred substantially all of its assets into, or reorganised itself as, another entity (the Affected Party) where that does not amount to a Merger Without Assumption;

5(b)(v) Credit Event Upon Merger. If “Credit Event Upon Merger” applies and it or any of its Credit Support Providers or Specified Entities suffers a Designated Event (which is not a Merger Without Assumption) and the relevant entity’s (which will be the Affected Party) creditworthiness is materially weaker as a result.

A “Designated Event” means that the relevant entity:―

(1) merges with, or transfers substantially all of its assets into, or reorganises itself as another entity;

(2) comes under the effective voting control of another entity; or

(3) makes a substantial change in its capital structure by issuing or guaranteeing debt, equities or analogous interests, or securities convertible into them;

5(b)(vi) Additional Termination Event. If any “Additional Termination Event” is specified, the occurrence of that event (where the Affected Party will be as specified in the Confirmation or Schedule).

5(c) Hierarchy of Events

5(c)(i) As long as an event counts as an Illegality or a Force Majeure Event, it will not count as an Failure to Pay or Deliver, a non-repudiatory Breach of Agreement or the first limb of Credit Support Default.

5(c)(ii) In any other circumstances, an Illegality or a Force Majeure Event which also counts as an Event of Default or a Termination Event, will count as the relevant Event of Default or Termination Event, and not the Illegality or Force Majeure Event.

5(c)(iii) If a Force Majeure Event also counts as an Illegality, it will be treated as an Illegality and not a Force Majeure Event (unless covered by clause 5(c)(ii) above).

5(d) Deferral of Payments and Deliveries During Waiting Period. If an Illegality or a Force Majeure Event exists for a Transaction, payment and delivery obligations under that Transaction will be deferred until:―

5(d)(i) the first Local Business Day (or, for deliveries, the first Local Delivery Day) following the end of the Waiting Period for event in question; or, if earlier:

5(d)(ii) the first Local Business Day or Local Delivery Day on which the Illegality or Force Majeure Event does not exist.

Comparison between versions

These are the events that entitle you to close out some or all of your Transactions; to find out what hideous rigmarole you must go through when you have decided to do that, proceed directly to Section 6.

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)

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Discussion

This is a landing page for all the ISDA’s many and varied Events of Default. Since there are eight of them, and all of them have their own little idiosyncrasies, we have not tried to discuss individual items in great detail on this page, but have given them their own pages. These are here:

{{ISDA {{{2}}} Section 5(a) TOC}}

Here we will discuss them in the round as it were. As a collective.

Discussion

The process of closing out an ISDA following a Termination Event and not an Event of Default. There is a lengthy discussion of this here for our premium readers.

Among financing documents, The ISDA is — unique? Pioneering? Overcomplicated? — in having two types of event that can induce parties to call the whole thing off. Or parts of it.

That’s a part of the explanation: some things bring down only some transactions and not others.

Termination Events

Specific taxation and regulatory changes that affect only certain transactions or transaction types, that justify terminating those transactions, but not the whole kitten-caboodle.

And there are things that do justify bringing down the whole kitten-caboodle, but are no-one’s fault as such, just one of these regrettable things that life throws at us every now and then. Changes in tax or regulation that affect a counterparty, or both counterparties, meaning the ongoing trading relationship is not allowed, or is no longer economically efficient.

These events are “Termination Events”: they are complicated two ways: what is affected, and who is affected, which in turn determines who is entitled to call termination and, importantly calculate what is due, according to whose marks. In many cases it will be both parties, and there will be a splitting of the difference.

Events of Default

Then there are events that are someone’s “fault” — in a “banky” way: in that they generally indicate credit failure of some kind, and which necessarily bring down the whole shooting match, but only if the innocent party actually wants that. The close out calculations here are different, and a bunch of other funky ISDA tricks hang off these events too: notably the Section 2(a)(iii) flawed asset provision that allows the Non-Defaulting Party to shoulder arms and just sit there. This doesn’t apply to Termination Events, only Events of Default.

Additional Termination Events

Which leaves Additional Termination Events: bespoke events which parties negotiate into their Schedules, which behave like Termination Events despite in most cases being a lot more like Events of Default in their basic nature: they almost always address credit-impairment of some kind or other (NAV triggers, key person triggers and so on).

Section 5(a)

Events of Default can generally be contrasted with Termination Events. They tend to be more focused on the outright creditworthiness of the Defaulting Party: whether it could, even if it wanted to, perform its obligations. Termination Events on the other hand tend to be extraneous factors preventing a party from continuing the contract (Or making the contract uneconomic) even though it has the financial resources to do so.

The broad thrust of the Events of Default is:

1. Direct failures under the Master Agreement itself: Direct contraventions of the ISDA Master Agreement itself and its Transactions by one of the principals to the contract. Within here we have:
   1. Failure to Pay, which became Failure to Pay or Deliver when the cash-only 1987 ISDA gave way to the broader range of non-cash underlying assets under the 1992 ISDA;
   2. Breach of Agreement: Breach of any obligation other than a payment or delivery obligation
   3. Misrepresentation: Breach of any cross-my-heart-and-hope-to-die sort of precontractual representation made undere the contract
   4. Credit Support Default: Failure to provide collateral under a Credit Support Document. While in ordinary banking world a credit support obligation would generally be provided by someone other than a party to the contract. This is not so on Planet ISDA: (some) CSAs and CSDs are “Credit Support Documents”. So this counts as these are mainly principal obligations of the parties themselves (though of course end users will often be guaranteed).

2. Direct failures under other Agreements: Direct contraventions by parties to the ISDA Master Agreement of other contractual obligations that are sufficiently serious to make the Non-Defaulting Party freak under the ISDA Master Agreement. Within this bucket we have:

   1. Default under Specified Transaction: The Defaulting Party fails directly to the Non-Defaulting Party to perform under a swap-like transaction, only one that is not documented under the ISDA Master Agreement itself, but under a different master trading agreement;
   2. Cross Default: The Defaulting Party fails directly to the Non-Defaulting Party to perform to someone else altogether under a loan-like Transaction, over a certain Threshold Amount;

3. Unacceptable credit deterioration: The Defaulting Party or its third-party Credit Support Providers suffers a dramatic non-transactional reversal of fortunes such that the Non-Defaulting Party has credible doubts it will ever see its net in-the-money positions realised, whether or not they are currently in-the-money. Into this bucket goes:

   1. Bankruptcy: The Defaulting Party suffers one of the many different ways a merchant can go titten hoch. There are a lot of them, and they are fraught;
   2. Merger Without Assumption: The Defaulting Party is somehow taken over, reincorporated, reconstituted through a corporate event or otherwise magicked into a spiritual realm in which its earthly debts and obligations are not taken up by whomever the resulting entity is.

Events of Default by nature, speak to fundamental and time-honoured verities of the financial system, so it should not be a great surprise that they have not really changed throughout the three major versions of the ISDA Master Agreement. Honourable mention should also go to the Additional Termination Events that credit department will insist on shoehorning into the schedule in a bid to stay relevant: while these are not Events of Default as such, they tend to have a same credit-related quality to them

Practical differences between “Affected Party” and “Defaulting Party”

What is the practical, economic difference between being closed out on the same Transaction for an Event of Default and a Termination Event?

This is something that all ISDA ninjas know, or sort of intuit, in a sort of semi-conscious, buried-somewhere-deep-in-the-brain-stem kind of way, but they may mutter darkly and try to change the subject if you ask them to articulate it in simple English.

To be fair the topic might be chiefly of academic interest were it not for the unfortunate habit of the same “real world” event potentially comprising more than one variety of termination right. This leads to some laboured prioritisation in the ISDA, and sometimes some in the Schedule too. What if my Tax Event upon Merger is also a Credit Event Upon Merger and, for that matter, also a Force Majeure Event? That kind of question.

A trap for Cinderella

When adding any new Termination Event you must ALWAYS label it a new “Additional Termination Event” under Section 5(b)(vi), and not a separate event under a new Section 5(b)(vii) etc.

If, instead of being expressed as an “Additional Termination Event”, which is how the ISDA Mechanism is intended to operate, it is set out as a new “5(b)(vii)” it is not designated therefore as any of an “Illegality”, “Tax Event”, “Tax Event Upon Merger”, “Credit Event Upon Merger” or “Additional Termination Event”, so therefore, read literally, is not caught by the definition of “Termination Event” and none of the Termination provisions bite on it.

I mention this because we have seen it happen. You can take a “fair, large and liberal view" that what the parties intended was to create an ATE, but why suffer that anxiety?

A Trap for Cinderella was a baffling 2013 remake of the old French thriller Piège pour Cendrillon, by the way.

Triggering formalities in Section 6(b)

The Termination Events themselves are crafted as absolute events, without the need for notices or actions on the part of the Transaction Counterparties to activate them.

But they do not go live automatically: they must be activated by the Non-affected Party.

The formal triggering process is set out in Section 6(b) and there is an amount of pre-trigger faffery (since not all of them will be apparent to a Non-affected Party, the Affected Party must give notice and then efforts must be made to fix or avoid them before there is any question of termination) before one gets onto the actual process, which is set out in Section 6(b)(iv).

Clause-by-clause

Section 5(b)(i) Illegality

An Illegality is a Section 5(b) Termination Event — being one of those irritating vicissitudes of life that are no-one’s fault but which mean things cannot go on, and not a Section 5(a) Event of Default, being those perfidious actions of one or other Party which bring matters to an end which, but for that behaviour, ought really to have been avoided.

Note also the impact of Illegality and Force Majeure on a party’s obligations to perform through another branch under Section 5(e), which in turn folds into the spectacular optional representation a party may make under 10(a) to state the blindingly obvious, namely that the law as to corporate legal personality is as is commonly understood by first-year law students. Who knows — maybe it is different in emerging markets and former Communist states?

For the silent great majority of swap entities for whom it is not, the curious proposition arises: what is the legal, and contractual, consequence of electing not to state the blindingly obvious? Does that mean it is deemed not to be true?

If the rules change, that is beyond your control, so it can’t be helped and hence Illegality is a Termination Event not an Event of Default. The 2002 ISDA develops the language of the 1992 ISDA to cater to insomniacs and paranoiacs but does not really add a great deal of substance.

An Illegality may only be triggered after exhausting the fallbacks and remedies specified in the ISDA Master Agreement.

Waiting Period

The point of Waiting Period is, for potential scenarios that might wind up justifying termination later, but you don’t yet know that, to build in a period to wait and see. For Illegality events (Section 5(b)(i)) is three Local Business Days — it is not so likely that an Illegality will sort itself out; for a Force Majeure Event (5(b)(ii) — where insh’Allah, things will come right and everyone can eventually go back to what they were doing, it is eight Local Business Days.

Waiting Periods — as defined in the ISDA Master Agreement also sometimes show up sometimes in other booklets — for example, ISDA’s Emissions Annex.

Through the good offices of Section 5(d), payments and deliveries which otherwise would be due during a Waiting Period are suspended.

Section 5(b)(ii) Force Majeure (2002 only)

For the last word on force majeure, the JC’s ultimate force majeure clause is where it’s at. Breaking what must be a habit of a lifetime, somehow ISDA’s crack drafting squad™ managed to refrain from going crazy-ape bonkers with a definition of force majeure and instead, didn’t define it at all. In the 1992 ISDA they didn’t even include the concept.

Interlude: if you are in a hurry you can avoid this next bit.

I don’t know this, but I am going to hazard the confident hypothesis that what happened here was this:

ISDA’s crack drafting squad™, having convened its full counsel of war, fought so bloodily over the issue, over so long a period, that the great marble concourse on Mount Olympus was awash with the blood of slain legal eagles, littered with severed limbs, wings, discarded weapons, arcane references to regional variations of tidal waves, horse droppings from Valkyries etc., that there was barely a soul standing, and the only thing that prevented total final wipe-out was someone going, “ALL RIGHT, GOD DAMN IT. WE WON’T DEFINE WHAT WE MEAN BY FORCE MAJEURE AT ALL.”

There was then this quiet, eerie calm, when remaining combatants suddenly stopped; even those mortally wounded on the floor looked up, beatifically; a golden light bathed the whole atrium, choirs of angels sang and the chairperson said, “right, well that seems like a sensible, practical solution. What next then?”

“We thought we should rewrite the 2002 ISDA Equity Derivatives Definitions in machine code, your worship.”

“Excellent idea! Let’s stop faffing around with this force majeure nonsense and do that then!”

Ok back to normal.

Force Majeure in the 1992 ISDA

We may have said this before but, just because there isn’t a Force Majeure proper in the preprinted 1992 doesn’t mean people don’t borrow the concept from the 2002 — which has been around for, you know, 21 years now — and put it in anyway. One thing we can’t fathom is what possessed ISDA’s crack drafting squad™ to put it in at Section 5(b)(ii), rather than Section 5(b)(iv) just before the Additional Termination Event section, because for absolute shizzle anyone familiar with one version of the ISDA Master Agreement is going to get confused as hell if they start misunderstanding clause references in the other.

Act of state

Note the reference to “act of state”. Now a state, rather like a corporation, is a juridical being — a fiction of the law — with no res extensa as such. It exists on the rarefied non-material plane of jurisprudence. There are, thus, only a certain number of things that, without the agency of one if its employees, a state can do, and these involve enacting and repealing laws, promulgating and withdrawing regulations, signing treaties, entering contracts and, where is has waived its sovereign immunity, litigating their meaning.

Thus, a force majeure taking the shape of an act of state is, we humbly submit, a change in law which makes it impossible for one side or the other to perform its obligations. Compare, therefore, with Illegality.

Waiting Period (2002)

The point of Waiting Period is, for potential scenarios that might wind up justifying termination later, but you don’t yet know that, to build in a period to wait and see. For Illegality events (Section 5(b)(i)) is three Local Business Days — it is not so likely that an Illegality will sort itself out; for a Force Majeure Event (5(b)(ii) — where insh’Allah, things will come right and everyone can eventually go back to what they were doing, it is eight Local Business Days.

Waiting Periods — as defined in the ISDA Master Agreement also sometimes show up sometimes in other booklets — for example, ISDA’s Emissions Annex.

Through the good offices of Section 5(d), payments and deliveries which otherwise would be due during a Waiting Period are suspended.

Section 5(b)(ii)/(iii) Tax Event

Basically, the gist is this: if the rules change after the Trade Date such that you have to gross up an Indemnifiable Tax would weren’t expecting to when you priced the trade, you have a right to get out of the trade, rather than having to ship the gross up for the remainder of the Transaction.

That said, this paragraph is a bastard to understand. Have a gander at the JC’s nutshell version (premium only, sorry) and you’ll see it is not such a bastard after all, then.

In the context of cleared swaps, you typically add a third limb, which is along the lines of:

(3) required to make a deduction from a payment under an Associated LCH Transaction where no corresponding gross up amount is required under the corresponding Transaction Payment under this Agreement.

Section 5(b)(iii)/(iv) Tax Event Upon Merger

This is you can imagine, a red letter day for ISDA’s crack drafting squad™ who quite outdid itself in the complicated permutations for how to terminate an ISDA Master Agreement should there be a Tax Event or a Tax Event Upon Merger. Things kick off in Section 6(b)(ii) and it really just gets better from there.

So, Tax Event Upon Merger considers the scenario where the coming together of two entites — we assume they hail from different jurisdictions or at least have different practical tax residences — has an unfortunate effect on the tax status of payments due by the merged entity under an existing Transaction.

It introduces a new and unique concept — the “Burdened Party”, being the one who gets slugged with the tax — and who may or may not be the “Affected Party” — in this case the one subject to the merger.

Section 5(b)(iv)/(v) Credit Event Upon Merger

Known among the cognoscenti as “CEUM”, the same way Tax Event Upon Merger is a “TEUM”. No idea how you pronounce it, but since ISDA ninjas communicate only in long, appended, multicoloured emails and never actually speak to each other, it doesn’t matter.

Pay attention to the interplay between this section and Section 7(a) (Transfer). You should not need to amend Section 7(a) (for example to require equivalence of credit quality of any transferee entity etc., because that is managed by CEUM.

Note also the interrelationship between CEUM and a Ratings Downgrade Additional Termination Event, should there be one. One can be forgiven for feeling a little ambivalent about CEUM because it is either caught by Ratings Downgrade or, if there is no requirement for a general Ratings Downgrade, insisting on CEUM seems a bit arbitrary (i.e. why do you care about a downgrade as a result of a merger, but not any other ratings downgrade?)

Section 5(b)(v)/(vi) Additional Termination Events

Additional Termination Events are the other termination events your Credit department has dreamt up for this specific counterparty, that didn’t occur to the framers of the ISDA Master Agreement — or, at any rate, weren’t sufficiently universal to warrant being included in the ISDA Master Agreement for all. While the standard Termination Events tend to be “non-fault” events which justify termination of the relationship on economic grounds, but not on terms necessarily punitive to the Affected Party, Additional Termination Events are more “credit-y”, more susceptible of moral outrage, and as such more closely resemble Events of Default than Termination Events.

Common ones include:

• NAV triggers (for hedge funds)
• Key man provisions (for hedge funds)
• Investment manager insolvency or loss of licence
• Parent divestment (where counterparty is a financing subsidiary)

There is a — well, contrarian — school of thought that Additional Termination Events better serve the interests of the Ancient Guild of Contract Negotiators and the Worshipful Company of Credit Officers than they do the shareholders of the institutions for whom these artisans practise their craft, for in these days of zero-threshold CSAs, the real credit protections in the ISDA Master Agreement are the standard Events of Default (especially Failure to Pay or Deliver and Bankruptcy).

It’s a fair bet no-one in the organisation will have kept a record of how often you pulled NAV trigger. It may well be never.

“Ahh”, your credit officer will say, “but it gets the counterparty to the negotiating table”.

Hmmm.

Section 5(c)

Compared with its Byzantine equivalent in the 2002 ISDA the 1992 ISDA is a Spartan cause indeed: it is as if ISDA’s crack drafting squad™ assumed all ISDA users would be cold, rational economists who instinctively appreciate the difference between causation and correlation — or hadn’t considered the virtual certainty that they would not be — and therefore did not spell out that where your Event of Default is itself, and of itself, the Illegality, this hierarchy clause will intervene but it will not where your it simply is coincidental with one. I.e., if you were merrily defaulting under the ISDA Master Agreement anyway, and along came an Illegality impacting your ability to perform some other aspect of the Agreement, you can’t dodge the bullet.

In the 2002 ISDA the JC thinks he might have found a bona fide use for the awful legalism “and/or”. What to do if the same thing counts as an Illegality and/or a Force Majeure Event and an Event of Default and/or a Termination Event. Template:M gen 2002 ISDA 5 Template:M detail 2002 ISDA 5

Section 6

Section 6 in a nutshell

6. Early Termination
6(a) Right to Terminate following Event of Default. If one party (“Defaulting Party”) suffers an Event of Default, the other (the “Non-defaulting Party”) may, by not more than 20 days’ notice, designate an Early Termination Date for all outstanding Transactions. If Automatic Early Termination applies to the Defaulting Party and the Event of Default it is qualifying Bankruptcy event, the Early Termination Date will occur:

(i) upon the Bankruptcy event, if under 5(a)(vii)(1), (3), (5) or (6) or if analogous, (8); and

(ii) immediately before institution of the relevant proceeding, if under 5(a)(vii)(4) or if analogous, (8).

6(b) Right to Terminate Following Termination Event.

6(b)(i) Notice. Upon becoming aware of a Termination Event the Affected Party will promptly give the other party with reasonable details of it and each Affected Transaction (or, if it is a Force Majeure Event, make reasonable efforts to do so).

6(b)(ii) Transfer to Avoid Termination Event

If there is a Tax Event with only one Affected Party or a Tax Event Upon Merger where the Burdened Party is the Affected Party, before designating an Early Termination Date the Affected Party must use all reasonable efforts to transfer, within 20 days of giving notice of the Termination Event, all its rights and obligations under the Affected Transactions to one of its Offices or Affiliates so that the Termination Event ceases to exist.

If it cannot make such a transfer, it will advise the other party within the 20 day period, and the other party may effect such a transfer within 30 days after the original notice of Termination Event.

Any such transfer by a party under this Section will require the of the other party’s prior written consent (which may not be withheld if the other party’s prevailing policies would permit it to enter into transactions on the terms proposed).

6(b)(iii) Two Affected Parties. If there is a Tax Event with two Affected Parties, each must use all reasonable efforts agree within 30 days after the Termination Event Notice to avoid it.

6(b)(iv) Right to Terminate

(1) Termination Events other than Illegality and Force Majeure Events: If the Termination Event still exists but:―

(A) Tax Termination Events: a neither party has managed to avoid a Tax Event or Tax Event Upon Merger as contemplated in Section 6(b)(ii) or 6(b)(iii) within 30 days of a Termination Event Notice; or

(B) Other Termination Events: there is a Credit Event Upon Merger, an Additional Termination Event or a Tax Event Upon Merger where the Burdened Party is not the Affected Party:

either party (if both are Affected Parties) or the Non-Affected Party (in any other case) may, on not more than 20 days’ notice, designate an Early Termination Date for all Affected Transactions.

(2) Illegality and Force Majeure Events: If an Illegality or Force Majeure Event still exists when its Waiting Period has expired:―

(A) Subject to clause (B) below, either party may, on not more than 20 days’ notice, designate an Early Termination Date:

(I) for all Affected Transactions, or

(II) for fewer than all Affected Transactions by specifying which Affected Transactions it wishes to terminate, effective no earlier than two Local Business Days following the effective day of its notice, as an Early Termination Date for those designated Affected Transactions only. In this case the other party may, by notice, terminate any of the outstanding Affected Transactions as of the same Early Termination Date.

(B) Where the Illegality or Force Majeure Event relates to performance under a Credit Support Document, an Affected Party may only designate an Early Termination Date following designation by the other party of an Early Termination Date, for fewer than all Affected Transactions under this Section.

6(c) Effect of Designation: If an Early Termination Date is designated:

(i) it will take place when designated, even if the event which triggered no longer exists.

(ii) no more payments or deliveries will be required under any Terminated Transactions.

Any Close-out Amount will be determined under Section 6(e).
6(d) Calculations; Payment Date.

(i) Statement. As soon as practicable following an Early Termination Date, each party will calculate its Section 6(e) amount and give the other party a statement:

(1) showing reasonable detail of its calculations;

(2) specifying any Early Termination Amount payable; and

(3) giving its bank details for payment of the Early Termination Amount.

Its records of any quotation or market data it uses will be conclusive of their accuracy.

(ii) Payment Date. An Early Termination Amount due in respect of any Early Termination Date will, together with any applicable interest, be payable

(1) on the day its Section 6(d) statement is effective (if the Early Termination Date follows an Event of Default) and

(2) two Local Business Days after the day its Section 6(d) statement is effective (or, where there were two Affected Parties, after the second statement is effective) (where the Early Termination Date follows a Termination Event.

6(e) Payments on Early Termination. If an Early Termination Date occurs, the “Early Termination Amount” will be determined as follows (subject to Section 6(f)).

6(e)(i) Events of Default. On an Early Termination Date following an Event of Default, the Non-defaulting Party will determine Early Termination Amount in the Termination Currency as the sum of:

(a) the Close-out Amounts for each Terminated Transaction plus

(b) Unpaid Amounts due to the Non-defaulting Party; minus

(c) Unpaid Amounts due to the Defaulting Party.

If the Early Termination Amount is positive, the Defaulting Party will pay it to the Non-defaulting Party. If negative, the Non-defaulting Party will pay its absolute value to the Defaulting Party.

6(e)(ii) Termination Events. If the Early Termination Date results from a Termination Event:―

(1) One Affected Party. If there is one Affected Party, the Early Termination Amount will be determined as if they were Events of Default under Section 6(e)(i) (but subject to the Mid-Market Events rider below).

(2) Two Affected Parties. If there are two Affected Parties, each party will determine the Termination Currency Equivalent of the Close-out Amounts for all Terminated Transaction and the Early Termination Amount will be:

(A) the sum of

(I) half of the difference between the higher amount (determined by party “X”) and the lower amount (determined by party “Y”) and

(II) the Termination Currency Equivalent of the Unpaid Amounts owing to X minus

(B) the Termination Currency Equivalent of the Unpaid Amounts owing to Y.

If the Early Termination Amount is a positive number, Y will pay it to X; if negative , X will pay its absolute value to Y.

(3) Mid-Market Events. In either case where the Termination Event is an Illegality or a Force Majeure Event, when determining a Close-out Amount the Determining Party will use mid-market valuations that do not take the Determining Party’s own creditworthiness into account.

6(e)(iii) Adjustment for Bankruptcy. If an “Automatic Early Termination” happens, one can adjust the Early Termination Amount to reflect payments or deliveries actually made between the automatic Early Termination Date and the payment date determined under Section 6(d)(ii).

6(e)(iv) Adjustment for Illegality or Force Majeure Event. The failure by a party or its Credit Support Provider to pay an Early Termination Amount when due will not be a Failure to Pay or Deliver or a Credit Support Default if caused by an Illegality or a Force Majeure Event. The unpaid amount will:

(1) be treated as an Unpaid Amount for a subsequent Early Termination Date resulting from an Event of Default, a Credit Event Upon Merger or an Additional Termination Event affecting all outstanding Transactions; and

(2) otherwise accrue interest in accordance with Section 9(h)(ii)(2).

6(e)(v) Pre-Estimate. The parties acknowledge that:

(a) Each Early Termination Amount is a reasonable pre-estimate of loss and not a penalty; and

(b) neither party may recover any additional damages as a consequence of terminating Terminated Transactions.

6(f) An Innocent Party may, by notice, set-off any part of an Early Termination Amount payable by one party against any Other Amounts payable by the other under any other agreement, converting currencies if necessary and estimating unascertained obligations in good faith, but it must account for any difference between its estimate and the amount when it is finally ascertained.

Comparison between versions

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)

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Discussion

See section 12 for what this all means in a time of global pandemic lockdown. See also the separate article all about Automatic Early Termination, which features in the 1992 ISDA and the 2002 ISDA and deserves a page all of its own.

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)

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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.

Section 6(b)

Between the 1987 ISDA and the 1992 ISDA the changes were very superficial, as this comparison demonstrates.

Between the 1992 ISDA and the 2002 ISDA, there was a but more re-engineering, largely to account for the new Force Majeure Event and some tidying up, but beyond that Section 6(b) works in the same general way under the 1992 ISDA and 2002 ISDA. Here is a comparison of that.

Section 6(b)(i)

Updated in 2002 with special pleadings relating to the newly-introduced Force Majeure Termination Event.

Section 6(b)(ii)

Note in the 2002 ISDA there is no reference to Illegality (or for that matter Force Majeure, which did not exist under the 1992 ISDA but tends to treated rather like a special case of Illegality and therefore, we think, would have been included in this provision of the 1992 ISDA if it had existed ... if you see what I mean).

When the 2002 ISDA gets on to the topic of Illegality and Force Majeure it allows the Unaffected Party to cherry-pick which Affected Transactions it will terminate, but then seems almost immediately to regret it (see especially in Section 6(b)(iv)). Under the 1992 ISDA if you wanted to pull the trigger on any Termination Event, you had to pull all Affected Transactions. Under the 2002 ISDA it is only binary for the credit- and tax-related Termination Events.

Otherwise, but for one consequential change — 1992’s “excluding” became 2002’s “other than” — I mean, you can just imagine the barney they must have had in the drafting committee for that one, can’t you — the provisions are identical.

Section 6(b)(iii)

Be careful here: Under the 1992 ISDA, if your Failure to Pay is also an Illegality it is treated as an Illegality: if there are two Affected Parties you will face a significant delay when closing out. A bit of a trick for young players.

Note also that reference to Illegality has been excised from the 2002 ISDA version. They changed this because, in practice, it turned out to too be hard to implement a transfer or amendment after an Illegality. Folks realised that if an Illegality happens you don’t want to have to wait 30 days to terminate, especially if you can’t rely on 2(a)(iii) to withhold payments in the meantime.

Section 6(b)(iv)

Oh, this section 6(b)(iv) stuff
Is sure stirring up some ghosts for me.
She said, “There’s one thing you gotta learn
Is not to be afraid of it.”
I said, “No, I like it, I like it, it’s good.”
She said, “You like it now —
But you’ll learn to love it later”

— Robbie Robertson

One’s right to terminate early following an Illegality or the newly introduced Force Majeure Termination Event get a proper makeover in the 2002 ISDA, but otherwise, the provisions are the same, but for some formal fiddling in the drafting.

Section 6(c)

The framers of the 2002 ISDA daringly changed a “shall” to a “will” in the final line. We approve, to be clear, but this is kind of out of character for ISDA’s crack drafting squad™. Otherwise, identical.

Section 6(d)

Broadly similar between the versions. Main differences are basic architectural ones (no definition of “Early Termination Amount” or “Close-out Amount” in the 1992 ISDA, for example), and the 2002 is a little more finicky, dealing with what to do if there are two Affected Parties, and also blithering on for a few lines about interest.

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

The 1987 ISDA was half-cocked and shambolic, and laboured under the wishful illusion that if the other guy blew up, even if he was in the money, it was kind of okay to just flip him the bird and walk off with a windfall (in the form of not owing him the money you like, actually owed him). Not cool these days. Once folks realised this wouldn’t fly from a netting perspective they tried to fix it in the 1992 ISDA, whose close-out methodology is truly hideous.

ISDA’s crack drafting squad™ overhauled whole close-out process, soup to nuts, in the 2002 ISDA, and is now much more straightforward — as far as you could ever say that about ISDA’s crack drafting squad™’s output. But a large part of the fanbase — that part west of Cabo da Roca — sticks with the 1992 ISDA. Odd.

Differences, in very brief:

The 1992 ISDA has the infamous Market Quotation and Loss measures of value, and the perennially-ignored First Method and the more sensible Second Method means of evaluating the termination value of terminated Transactions. The 2002 ISDA has just the Close-out Amount to cover everything. So while the 1992 ISDA is far more elaborate and over-engineered, this is not to deny that the 2002 ISDA is elaborate or over-engineeered.

The 2002 ISDA has a new Section 6(e)(iv) dealing with Adjustment for Illegality or Force Majeure Event. This wasn’t needed in the 1992 ISDA, which didn’t have Force Majeure Event at all, and a less sophisticated Illegality.

Discussion

Dive in ⇒

This is one of the monster clauses of the ISDA Master Agreement. JC has given each of its subclauses its own page. You can access them by clicking on the links in the wikitext, or, okay, by clicking here:

• Section 6(a) (Right to Terminate Following Event of Default)
• Section 6(b) (Right to Terminate Following Termination Event)
• Section 6(c) (Effect of Designation)
• Section 6(d) (Calculations)
• Section 6(e) ( Payments on Early Termination)

But, generally:

No general “no-fault” termination right under the ISDA

Unlike the 2010 GMSLA and many other — ahh, less sophisticated master agreements — the ISDA Master Agreement doesn’t have a general termination right of this sort at all. It is like one of those fancy fixie pushbikes that cost seven grand and don’t even have brakes. You can only terminate Transactions, not the master agreement construct which sits around them. The empty vessel of a closed-out ISDA thus remains for all eternity as an immortal, ineffectual husk. This is to do with paranoid fears about the efficacy of the ISDA’s sainted close-out netting terms if you do terminate the agreement — meh; maybe — but I like to think it is because, before he was cast out from heaven, the Dark Lord made plans to unleash his retributive fury upon the world through a sleeping army of wight-walker zombie ISDAs, doomed to roam the earth until the day of judgment, apropos nothing but there, not alive, but un-dead, ready to reanimate and rally to the Dark Lord’s banner and rain apocalyptic hell on we errant descendants of the Good Man, who did not heed His warnings of financial weapons of mass destruction.

How the close-out mechanism works

It’s optional ...: An Event of Default gives the “Non-defaulting Party” a right (but not an obligation) to designate an Early Termination Date with respect to all outstanding Transactions on not more than 20 days’ notice.

... Unless AET applies: Where Automatic Early Termination applies to a party (being jurisdiction-dependent, it often will only apply to one party) the Non-defaulting Party loses its optionality should the Event of Default be Bankruptcy: all Transactions automatically terminate whehter you want them to or not, and whether you realise it or not. This is plainly sub-optimal from a Non-defaulting Party's perspective. You should therefore only switch on AET if you are sure you need it (e.g. for counterparties in jurisdictions where close-out netting may fail in an insolvency, but not before). Being sure generally means “having a netting opinion telling you netting does not work without it.” In other words, AET is one provision you should not insist on just because the other party insists upon it against you).

Not triggering an Event of Default can be controversial: For what this optionality not to terminate means, and how controversial it can be, see the commentary to Section 2(a)(iii).

Once all Transactions are terminated, you move to Section 6(e) which directs how to value the Transactions (it depends on who is the Defaulting Party, and whether you have elected Loss or Market Quotation, and First Method or Second Method. Under the 2002 ISDA it is much easier.

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?”

Section 6(b)

There is a difference between Termination Events that are non-catastrophic, and usually Transaction-specific, and those that are catastrophic, which are usually counterparty specific.

Non-catastrophic ones affecting just a subset of Transactions might be caused by, say, a Tax Event or a local Illegality, but in any weather do not concern the solvency, creditworthiness or basic mendacity of your counterparty. They generally won’t have much, directly, to do with your counterparty at all beyond the jurisdictions it inhabits and the laws it is subject to. These are generally the Termination Events, but not Additional Termination Events.

The catastrophic ones are by their nature affect — that is, “Affect” — all Transactions. These generally are the bespoke Additional Termination Events your credit department insisted on — or theirs did; they will have something to do with the naughtiness of lack of fibre of your counterparty (or you!), and these function for most respects a lot more like Events of Default.

Thus, in the drafting of ISDA Schedules, CSAs and so on, you will often find laboured reference to Events of Default and/or Termination Events which lead to Early Termination Dates with respect to all outstanding Transactions as some kind of special, hyper-exciting, class of Termination Event.

Lucky premium content subscribers get a lot more discussion about the practical implications of all the above and a table comparing the events.

Section 6(b)(i)

Note the difficulty of practical compliance with this provision, given a sizeable ISDA portfolio, and the requirement for actively monitoring not only standard Termination Events, but also Additional Termination Events, which may be counterparty or even Transaction-specific.

Be aware of the notices provision of the ISDA Master Agreement, especially if you’re using a 1992 ISDA and you were thinking of serving by email — NatWest Bank could tell you a thing or two about that, as this lengthy article explains — or if the world happens to be in the grip of madness, hysteria, pandemic or something equally improbable like an alien invasion.

Section 6(b)(ii)

Once the Waiting Period expires, it will be a Termination Event entitling either party to terminate some or all Affected Transactions. Partial termination is permitted because the impact on an event on each Transaction may differ from case to case (eg transactions forming part of a structured finance deal like a repack or a CDO) might not be easily replaced, so the disadvantages of terminating may outweigh the advantages.

As far as branches are concerned this is relatively uncontroversial, especially if yours is a multi-branch ISDA Master Agreement. But there is an interesting philosophical question here, for, without an express pre-existing contractual right to do so, a party may not unilaterally transfer its obligations under a contract to someone else. That, being a novation, requires the other party’s consent. This is deep contractual lore, predating the First Men and even the Children of the Woods. So if the Affected Party identifies an affiliate to whom it can transfer its rights and obligations, the Non-affected Party still may withhold consent. True, it is obliged to provide consent if its policies permit but — well — y’know. Polices? Given the credit department’s proclivities for the fantastical, it’s a fairly safe bet they’ll be able to find something if they don’t feel up to it.

That is to say, this commitment falls some wat short of the JC’s favourite confection: “in good faith and a commercially reasonable manner”.

Note also that if an Non-Affected Party does elect partial termination, the Affected Party has the right to terminate some or all of the remaining Transactions: this prevents Non-Affected Parties being opportunistic. Heaven forfend.

Section 6(b)(iii)

Handwaving appeals to one another’s good natures with this talk of reasonableness and, of course, both parties will probably be incentivised to keep the trade on foot if some unfortunate tax eventuality comes about — seeing as they were incentivised enough to start it —but ultimately, this is an agreement to agree, however you dress it up, and is as contractually enforceable as one. That is, not very.

Section 6(b)(iv)

What a beast. If you track it through in Nutshell™ terms, it isn’t as bad as it looks, but you have the ISDA ninja’s gift for over-complication, and ISDA’s crack drafting squad™’s yen for dismal drafting, to thank for this being the trial it is.

To make it easier, we’ve invented some concepts and taken a few liberties:

“Unaffected Transaction”, which saves you all that mucking around saying “Transactions other than those that are, or are deemed, to be Affected Transactions” and so on;

Termination Event Notice: An elegant and self-explanatory alternative to “after an Affected Party gives notice under Section 6(b)(i)”.

We take it as logically true that you can’t give 20 days’ notice of something which you then say will happen in fewer than 20 days. Therefore, there is no need for all this “designate a day not earlier than the day such notice is effective” nonsense.

So with that all out the way, here is how it works. Keep in mind that, unlike Events of Default, Termination Events can arise through no fault of the Affected Party and, therefore, are not always as apocalyptic in consequence. Depending what they are, they may be cured or worked-around, and dented Transactions that can’t be panel-beaten back into shape may be surgically excised, allowing the remainder of the ISDA Master Agreement, and all Unaffected Transactions under it, to carry on as normal. So here goes:

Divide up the types of Termination Event

Tax ones: If a Tax Event or a TEUM where the party merging is the one that suffers the tax, the parties have a month to try to rearrange matters between them, their offices and affiliates to avoid the tax issue. Only once that has failed are you in Termination Event territory. See Section 6(b)(ii) and 6(b)(iii).

Non-Affected Party ones: If it’s a CEUM, an ATE or a TEUM where the Non-Affected Party suffers the tax, then if the other guy is a Non-Affected Party, then (whether or not you are) you may designate an Early Termination date for the Affected Transactions.

Illegality and Force Majeure: Here, if you are on a 2002 ISDA, there may be a Waiting Period to sit through, to see whether the difficulty clears. For Force Majeure Event it is eight Local Business Days; for Illegality other than one preventing performance of a Credit Support Document: three Local Business Days. So, sit through it. Why is there exception for Illegality on a Credit Support Document? Because, even though it wasn’t your fault, illegality of a Credit Support Document profoundly changes your credit assessment (in a way that arguably, even a payment or delivery obligation doesn’t), and that is the most fundamental risk you are managing under the ISDA Master Agreement.

Section 6(c)

Once you have designated your Early Termination Date under Section 6(a), proceed directly to Section 6(e) to determine the Close-out Amount (if you are under a 2002 ISDA, or “tiresomely unlabelled amount payable upon early termination of the ISDA Master Agreement” if you a labouring under a 1992 ISDA).

The key thing to observe here is that, suddenly, all Transactions vanish, and all payments and deliveries due under them are suspended, to be replaced by the single Close-out Amount per Transaction, which is then subsumed into the Early Termination Amount for the whole agreement. Note the Close-out Amount does not have an independent existence as a payable amount owed by any party at any point: it is simply a calculation one makes, by reference to a now extinguished Transaction, on the way to determining the whole-agreement Early Termination Amount. This is why a Transaction-specific guarantee is a flawed type of Credit Support Document — at the very point you call upon it, the Transaction will vanish.

Section 6(d)

Section 6(d) is to do with working out the termination value of Transactions for which you’ve just designated an Early Termination Date (or, in the 1992 ISDA, the thing you wished they’d defined as an Early Termination Date).

Under the ’92 one uses Loss and Market Quotation, and all that Second Method malarkey, and in the 2002 ISDA the much neater and tidier Close-out Amount concept.

Generally, this is good fat-tail paranoia material, so once upon a time parties used to negotiate it heavily. General SME-drain from the negotiation talent pool over the years due to vigorous down-skilling means people are less fussed about it now.

A popular parlour game among those pedants who still insist on using the 1992 ISDA — or, in fairness, are forced to by some other pedant further up their chain, or a general institutional disposition towards pedantry — is to laboriously upgrade every inconsistent provision in the 1992 ISDA to the 2002 ISDA standard except the one provision of the 1992 ISDA they always liked — if the pedant is in question is from the Treasury department, that will be the longer grace period in the Failure to Pay; if she is from Credit, it absolutely won’t be.

You might well ask why anyone would be so bloody-minded, but then you might well ask why anybody watches films from the Fast and Furious franchise. Because they can.

Or, possibly, to preserve the slightly more generous grace periods for Failure to Pay (three days in the 1992 ISDA versus one in the 2002 ISDA) and Bankruptcy (thirty days in the 1992 ISDA versus 15 in the 2002 ISDA) in which case, you’d retrofit longer grace periods into the new version, wouldn’t you? But no).

Section 6(e)

For our step-by-step guide to closing out an ISDA Master Agreement see Section 6(a).

On the difference between an “Early Termination Amount” and a “Close-out Amount”

Regrettably, the 1992 ISDA features neither an Early Termination Amount nor a Close-out Amount. The 2002 ISDA has both, which looks like rather an indulgence until you realise that they do different things.

A Close-out Amount is the termination value for a single Transaction, or a related group of Transactions that a Non-Defaulting Party or Non-Affected Party calculates while closing out an 2002 ISDA, but it is not the final, overall sum due under the ISDA Master Agreement itself. Each of the determined Transaction Close-out Amounts summed with the various Unpaid Amounts to arrive at the Early Termination Amount, which is the total net sum due under the ISDA Master Agreement after the close-out process. (See Section 6(e)(i) for more on that).

Section 6(f)

One does not exercise a set-off right willy nilly. Unless one is, mutually, settlement netting (where on a given day I owe you a sum, you owe me a sum, and we agree to settle by one of us paying the other the difference) set-off is a drastic remedy which will be seen as enemy action. You would not do it, without agreement, to any client you expected to keep. So, generally, use set-off as a remedy it only arises following an event of default.

A bit of a bish in the 2002 ISDA

Set-off in the 2002 ISDA borrows from the text used to build it into the 1992 ISDA but still contains a rather elementary fluff-up: it imagines a world like our own, but where the Early Termination Amount is payable one way, while all Other Amounts are only payable the other. Life, as any fule kno, is not always quite that convenient.

For example:

Payer owes Payee an Early Termination Amount of 10 Payee owes Payer Other Amounts of 50 Net: Payee owes Payer 40.

But what if there are Other Amounts payable the same way as the Early Termination Amount?

Payer owes Payee an Early Termination Amount of 10 Payer owes Payee Other Amounts of 40 Payee owes Payer Other Amounts of 50 Net: Payee owes Payer 40. Whoops: Payee is still owed 40 by Payer so is an unsecured creditor '

Not ideal. But fixable if you’re prepared to add some dramatically anal language:

6(f) Set-Off. Any Early Termination Amount (or any other amounts, whether or not arising under this Agreement, matured, contingent and irrespective of the currency, place of payment of booking of the obligation)” payable to one party (the “Payee”) by the other party (the “Payer”), ...

Section 7

Section 7 in a nutshell

7. Transfer
Subject to Section 6(b)(ii), neither party may transfer any interest in or obligation under this Agreement without the other party’s prior written consent, except:―

7(a) Due to a merger with, or consolidation of substantially all of its assets into, another entity; and

7(b) A transfer of its rights to an Early Termination Amount under Sections 8, 9(h) and 11.

Comparison between versions

No great difference between the versions of Section 7 other than those yielded by ISDA’s crack drafting squad™ satisfying its usual yen for redundancy and over-particularity.

Any right under any contract is subject to applicable law, after all, and converting “any amount payable on early termination under Section 6(e)” to “the Early Termination Amount together with any amounts payable under various other random clauses of the agreement as a result of its early termination” may be more exacting than the 1992 ISDA version, but you could as easily have fixed it just by deleting “under section 6(e)”.

Discussion

Section 7 ought to head off the temptation felt, for example, by legal eagles who should come to be handling novations in years to come to insert laborious representations and warranties that neither party has assigned any of its obligations — but knowing the sorts of legal eagles who usually get assigned to such thrilling tasks, it won’t. Nor will the fact that the 2004 ISDA Novation Definitions includes that representation. Sigh. Template:M gen 2002 ISDA 7 Template:M detail 2002 ISDA 7

Section 8

Section 8 in a nutshell

8. Contractual Currency
8(a) Payment in the Contractual Currency: Each payment under this Agreement must be made in the currency specified for that payment (the “Contractual Currency”). Payments made in a Non-Contractual Currency will only discharge an obligation to the extent the recipient, having converted it into the Contractual Currency in good faith using commercially reasonable procedures, achieves the full amount payable in the Contractual Currency.

(i) If the converted amount falls short of the amount payable in the Contractual Currency, the payer must immediately pay the necessary balance in the Contractual Currency.

(ii) If the converted amount exceeds the full amount payable in the Contractual Currency, the payee must promptly refund the excess.

8(b) Judgments. If a party obtains judgment in a Non-Contractual Currency against the other for any amount due under this Agreement and, having recovered that judgment debt, a shortfall or excess remains over the original amount due in the Contractual Currency (due to the exchange rate at which the judgment creditor, in good faith and a commercially reasonable manner, converted the judgement debt into the Contractual Currency), that judgment creditor:

(i) will be entitled to immediately receive from the other party, the value of any such shortfall in the Contractual Currency; and

(ii) must promptly refund to the other party any such excess in the Contractual Currency.

8(c) Separate Indemnities. The indemnities in this Section 8 are independent of the parties’ other obligations in this Agreement. They create separate causes of action. They will apply notwithstanding any indulgence granted to the payer by the payee, or any other claims made or judgments awarded for amounts due under this Agreement.
8(d) Evidence of Loss. Under Section 8, it will be enough if a party can show that it would have suffered a loss had it actually made the currency conversion.

Comparison between versions

But for a burst of excitement and vigour by dint of which ISDA’s crack drafting squad™ found itself desirous of moving the obvious-stating “rate of exchange” definition from Section 8(b) to the main definitions section — a result of that unnecessarily defined expression also showing up in the 2002 ISDA’s new Section 6(f) — and for a mildly different way of expressing the idea of “commercial reasonableness” — Section 8 of the 1992 ISDA survived unscathed when overhauled for the 2002 ISDA.

There is no definition of Non-Contractual Currency in the ISDA Master Agreement. But I made one, because it makes life easier. Just go with me on this one.

Discussion

This is what, in the bond world, they call a currency indemnity. A currency indemnity is a part of the boilerplate that is so deeply entrenched, a piece of cod that passeth so much understanding, that generations of legal eagles have just abided by it, never asking what it is or why it is there. The young JC was one such eagle.

The currency indemnity just is. You will find in in the ISDA, in loans, bonds, repacks — in fact sprayed wordily over almost any kind of financial instrument; a kind of comfy textual furniture to make it all seem serious and important.

In a nutshell: roll with it

So if you are in a hurry, stop there: a currency indemnity is fine; people don’t usually fiddle with it: leave it; carry on.

Do not expect much by way of negotiation (among others, for the same reason: no-one else knows any better than you do what one should negotiate in a currency indemnity).

For those who remain curious

For those with the time and deep natural curiosity, or who are vexed about the “i” word, we offer the following. Take it with a pinch of salt; after all, we wrote it with one.

Let’s say I borrow from you, in euros.

Being an OG in the international capital markets, in the course of my business I will truck in all kinds of flakey currencies, payments in kind and weird securities — but I will still promise to repay my loan from you, in euros. That is my resting, fundamental contractual obligation. Euros.

Now, being an OG, I will have a sophisticated treasury function to watch lovingly over my cashflows, and it will execute such hedges currency conversions and otherwise work whatever magic I need to meet my outgoings, including the principal and interest I owe you.

This much should not really be a surprise: I borrow in euros, I repay in euros.

But all this goes out the window if — heaven forfend, and all that — I go titten hoch. At this point my treasury team would find it hard to execute the necessary hedges and conversions, even if they weren’t wandering around outside the building, woozily clutching Iron Mountain boxes full of gonks, deal toys, tombstones, pilfered stationery and personal effects. But, alas and alack, they will be. This is the whole of the law.

Now the receivers and administrators will busily be calling in, converting and collecting and liquidating my remaining assets, cash balances and generally figuring out how to best sort out my creditors, of which you are but one. There is a disaster scenario in which a failed, or failing, debtor — me — has no euros and instead offers up cash in non-contractual currencies, by way of full or partial satisfaction of what I owe. This isn’t Local courts which administer my insolvency might oblige them to do this.

No, that isn’t what the contract preferred, but it is a fact of life, so the contract allows it. That is what the currency indemnity does. It gudgingly, grants that this sort of thing can happen and puts some parameters around what goes down in such a case.

Components of a normal currency indemnity

This will boil down to the following:

Limited discharge: A non-contractual currency will only discharge the debt to the value in the contractual currency that the creditor achieves by converting it into the contractual currency in the market on reasonable terms.

No prejudice re the shortfall: If there is a shortfall, the debtor remains immediately liable for the balance: that is, the partial payment in the non-contractual currency doesn’t somehow hamstring the creditor’s legal rights to go after the rest

Reimburse excess: If there is an excess — happy days, right? — the creditor should promptly return it. Ie the non-currency payment is only am unconditional payment to the extent of the debt. This is quite a complicated ontological concept which it is best not to think about, so call this an absolute payment with a contingent reimbursement right.

Court judgments: If you are imprudent to litigate with a capital markets OG in its own jurisdiction, and you are awarded damages in a non-contractual currency (the JC is no litigator but is given to understand local courts can do this sort of thing, whether the victor likes it or not), then the same issue arises, and it is treated the same way.

Separate indemnities: Just to bring home the point, if accepting the non-contractual currency does somehow operate to undermine or waive the primary obligation to pay in full in the contractual currency, then the obligations created by the currency indemnity clause stand as separate indemnity payments. (This, by the way, is “indemnity” in its narrow sense, as “a unilateral obligation to pay a defined sum of money not by way of recompense or damages for some other failure, but just because you have agreed to pay it” and not in its “Help! Help! We are all going to die under a Cardozan excess of indeterminate liability” sense.) This is probably most important in the context of judgment debts, where the debtor might (rightly) complain that it had no choice but to pay in the local currency, and therefore try to argue that that local currency judgment, if paid in full, should discharge the debt ad to hell with the vagaries of the foreign exchange markets. The currency indemnity should put, er, paid to that argument by constructing an entirely independent obligation to pay the balance.

No requirement to actually convert: You may see a rider, as in the ISDA, that one should not have to actually convert the currency you received at a loss to prove a loss: it is okay to keep your money in the tendered currency and not crystallise the position.

Section 8(a)

One could have stopped after the first sentence, but it is a rare ISDA ninja that can help himself babbling. ISDA ninjas would make terrible used-car salespeople.

Why the ISDA Master Agreement feels the need to contemplate the discharge of obligations in one currency by payment of an amount in another — non-compliance with the clear terms of the contract in other words — we can only guess. The payer’s ability to plow this obverse furrow still depends on the payee’s good humour: the payee is not obliged to indulge the payer, but may, by converting the tendered amount into the Contractual Currency.

If there is a shortfall, the payer must pay it immediately — fair, since the payer is craving the recipient’s indulgence in the first place and is really courting a Failure to Pay or Deliver by his cavalier behaviour.

If there is an excess, the recipient must return it promptly — also fair, seeing as she didn’t ask to be paid in Brazilian Real, and had to go to all the trouble of converting it and faffing around at the FX counter at that little shop in the arcade near Liverpool Street.

Section 8(b)

Enforcing judgments in far-flung places

It is a fact of life that when enforcing a cross-border contract, you may find yourself journeying to foreign climes in a bid to prise assets and payments out of a foreign counterparty. Places like Italy. With the best will in the world, and the firmest written intentions that the agreement be governed by English law and justiciable exclusively by her majesty’s courts, that may still mean engaging with, and obtaining judgments from foreign court systems, if that is where your counterparty and its financial resources are located. Those courts may be obliged to award their judgments, about your judgment, in their local currency. That exposes you to FX risk. This clause requires the parties to true up — immediately, should the windfall accrue to the Defaulting Party, only promptly if it accrues to the innocent one — by reference to a fairly determined “rate of exchange”.

Nerd’s point: This obligation is, strictly speaking, an indemnity obligation, in the true sense of that concept, in that is a payment that becomes due by reference to an externality that was not caused by breach of contract (even though originally it might have arisen out of one). So that’s nice.

Rate of exchange

Abvout that “rate of exchange” — in the 1992 ISDA defined on the spot; in the 2002 ISDA promoted to the big league and featuring in the main Definitions section. Allow the JC a pet moan. Goddamn “definitions”.

You could scarcely ask for a less necessary definition. In their hearts, you sense ISDA’s crack drafting squad™ knew this, for they couldn’t find it in themselves to even capitalise it. In the 1992 ISDA, rate of exchange didn’t even make the Definitions section, but was half-heartedly tacked onto the end of a clause halfway through the Contractual Currency section. It made it into the 2002 ISDA’s Definitions Section only because it somehow wangled its unecessary way into the new Set-off clause (Section 6(f) of the 2002 ISDA).

But if two guiding principles of defining terms are (i) don’t, for terms you only use once or twice, and (ii) don’t, if the meaning of the thing you are considering defining is patently obvious — then “rate of exchange” comprehensively fails the main criteria of a good definition.

The JC’s general view is, all other things being equal, to ease comprehension, eschew definitions.

Also, could they not have used “exchange rate”, instead of rate of exchange?

Section 8(c)

So who even knew the things in Section 8(a) and 8(b) were indemnities?

They are, in the strict literal sense of an indemnity: a contractual promise to pay a sum of money (the difference between the amount paid in the Non-Contractual Currency and the actual amount owed in the Contractual Currency) in circumstances not (strictly) amounting to a breach; they are not in the popular (but misconceived) conception of an indemnity as some kind of all-conquering smart bomb.

Now, we must hush, if we want to get home at a reasonable hour, because the Indemnity is one of the JC’s pet subjects. Get him started and that’s the evening gone.

Section 8(d)

So if your clottish counterparty can’t follow simple instructions and sends you Lire rather than Pesetas, and thereby fails to cover your loss, as long as you can prove what the exchange rate was at the time you would have exchanged it into the Contractual Currency, you can recover a loss, even if you didn’t.

Now this, to me, seems a little controversial. What if the exchange rate dropped through the floor, then recovered, and the Non-Affected Party held his nerve. Can he then cherry-pick? Template:M detail 2002 ISDA 8

Section 9

Section 9 in a nutshell

9. Miscellaneous
9(a) Entire Agreement. This Agreement is the entire agreement between the parties on its subject matter. Neither party has relied on any representation (except the actual Representations) when entering into it and each party therefore waives all rights it might otherwise have to claim it has. That said, nothing will limit either party’s liability for fraud.
9(b) Amendments. An amendment of, or waiver given under, this Agreement will only be effective if in writing and executed by each of the parties otherwise suitably electronically confirmed.
9(c) Survival of Obligations. Without prejudice to Sections 2(a)(iii) and 6(c)(ii), the parties’ obligations will survive the termination of any Transaction.
9(d) Remedies Cumulative. Except otherwise stated, a party’s rights under this Agreement are additional to any rights it happens to have at law.
9(e) Counterparts and Confirmations.

9(e)(i) Counterparts: This Agreement (and any amendment) may be executed in counterparts.

9(e)(ii) Confirmations: The parties will be bound by the terms of each Transaction from the moment they agree to those terms. They must agree a confirmation (which they will designate as a Confirmation) as soon as practicable afterwards. The Confirmation will be evidence of a binding supplement to this Agreement. They may do this electronically (including by email!).

9(f) No Waiver of Rights. A failure to exercise any right under this Agreement will not waive that right. Any exercise of a right will not be preclude any later exercise of that right, or the exercise of any other right.
9(g) Headings. Headings in this Agreement are for convenience only and should not be considered when interpreting this Agreement.
9(h)(i) Prior to Early Termination. Before an Early Termination Date is designated for the relevant Transaction:―

(1) Interest on Defaulted Payments. If a party defaults on any payment obligation, it will pay interest on the overdue amount from the original due date to the actual payment date (excluding any relevant Waiting Period), at the Default Rate.

(2) Compensation for Defaulted Deliveries. If a party defaults on any delivery obligation, it will, on demand:

(A) compensate the other party per the relevant Confirmation; and

(B) pay interest on the fair market value of the delivery obligation from the original due date to the actual delivery date (excluding any period to which clause (4) below applies), at the Default Rate. The innocent party will determine the fair market value as of the scheduled delivery date in good faith and a commercially reasonable manner.

(3) Interest on Deferred Payments. If:―

(A) a party does not pay an amount that, but for Section 2(a)(iii), would have been payable, it will, subject to (B) and (C) below, pay interest on demand from the date the amount would otherwise have been payable to the date it actually becomes payable, at the Applicable Deferral Rate;

(B) a payment is deferred under Section 5(d), the party which would otherwise have been required to make it will (as long as no Event of Default or Potential Event of Default exists, pay interest on demand from the original due date to the earlier of the date it is no longer deferred and the date on which the Event of Default or Potential Event of Default occurs, at the Applicable Deferral Rate; or

(C) a party fails (after giving effect to any deferral period set out in (B) above) to make any payment because of an Illegality or a Force Majeure Event it will, as long as the Illegality or Force Majeure Event continues and no Event of Default or Potential Event of Default exists, pay interest on demand from the date the party failed to make the payment (or, if later, the date the payment is no longer deferred) to the earlier of the date on which the Illegality or Force Majeure Event ceases and the date on which an Event of Default or Potential Event of Default occurs to that party (excluding any period in which compensation is due under clause (B) above), at the Applicable Deferral Rate.

(4) Compensation for Deferred Deliveries. If:―

(A) a party does not settle any delivery that, but for Section 2(a)(iii), it would have been required to make; or

(B) a delivery is deferred under Section 5(d); or

(C) a party fails to deliver because of an Illegality or Force Majeure Event when any applicable Waiting Period has expired,

that party will compensate and pay interest to the other party on demand (after such delivery becomes required) as required the relevant Confirmation.

9(h)(ii) Early Termination. Upon an Early Termination Date on a Transaction:―

9(h)(ii)(1) Unpaid Amounts. To determine an Unpaid Amount for that Transaction, interest will accrue on any payment obligation or the fair market value of any delivery obligation from the date the obligation was due to be performed until the Early Termination Date, at the Applicable Close-out Rate.

9(h)(ii)(2) Interest on Early Termination Amounts. If an Early Termination Amount is due it must be paid with interest in the Termination Currency from the Early Termination Date until the date it is paid, at the Applicable Close-out Rate.

9(h)(iii) Interest Calculation. Any interest under this Section will compound daily and be for the actual number of days elapsed.

Comparison between versions

Section 9(a): The first sentence is more or less the same in each version. Then the 2002 ISDA adds a lengthy disclaimer of any pre-contractual representations — presumably, not counting the express ones patiently documented in Section 3.
Section 9(b): Section 9(b) is, as far as makes any difference whatsoever unchanged between the 1992 ISDA and the 2002 ISDA. There are some formalistic changes, but — you know.
Section 9(c): Section 9(c) is identical as between 1992 ISDA and the 2002 ISDA.
Section 9(d): This clause is identical in the 1992 ISDA and the 2002 ISDA.
Section 9(e): But for some finicking around at the margin — allowing Confirmations to be exchanged by telex, fax or email; that kind of thing — the 2002 ISDA is substantially the same as for the 1992 ISDA
Section 9(f): This clause is identical in the 1992 ISDA and the 2002 ISDA.
Section 9(g): This clause is identical in the 1992 ISDA and the 2002 ISDA.
Section 9(h): There is no strict equivalent to Section 9(h) in the 1992 ISDA. But see Section 2(e), which is a half-arsed attempt at the same thing.

Friends of the JC will know that “half-arsed” isn’t always bad, of course — it can be quite good, in fact — characterising, as it does, the sum total of the JC’s paltry achievements on this barren rock — and in any case, it leaves something to the imagination and we all like a little private intellectual space to indulge our whims and fantasies every now and then, don’t we?

As you step through this monstrosity, going to town on devilish details as it does, you may find it leads you directly into the “I’m sorry I asked” file.

Are you sorry yet? Well, you did ask.

Discussion

Section 9(a)

What you see is what you get, folks: if it ain’t written down in the ISDA Master Agreement, it don’t count, so no sneaky oral representations. But, anus matronae parvae malas leges faciunt, as we Latin freaks say: good luck in enforcing that if your counterparty is a little old lady.

Note also that liability for a fraudulent warranty or misrepresentation won’t be excluded. So if your oral representation or warranty is a bare-faced lie, the innocent party can maybe still rely on it in entering the agreement, even if it isn’t written down, though good luck parsing the universe of possible scenarios to figure out when that qualification might bite.

Smart-arse point: A warranty is a contractual assurance, made as part of a concluded contract, and cannot, logically, be relied on by the other party when entering into the contract. An assurance on which one relies when deciding to enter into a contract is a representation.

Confirmations

“This Agreement”, courtesy of how it is defined in Section 1(c), includes the ISDA Master pre-printed form, Schedule and each Confirmation entered into under it.

The entire agreement clause is legal boilerplate to nix any unwanted application of the parol evidence rule — to make sure one only cares for the four corners of the written agreement, and no extra-documentational squirrelling is allowed. Which might be a problem because the time-honoured understanding between all right-thinking derivatives trading folk is that the oral agreement, between the traders is the binding legal agreement, and not the subsequent confirmation, hammered out between middle office and operations folk after the trade is done. Hasten to Section 9(e)(ii) — the Confirmation is only evidence of the binding agreement. Could that be it?

Section 9(b)

ISDA’s crack drafting squad™ takes a clause which didn’t really need to be said, and converts it into a monster. If we convert this to symbolic logic it must mean this:

Effective amendment or waiver =In writing AND [EITHER executed by each party OR confirmed by exchange of [EITHER Telex OR electronic message]]

“In writing” means recorded for posterity, in words ingestable by means of the eyes, as opposed to the ears. This is not the OED definition, I grant you — I made it up just now — but it zeroes in on the immutable fact that, whether it is on parchment, paper, cathode ray tube, LED screen or electronic reader, you take in writing by looking at it. Not “orally” — from the mouth — or for that matter, “aurally” — through the ears — nor, in the JC’s favourite example, via semaphore — by a chap waving flags from a distant hill — but in visible sentences, made up of visual words.

Sentences. Words. Mystic runes carved upon the very living rock. Anything else? Could “writing” include memes? GIFs? Emojis? We suppose so — but do you “write” them, as such? — but to the wider question “can communications apprehended visually but of a non-verbal nature be contractually significant?” the answer is undoubtedly yes.

Acceptance, to be legally binding, need not be “in writing”. Nor “orally”. Acceptance just needs to be clear. Whether one has accepted is a matter for the laws of evidence. There is little doubt that one who has signed, sealed and delivered a parchment deed by quill in counterpart has accepted its contents — it is about as good evidence as you could ask for, short of the fellow admitting it in cross-examination — but a merchant need not, and often does not, reach this gold standard when concluding commercial arrangements about town.

Who has not stumbled morosely into the newsagent of a Sunday morning, wordlessly pushed a copper across the counter and left with a copy of The Racing Post, not having exchanged as much as a glance with the proprietor? Do we doubt for an instant that a binding contract was formed during that terse interaction?

There is, in theory, a whole ecosystem of non-verbal communications — winks, nods, wags, shaken heads, facial tics and cocked eyebrows — and nor should we forget, those who stand on distant hills and communicate by smoke signal, Greek heroes who miscommunicate their safe return by sail colour or modern admirals who transmit instructions to the fleet using a flag sequence.

Any of these can, in theory, convey offer, acceptance and consideration as well can a written or oral communication.

Emojis

The King’s Bench of Saskatchewan — not an English court to be sure, but of persuasive value, especially when speaking this much sense — has recently affirmed the JC’s conviction about emojis 😬.

In an argument about whether a merchant was bound to supply a consignment of flax on the back of an exchange of SMS messages.

The plaintiff drew up a contract to purchase SWT 86 metric tonnes of flax from the defendant, wet-signed it, took a photo of the contract and texted the photo to the defendant with the text message: “Please confirm flax contract”.

The defendant texted back “👍”.

The defendant didn’t eventually deliver the flax, and by the time the plaintiff could source alternative flax prices had gone up. The plaintiff claimed damages.

The defendant argued the thumbs-up emoji simply confirmed that he received the Flax contract but was not acceptance of its terms. He claimed he was waiting for the full terms and conditions of the Flax Contract to review and sign. Partly on the basis of a prior course of dealing with deals done on monosyllabic text messages, the court wasn’t having it:

“This court readily acknowledges that a 👍 emoji is a non-traditional means to “sign” a document but nevertheless under these circumstances this was a valid way to convey the two purposes of a “signature” – to identify the signator ... and as I have found above – to convey ... acceptance of the flax contract.

I therefore find that under these circumstances that the provisions of [the Canadian Sale of Goods Act 1978] have been met and the flax contract is therefore enforceable. ”

Section 9(c)

Netting and close-out

Why should this matter here? Well, because netting, in a word. Here the fabulous nuances of the ISDA Master Agreement come into play. Close-out netting — as we all know, a clever if somewhat artificial and, in practical application, quite tedious concept — is not something that just happens by operation of the common law. Set-off, which does, is a narrower and flakier thing requiring all kinds of mutuality that might not apply to your ISDA Master Agreement.

The contractual device of close-out netting, by contrast, relies on the patient midwifery of ISDA’s crack drafting squad™ and the sophisticated contrivances they popped into the ISDA Master Agreement: especially the parts that say all Transactions form a Single Agreement, and those long and dusty passages in Section 6 which painfully recount how one terminates those Transactions and nets down all the resulting exposures should things go tits up.

Now, it really wouldn’t do if one were found to have thrown those clever legal artifacts on the fire before seeking the common law’s help to manage your way out of a portfolio with a busted counterparty would it. Section 9(c) is there to avoid the doubt that you might have done so: Just because you’ve declared an Early Termination Date, that doesn’t mean all bets are off. Just the live Transactions.

As far as the JC can see, through his fogged-up, purblind spectacles, this doubt, like most, didn’t need avoiding and shouldn’t have been present in the mind of a legal eagle of stout mental fortitude: it is clear on its face that terminating a transaction under pre-specified mechanism in the contract is not to cancel the contract and sue for damages, but to exercise an option arising under it, and all your mechanical firepower remains in place.

Indeed, there is no mechanism for terminating an ISDA Master Agreement itself, at all. Even in peace-time. This has led at least one commentator to hypothesise that this proves that derivatives trading is all some kind of Illuminati conspiracy.

Section 9(d)

Over the centuries the common law, as we know, has done a fine job of shaping and polishing a merchant’s remedies for breach of contract: — remedies which are, broadly, indifferent to what the contract happens to say.

The reason for that is simple: by the time a merchant comes to ask about its rights upon breach, the instrument that conferred them is broken.

Fruity expectations of a healthy, long and fecund forward relationship lie suffocating upon the salted earth. The contract is the proverbial “ex parrot”: it is no longer a reliable guide to how one should expect the other to behave. The defaulter is a defaulter and cannot be relied upon to do what she promised to do. So, nor is the aggrieved party be expected to carry on doggedly popping coppers in the slot: the common law asks that she conducts herself reasonably and with good faith in the circumstances; it does not demand a total want of common sense.

The sacred pact having fractured, it is for the court to draw upon its centuries of analogy to put the matters right.

It does that by reference to its own principles, not the contract’s: causation, contribution, foreseeability and determinacy of loss. the court applies these to the deal the suitor thought it had to work out a juridical compensation for its loss of bargain.

That is the magnificent furniture the laws of England bestow upon us. It seems counterproductive — passive aggressive, almost — for a party to insist, in detail, on what should happen its customer does not do it promises to do. Bloody-minded, almost.

Where the contract involves a bank, though — especially one that is lending you money — it is de rigueur. Banks like to rule out doubt, help themselves to extra rights: liens, set-off, netting of liabilities — banking contracts are a kind of research and development department where clever people contrive intricate clockwork escapements governing the grounds on which they deploy capital. Here “ex-parrotness” is the overriding mischief a lender seeks to manage, and legal eagles like to reinforce the ancient customary rules of contract.

It isn’t that the common law is no good; it is just that where you clearly foresee a specific breach, a contract can be better. The law of unintended consequences rules the world of finance, though, and it is not hard to imagine carefully drawn contractual terms working out worse than the general rules relating to fundamental breach. Hence this boilerplate: careful provisions designed to assist a wronged party should not be allowed to get in the way of general law of contract if it would work out to be better, and this slug of boilerplate is meant, to ensure — by means of contractual term — that they do not.

Section 9(e)

In which the ISDA Master Agreement deals with the pointless topic of counterparts, and the workaday one of Confirmations.

Section 9(e)(i) Counterparts

There is an impassioned essay about the idiocy of counterparts clauses elsewhere. For now, just know this:

Black’s Law Dictionary has the following to say on counterparts:

“Where an instrument of conveyance, as a lease, is executed in parts, that is, by having several copies or duplicates made and interchangeably executed, that which is executed by the grantor is usually called the “original,” and the rest are “counterparts;” although, where all the parties execute every part, this renders them all originals.”

Sometimes it is important that more than one copy of a document is recognised as an “original” — for tax purposes, for example, or where “the agreement” must be formally lodged with a land registry. But these cases, involving the conveyance of real estate, are rare — non-existent, indeed, when the field you are ploughing overflows with flowering ISDA Master Agreements, confidentiality agreements and so on. If yours does — and if you are still reading, I can only assume it does, or you are otherwise at some kind of low psychological ebb — a “counterparts” clause is as useful to you as a chocolate tea-pot.

Indeed: even for land lawyers, all it does is sort out which, of a scrum of identical documents signed by different people, is the “original”. This is doubtless important if you are registering leases in land registries, or whatever other grim minutiae land lawyers care about — we banking lawyers have our own grim minutiae to obsess about, so you should forgive us for not giving a tinker’s cuss about yours, die Landadler.

ANYWAY — if your area of legal speciality doesn’t care which of your contracts is the “original” — and seeing as, Q.E.D., they’re identical, why should it? — a counterparts clause is a waste of trees. If the law decrees everyone has to sign the same physical bit of paper (and no legal proposition to our knowledge does, but let’s just say), a clause on that bit of paper saying that they don’t have to, is hardly going to help.

Mark it, nuncle: there is a chicken-and-egg problem here; a temporal paradox — and you know how the JC loves those. For if your contract could only be executed on several pieces of paper if the parties agreed that, then wouldn’t you need them all to sign an agreement, saying just that, on the same piece of paper? And since, to get that agreement, they will have to sign the same piece of paper, why don’t you just have done with it and have them all sign the same copy of the blessèd contract, while you are at it?

But was there ever a logical cul-de-sac so neat, so compelling, that it stopped a legal eagle insisting on stating it anyway, on pain of cratering the trade? There are little eaglets to feed, my friends.

“Trade” versus “confirmation”: celebrity death-match

If a trader agrees one thing, and the confirmation the parties subsequently sign says another, which gives? A 15 second dealing-floor exchange on a crackly taped line, or the carefully-wrought ten page, counterpart-executed legal epistle that follows it?

The original oral trade prevails. As to why — we address that in the premium section.

Dare we mention ... email?

Note also the addition of e-mail as a means of communication to the 2002 ISDA (email not really having been a “thing” in 1992). This caused all kinds of fear and loathing among the judiciary, when asked about it, as can be seen in the frightful case of Greenclose v National Westminster Bank plc.Oh dear, oh dear, oh dear.

Timely confirmation regulations and deemed consent

Both EMIR and Dodd Frank have timely confirmation requirements obliging parties to have confirmed their scratchy tape recordings within a short period (around 3 days). This fell out of a huge backlog in confirming structured credit derivatives trades following the Lehman collapse.

Roger Moore indahouse

Lastly, a rare opportunity to praise those maestros of legal word-wrangelry, ISDA’s crack drafting squad™. In Section 9(e)(ii), they contemplate that one might agree a Transaction “orally or otherwise”. This is a smidgen wider than the usual legal eagle formulation of orally or in writing. It shows that while the swaps whizzes were conservative about how to close out a Transaction, when putting one on you are constrained only by the bounds of your imagination and the limits of interpersonal ambiguity: not just written words, nor even oral ones, but the whole panoply of possible human communications: semaphore, naval flags, Morse code, waggled eyebrows, embarrassed smiles and any other kinds of physical gesture.

Section 9(f)

Waiver: a place where the laws of the New World and the Old diverge. Does one really need a contractual provision dealing with the consequences of a fellow’s good-natured indulgence when carrying on commerce under an ISDA Master Agreement? Those with an English qualification will snort, barking reference to Hughes v Metropolitan Railway and say this Section 9(f) is inconsequential fluff that goes without saying; those acquainted with the Uniform Commercial Code and the monstrous slabs of Manhattan will tread more carefully, lest they create a “course of dealing”.

Since the ISDA Master Agreement was designed with either legal system in mind, ISDA’s crack drafting squad™ came up with something that would work in either. To be sure, it is calculated to offend literary stylists and those whose attention span favours minimalism amongst those who ply their trade in the old country, but it does no harm.

Section 9(g)

So suddenly, in Section 9(g) of all places, the members of ISDA’s crack drafting squad™ wake up out of their collective fever dream, and this is what they say: It’s like, “okay, so we wrote them; we did put them here — hands up, we admit it — but we don’t mean anything by them”. And what is a fellow to make of the headings before Section 9 that, short days ago, being a logical fellow, I read, enjoyed and imbued with symbolic meaning? Am I supposed to just throw that crystalline construct away now? It just seems such a waste.

Don’t you just love lawyers?

Section 9(h)

Section 9(h) deals with the various scenarios where interest — over and above the amounts stated to be payable as Fixed Rate and Floating Rate Options under a given Transaction — might apply to deferred and delayed payments under the ISDA.

Those scenarios are:

Payment default: Someone fails to pay money under a Transaction when they are meant to.

Delivery default: Someone fails to deliver a non-money asset under a Transaction when they are meant to.

Non-default deferral: Some other externality intervenes to make payment impossible, which does not amount to default: a market disruption, a Force Majeure Event, a forced suspension of obligations for reasons beyond the control or fault of either party.

The innocent and the damned

In that magically over-complicated way that is the blast signature of ISDA’s crack drafting squad™, the interest rate that applies to delinquency differs depending on the reason for it; the more “at fault” a party is, the more punitive the rate.

“Innocent” deferrals attract a rate called the Applicable Deferral Rates. The more punitive one are called Default Rates. (This, by the way, is one of the significant “upgrades” from the 1992 ISDA, which had a rather half-hearted penalty interest provision in Section 2(e)).

Assets versus cash

Also, the calculation basis is more complicated if the deferral involves the delivery of an asset since you need a way of figuring out the market value of the asset on which interest can be said to accrue.

Waiting periods

And since one kind of deferral can morph into another — upon the expiry of a Waiting Period, for example — the exact computation of deferrals is fraught. You might even think that the ’squad’s quest for infinite exactitude in a scenario which in many cases will include a bankrupt debtor who isn’t going to pay you much of what you are owed in any case, is a bit overdone. We couldn’t possibly comment.

Section 10

Section 10 in a nutshell

10. Offices; Multibranch Parties

10(a) If this Section applies, whenever a party enters a Transaction through a branch Office, it represents that recourse against it will be the same as if it had entered through its head office (subject to any Waiting Period for an Illegality or a Force Majeure Event).

10(b) If a party is a Multibranch Party it may, subject to clause 10(c) below, enter into and book Transactions and make and receive payments through Office listed for that party in the Schedule.

10(c) The Office through which a party enters into a Transaction will be specified in the Confirmation or, if not specified, that party’s head office. The specified Office will also be the Office in which that party books and makes and receives payments and deliveries under Transaction. Except to make a Transfer to Avoid Termination Event neither party may change its specified Office for a Transaction without the the other’s prior written consent.

Comparison between versions

A bit of development from the 1992 ISDA to cater for the more fiddlesome nature of the 2002 ISDA (in particular the effect of Illegality and Force Majeure events that affect some branches of a Multibranch Party but not others).

Discussion

Section 10 of the ISDA Master Agreement allows parties to specify whether they are Multibranch Parties. Electing “Multibranch Party” status allows you to transact out of the named branches of the same legal entity.

Section 10(a)

A seldom-regarded but basically potty representation thrown in to allow parties to represent that if it trades through a minor branch, recourse against it will be no different from the recourse it would have had it traded though its head office.

Law students of all vintages will remember from Company Law class that this is necessarily the case: this is what the legal fiction of the “corporate legal personality” is designed to do: create a new, unitary “person” who is liable at law, can sue and be sued, live, love and survive independently of its stakeholders, for anything done in the name of that company — as long as intra vires and properly authorised by the company, regardless of where and through whose agency it is done.

Now it may be the case that certain primitive jurisdictions, for certain primitive entity types, this is not the case but, if so, the answer ought to be do not trade with entities like that or, if you really must, do not trade with entities like that out of branches that won’t bind the legal entity.

There is a chicken-and-egg problem here: if you do, then Q.E.D. the entity is not bound. Yes, you may be left with an action for damages (in tort — there is no contract, remember) for misrepresentation, but we think the better approach is for your onboarding and credit sanctioning teams to do their due diligence before you start trading, and avoid trading with entities like this.

Section 10(b)

The one place where all this lofty talk about “legal personhood” and “it not mattering a jot which part of a corporate organisation makes the promise to be bound by the contract” falls about is when it comes to taxation. Taxation authorities don’t care about holistic entities, only the bits of them that are in their jurisdiction and over whose income and outgoing they have power to tax.

So, while it might not matter to you or your counterparty which bit of your organisation “did the deed” or “reaped its rewards”, it will matter to their respective tax departments, and the taxing authorities to which appendages of the entity are beholden. Yes, the net tax burden on the whole entity is the same, but one still tries to “optimise” that burden as best one can, by arranging things to be as far beyond the reach of nefarious excise authorities as can be plausibly arranged. Don’t @ me folks: I don’t make the rules.

Section 10(c)

Again, a provision largely there to keep the respective tax departments happy. Each books the transaction depending on certain tax representations from the other; if the other then changes Offices or some such thing in a way that upsets that careful tax analysis, well —

Simple: just don’t fiddle with Offices and Branches post execution. Why would you? (Unless to correct an error you made on the Trade Date ... ) Details fans will immediately note that, from the point of view of legal and corporate philosophy — surely a subject dear to every attorney’s heart — the differing branches of a legal entity have no distinct legal personality any more than does a person’s arm or leg have different personality from her head. So being a “multibranch” party seems immaterial.

Taxation

Those details fans will have overlooked the strange, parallel universe of taxation. Here physical presence and not legal personality is what matters. Specifying that your counterparty may trade from its offices in, for example, Prague, Kabul or The Sudan may impact the tax payable on payments under the relevant transactions under the ISDA. Where both parties are multibranch parties and have numerous overseas branches, a complex multilateral analysis of all the different permutations is assured.

It is basically a withholding tax gross-up risk. If withholding tax arises on a payment made through your office in Tel Aviv, and the counterparty hasn’t provided evidence of an exemption from withholding, it may argue that we have to gross-up the payment because we did not disclose that we would make payments from Tel Aviv and had we, they would have proved their exemption. So failing to disclose that ILS payments will originate from Israel, may be a material misrepresentation by omission.

Therefore, a double-jeopardy: counterparties may refuse to make the necessary Payee Tax Representation because they didn’t think it would be needed. So, no Payee Tax Representation + no Multibranch ISDA election = potential withholding tax gross up or a possible Misrepresentation Event of Default.

Now you could disclose the branch in a Confirmation (but good luck remembering to do that, and you may not have one in an electronically booked Transaction), or you could inject more detailed representations in Part 5 — but none is as simple as putting “Tel Aviv” in the Multibranch election.

Must you complete onboarding in each jurisdiction though?

Yes — and no. A case where the operational reality trumps the legal theory. If you have a Multibranch ISDA that lists, say, Prague, The Sudan and Wellington, do you need to onboard the client in each of those jurisdictions? Students of onboarding will recognise this as a collossal disincentive to adding branches willy-nilly, but that legal implication will typically depend on an operational setup in the broker’s systems without which it won’t be possible to book a trade in that jurisdiction whatever the legal docs say. So look upon the legal contract as permissive; the thing that will drive your KYC obligations and trigger the onboarding onslaught will be opening an account in your systems at a later date.

Netting

While, by dint of the legal personality, it wouldn’t make any difference under English or New York law, and really shouldn’t anywhere else, there are those jurisdictions which are not so theoretically pure in their conceptualisation of the corporate form. Your counterparty may have the misfortune to be incorporated in such a place.

If so, the validity of close-out netting against that entity may indeed depend on the branch from which it transacts - and indeed there is a possibility that the governing law of the jurisdiction of the branch may endeavour to intervene (particularly relevant if it has assets). Another reason, perhaps, to disapply the “multibranch party” for a counterparty incorporated in such a jurisdiction. The way to check this is at the netting opinion review sheet contains the following question:

Does the opinion confirm that close-out netting under the agreement is enforceable notwithstanding the inclusion of branches in non-netting jurisdictions? Yes/No

Section 11

Section 11 in a nutshell

11 Expenses
A Defaulting Party will on demand indemnify the Non-Defaulting Party for all reasonable costs — including Stamp Tax — that the Non-Defaulting Party incurs in closing out Transactions and enforcing its rights against the Defaulting Party.

Comparison between versions

Observers will note that, but for the odd comma, Section 11 in the 1992 ISDA and the 2002 ISDA are identical. And deliciously brief. Not that they couldn’t be improved, of course; they just weren’t.

Discussion

An indemnity is all very well ...

Bear in mind, also, that your operating theory here is that your counterparty is a Defaulting Party — i.e., for all intents and purposes, broke. So while it’s a fine thing, this indemnity might not be of much practical use.

Is it covered in the close-out calculation?

No. The “Expenses” referred to in this provision would not be captured by the definition of “Close-out Amount” or “Early Termination Amount” because, Q.E.D., they arise only once that amount has been determined and the Non-Defaulting Party is in the process of collecting it.

Stamp Tax and Section 4(e)

In the limited circumstance of default, this section modifies the arrangement for who pays Stamp Tax as set out in Section 4(e) (which says it is the person whose tax residence precipitates it).

Applies to Events of Default, not Termination Events

This section applies only following an Event of Default, and not on a termination following an Termination Event. There is some cognitive dissonance there: while Events of Default in the main are meant to be more worthy of outrage than Termination Events — thereby justifying stentorian measures to recover losses and costs as a result — some Termination Events, and most Additional Termination Events — are credit- and solvency-related, thus equally deserving of the kind of opprobrium that would warrant on on-slapping of an indemnity. Template:M detail 2002 ISDA 11

Section 12

Section 12 in a nutshell

12. Notices
12(a) Effectiveness. Any communication under this Agreement may be given in any manner described below (except that communications about Events of Default and Termination Events or Early Termination may not be given by electronic messaging system or e-mail) as set out in the Schedule) and will be effective when delivered:―

(i) By hand: when delivered;

(ii) By telex: are you kidding me? Who has a telex these days? OK when the recipient’s answerback is received;

(iii) By fax: FAX??? When were you born Grampa? Ok when received in legible form (the burden of proof being on the sender and, no, a transmission report won’t do);

(iv) By registered mail: when delivered (or when delivery is attempted);

(v) By electronic messaging system: when received; or

(vi) By e-mail: when delivered delivered,

unless delivery or receipt happenens outside ordinary business hours on a Local Business Day, in which case it will be deemed effective on the following Local Business Day.
12(b) Change of Details. Either party may change its contact details by notice.

Comparison between versions

The major change between the versions of Section 12 (Notices) was the 2002 ISDA’s inclusion of e-mail as a means of communication in addition to the 1992 ISDA’s electronic messaging system. Also, fax and electronic messaging system are not permitted means of serving close-out communications (i.e., under Sections 5 and 6) under the 1992 ISDA, but fax is permitted under the 2002 ISDA, whereas electronic messaging system and email are not. Got all that?

Discussion

Who would have thought a Notices provision would be so controversial? Especially the question, “What is an electronic messaging system”?

This is defined, by the way, in Section 14 as:

“electronic messages” does not include e-mails but does include documents expressed in markup languages, and “electronic messaging system” will be construed accordingly.

No-one, it is humbly submitted, until Andrews, J. of the Chancery Division, was invited to opine on it in Greenclose v National Westminster Bank plc.

Mr Greenclose was the kind of “little old lady” — well, Welsh hotelier, but you get the picture — who induces judges to make bad law.

This decision does nothing to dispel the assumption that lawyers are technological Luddites who would apply Tip-Ex to their VDUs if they didn’t have someone to do their typing for them (and if they knew what a VDU was).

For there it was held that email is not an “electronic messaging system” and, as such, was an invalid means for serving a close-out notice under the 1992 ISDA, which doesn’t mention email. Read in-depth about that case here.

And that was before the entire, interconnected world decided, as an orchestrated whole, to cease the conduct of the business as a physical idea for an indefinite period in early 2020. Suddenly, a widely-used and, it was assumed, well-tested notices regime started to look like it might not work.

Oh, and another thing: who seriously has a telex in this day and age?

Mandatory, or not?

Section 12 specifies a variety of different formats by which a party “may” deliver notices under the ISDA Master Agreement. Ordinarily “may” implies discretion and optionality on a party, such that if it wishes it might choose something different. We have waxed lyrical elsewhere about the potential redundancy of such optional clauses. However, this is not how Andrews J saw this particular “may” in the idiosyncratic, but unappealed, case of Greenclose. This “may” means “must” and, as long as Greenclose remains the unchallenged last word in British jurisprudence, it excludes any other means of delivering a notice. Since hand-delivery and delivery by courier are mentioned but the ordinary post isn’t, this probably rules it out. (But if it’s important, who would use snail mail anyway?)

On the other hand it hardly needs to be said that all of the ordinary day-to-day communication under the ISDA Master Agreement between trading and back-office staff of each party — inconsequential matters like trading, payments, settlements, reconciliations, and margin — will happen by telephone and email, in naked disregard for the terms of the ISDA Master Agreement which, at that point, will be languishing languishing unobserved in an electronic document repository to which operations staff might not even have access. This somewhat gives the lie to Greenclose’s rather quaint apprehensions about how ISDA Master Agreements operate in practice.

Close-out notice restrictions

However curious Andrews J’s reasoning on “may”, note the overriding restriction on forms of notice for closing out: no email, no electronic messages. But note another dissonance: in the 1992 ISDA, close-out notification by fax was expressly forbidden; in the 2002, it is not: only electronic messaging systems and e-mail are verboten. Ironic, seeing how faxes have got on as a fashionable means of communication in the decades since they were sophisticated enough to be a plot McGuffin for a John Grisham novel.

“Deliver”

The Cambridge Dictionary says that to “deliver” is “to take goods, letters, parcels, etc. to people’s houses or places of work”.

Merriam Webster says it means “to take and hand over to or leave for another”.

The Collins Dictionary of British English, in a rather modishly modern English format, tells us “If you deliver something somewhere, you take it there”.

A bit more challengingly, the Lexico Oxford Dictionary says it means “bring and hand over (a letter, parcel, or goods) to the proper recipient or address”. Oxford’s language suggests a “handing” from sender to recipient, though a commonsense application of delivery through a letterbox to an address says the only “hands” involved are the sender’s.

An agent for the recipient does not need to be there; just that the notice is conveyed to the appointed place. It is no good refusing to answer the door, hiding behind the sofa or blocking up your letterbox with Araldite: if the sender’s agent brings a notice to your designated address, even by regular post, the sender has “delivered” it.

If it is, literally, impossible to arrange even an agent to hand-deliver a package, what then? Before the spring of 2020, most learned commentators would have regarded such a scenario as so absurd as to not dignify an answer. By April, ISDA was seeking advice about it.

Email vs electronic messaging system

A John Grisham McGuffin yesterday. well, in about 1986 actually.

The well-intended and, we think, presumed harmless — even modern — addition of email in the 2002 ISDA, in addition to “electronic messaging system”, persuaded the Chancery Division of the High Court to conclude that “electronic messaging system” and “email” are mutually exclusive things, rather than a basic commentary on ISDA’s crack drafting squad™ inability to let things go — a conclusion which the JC finds hard to accept, as you will see if you read the Greenclose v National Westminster Bank plc case note.

CSA

Note that the 1995 CSA subjects its notice provisions to this provision (see Paragraph 9(c) and 11(g). Template:ISDA notices and pandemics

Section 13

Section 13 in a nutshell

13. Governing Law and Jurisdiction
13(a) Governing Law. The governing law will be set out in the Schedule.
13(b) Jurisdiction. For any proceedings under this Agreement (“Proceedings”), each party irrevocably:―

13(b)(i) submits to:―

(1) for English law-governed Agreements, the non-exclusive jurisdiction of the English courts (or their exclusive jurisdiction where Proceedings involve a Convention Court); or

(2) for New York law-governed Agreements, the non-exclusive jurisdiction of the courts of the State of New York and the United States District Court located in Manhattan;

13(b)(ii) waives its right to object to such court as a venue for any Proceedings brought in, or claim it is an inconvenient forum, or that it has no jurisdiction; and

13(b)(iii) agrees that Proceedings brought in one jurisdictions will not preclude Proceedings in any other jurisdiction.

13(c) Service of Process. Each party appoints any Process Agent specified for it in the Schedule to receive service of process in any Proceedings. If a Process Agent cannot act, the appointing party must tell the other party and within 30 days appoint an acceptable substitute. The parties consent to service of process by hand, fax or registered mail per Section 12. This clause does not stop parties serving process in any other permissible manner.
13(d) Waiver of immunities. Each party irrevocably waives all sovereign immunity relating to any Proceedings and agrees not to claim any such immunity in any Proceedings.

Comparison between versions

Largely the same, in practical effect, between the two versions: the clause grants the non-exclusive jurisdiction of the courts of the governing law you have chosen: you can launch proceedings wherever you like, but you can’t complain if they are launched in a home court, which leaves open that you might complain if they are launched in some other, inconvenient, court.

No doubt a litigation lawyer would be outraged at this suggestion that the versions mean different things, but life’s too short.

Discussion

Section 13(a)

There are parts of the ISDA Master Agreement with which you will spend weeks, months, or even years of your life grappling, pushing and pulling the embedded and nested intellectual concepts around in your mind, scrabbling desperately for a handhold, trying with all your might to get some purchase on the forensic Play-Doh that these clauses represent. We are fairly confident, without even knowing you, that section 13(a) will not be one of them.

If it is, it may be time to get your coat.

Section 13(b)

On the disapplication of Section 13(b)(iii)

Where you wish to elect the exclusive jurisdiction of (say) English courts in your Schedule, you may wish to explicitly disapply the proviso to 13(b) which provides that nothing in this clause precludes the bringing of Proceedings in another jurisdiction (in the flush language of the 1992 ISDA version; in 13(b)(iii) of the 2002 ISDA version).

Strictly speaking, you shouldn’t need to do this: Section 1(b) provides that the inconsistency created by the use of the expression “exclusive jurisdiction” in the Schedule will prevail over the text the Master Agreement. But that won’t stop officious attorneys the world over trying.

But, counselor, be warned: if you do try to explicitly override it — you know, for good measure and everything — and your counterparty pushes back, having deliberately taken the clarifying language out of a draft, you may be in a worse position when interpreting the meaning of “exclusive jurisdiction”, precisely because the counterparty refused to rule out the use of other jurisdictions. A cracking example of the anal paradox at work.

Don’t be too clever by half, in other words.

“Convention Court”

The 1968 Brussels Convention on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters is this fellow. Be my guest. Let me know what you find.

The 1988 Lugano Convention on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters is this puppy. Knock yourself out, and let us know how you get on.

Section 13(c)

English law

Process agent
/ˈprəʊsɛs ˈeɪʤᵊnt/ (n.)

An agent located in a jurisdiction who is appointed by a contracting counterparty outside that jurisdiction to accept service of legal proceedings filed against it in the courts of that jurisdiction, to discharge the procedural requirement that they are physically served within the jurisdiction.

For English law contracts the jurisdiction in question is that of “the courts of England and Wales” — there is no such thing as United Kingdom law — the rules of English civil court procedure require process physically to be served within England or Wales (or, in theory, their adjacent territorial waters). Service in Scotland — or its territorial waters — will not do. This means you can serve process on someone rowing a boat in the Bristol Channel, but not in Inverness, much less on someone escaping in rowing a boat to, for example, the Isle of Skye.

A contracting counterparty whom you cannot rely on being in England or Wales should you have to sue it — one who has no permanent place of business there — you might ask to appoint as its agent a company who reliably will be there, and who is prepared to receive process served upon the counterparty and pass it on to head office. That person is a “process agent”.

The best kind of process agent is an English-domiciled affiliate of the contracting entity who is happy to perform that role, as it generally will do it for free. But if you don’t have one, there are dedicated process agency businesses who will act as your process agent for, naturally enough, a suitably outrageous fee.

New York law

The New York rules of civil procedure are here. As you might expect, they seem complicated. CT Corporation seems to charge a lot for serving process — so we assume there is a reason for that.

Section 13(d)

Don’t confuse sovereign immunity with ultra vires — cue thunder crack at the mention of Orange County or Hammersmith and Fulham council and a dramatic look from our house gopher — for they are quite different things.

• Ultra vires: If a contract is beyond your powers or capacity to enter into a contract in the first place then it is void ab initio; any payments you have made under that contract are also void and you may reclaim them, and you can appeal to the court system to do that. That is to say, ultra vires is an “intra-legal” measure, recognised, defended and enforced by the courts.
• Sovereign immunity: Sovereign immunity is a different, “extra-legal” thing: it is to say “I am, quite literally, above the law: I am the law, and I do not have to subject myself to the judicial branch of my law — or anyone else’s law — unless I choose to.” This extends to being free from judicial intervention if I decide not to perform my contractual obligations, but it also means I cannot myself resort to the court process to make my counterparty perform its obligations. If I choose to go to court, then I subject myself fully to the courts as regards actions my counterparty wishes to bring against me.

Section 14

Section 14 in a nutshell

14. Definitions
“Additional Representation” is defined in Section 3.
“Additional Termination Event” is defined in Section 5(b).
“Affected Party” is defined in Section 5(b).
“Affected Transactions” means:

(a) for an Illegality, Force Majeure Event, Tax Event or TEUM, all Transactions affected by the Termination Event (and if it is an Illegality or Force Majeure Event that affects Credit Support Document covering only some Transactions, those Transactions) and

(b) for any other Termination Event, all Transactions.

An “Affiliate” of an entity is another entity that controls, is controlled by, or is under common control with, that entity, where to “control” means to own a majority of an entity’s voting power.
“Agreement” is defined in Section 1(c).
“Applicable Close-out Rate” means:—

(a) on an Unpaid Amount:—

(i) if the Defaulting Party’s obligation, the Default Rate;

(ii) if the Non-defaulting Party’s obligation, the Non-default Rate;

(iii) if a deferred obligation under Section 5(d), if there is no Defaulting Party during the deferral period, the Applicable Deferral Rate; and

(iv) in any other case following a Termination Event (except interest which accrues under (iii) above), the Applicable Deferral Rate; and

(b) on an Early Termination Amount:—

(i) from the Early Termination Date until the Early Termination Amount is payable:—

(1) if payable by a Defaulting Party, the Default Rate;

(2) if payable by a Non-defaulting Party, the Non-default Rate; and

(3) in all other cases, the Applicable Deferral Rate; and

(ii) from the date the Early Termination Amount is payable until it is actually paid:—

(1) if unpaid because of an Illegality or Force Majeure Event the Applicable Deferral Rate;

(2) if payable by a Defaulting Party (excluding any period where (1) above applies), the Default Rate;

(3) if payable by a Non-defaulting Party (excluding any period where (1) above applies), the Non-default Rate; and

(4) in all other cases, the Termination Rate.

“Applicable Deferral Rate” means:—

(a) For Section 9(h)(i)(3)(A) [payments deferred under Section 2(a)(iii)], the market rate actually offered by a major bank in the interbank market for overnight deposits in that currency that the payer chose in good faith;

(b) For Section 9(h)(i)(3)(B) [payments deferred during a Waiting Period because of an Illegality or Force Majeure] and clause (a)(iii) of Applicable Close-out Rate, the market rate actually offered by a major bank in the interbank market for overnight deposits in that currency that the payer chose in good faith and in consultation with the other party; and

(c) For Section 9(h)(i)(3)(C) [payments not made after a Waiting Period expires while the Illegality or Force Majeure subsists] and clauses (a)(iv), (b)(i)(3) and (b)(ii)(l) of Applicable Close-out Rate, the average of the rate the payer obtains under (a) above and the annual rate of the payee’s cost of funding of that amount.

“Automatic Early Termination” is defined in Section 6(a).
“Burdened Party” is defined in Section 5(b)(iv).
“Change in Tax Law” means the enactment of or amendment to any law (or official interpretation) after the relevant Transaction is executed.
“Close-out Amount” means the losses the Determining Party would incur (positive) or gains it would realise (negative) in replacing the material terms and the option rights of the parties under a Terminated Transaction, determined as of the Early Termination Date (or, if that would not be commercially reasonable, such dates following that date as would be commercially reasonable) in good faith and in a commercially reasonable manner. The Determining Party may determine Close-out Amounts for groups of Terminated Transactions as long as all Terminated Transactions are accounted for.
Unpaid Amounts and Expenses in respect of Terminated Transactions are excluded from the Close-out Amount calculation.
The Determining Party may consider any of the following (unless it thinks they aren’t available or would produce an unconscionable result):

(i) quotations for replacement transactions that factor in the Determining Party’s creditworthiness and the ISDA terms between the Determining Party and the quoting party;

(ii) third party market data; or

(iii) internal quotes or market data if used by the Determining Party in the regular course to value similar transactions.

“Confirmation” is defined in the preamble.
“consent” includes things that are functionally like consents.
“Contractual Currency” is defined in Section 8(a).
“Convention Court” means any court which must apply Article 17 of the 1968 Brussels Convention or Article 17 of the 1988 Lugano Convention.
“Credit Event Upon Merger” is defined in Section 5(b).
“Credit Support Document” means anything described as such in the Schedule.
“Credit Support Provider” is defined in the Schedule.
“Cross Default” is defined in Section 5(a)(vi).
“Default Rate” means the payee’s self-certified cost of funding plus 1% per annum.
“Defaulting Party” is defined in Section 6(a).
A “Designated Event” means that the relevant entity:―

(1) merges with, or transfers substantially all of its assets into, or reorganises itself as another entity;

(2) comes under the effective voting control of another entity; or

(3) makes a substantial change in its capital structure by issuing or guaranteeing debt, equities or analogous interests, or securities convertible into them;

“Determining Party” means the party who determines the Close-out Amount.
“Early Termination Amount” is defined in Section 6(e).
“Early Termination Date” means the date determined under Section 6(a) or 6(b)(iv).
“electronic messages” and “electronic messaging system” excludes e-mails but includes XML documents and similar markup languages.
“English law” means the law of England and Wales. “Event of Default” is defined Section 5(a) as modified by the Schedule.
“Force Majeure Event” is defined in Section 5(b).
“General Business Day” means a day on which commercial banks are open for business.
“Illegality” is defined in Section 5(b).
An Indemnifiable Tax is any Tax that is not a Stamp Tax that is not a tax that would not be imposed if there were not a connection between the taxing authority’s jurisdiction and the recipient that did not arise solely from the recipient having performed any part of this Agreement in that jurisdiction.
“law” includes any treaty, law, rule or regulation, or tax practice.
“Local Business Day” means a General Business Day:

(a) For performing one’s general obligations: where specified in the Confirmation and where any relevant settlement system is operating;

(b) For working out when a Waiting Period expires: Where the Illegality or Force Majeure Event occurs,

(c) For any other payment: Where the account is located and, the principal financial centre for the relevant currency;

(d) For communications: For the recipient (and, for a Change of Account, where the new account will be located); and

(e) For a Default under Specified Transaction: In the relevant locations for performance under the Specified Transaction.

“Local Delivery Day” means, for purposes of Sections 5(a)(i) and 5(d), a day on which settlement systems are generally operating in the location specified in the Confirmation are open for business so delivery can be settled by usual market practice.
“Master Agreement” is defined in the preamble.
“Merger Without Assumption” is defined in Section 5(a)(viii).
“Multiple Transaction Payment Netting” is defined in Section 2(c).
“Non-affected Party” means the party that isn’t the Affected Party, if there is one.
“Non-default Rate” means a rate obtained in good faith by the Non-defaulting Party from a major bank in the interbank market for overnight deposits to reasonably reflect prevailing market conditions.
“Non-defaulting Party” is defined in Section 6(a).
“Office” means any of a party’s branches or offices.
“Other Amounts” is defined in Section 6(f).
“Payee” is defined in Section 6(f).
“Payer” is defined in Section 6(f).
“Potential Event of Default” means an event which, with the giving of notice or the passing of time, would be an Event of Default.
“Proceedings” is defined in Section 13(b).
“Process Agent” is defined in the Schedule.
“Rate of exchange” includes any premiums or exchange costs of buying or converting into the Contractual Currency.
“Relevant Jurisdiction” means any jurisdictions where a party (a) is incorporated and controlled, (b) has a specified Office (c) executes this Agreement; or (d) makes payments under this Agreement.
“Schedule” is defined in the preamble.
“Scheduled Settlement Date” means a due date for payment or delivery under Section 2(a)(i).
“Specified Entity” is defined in the Schedule.
“Specified Indebtedness” means any borrowed money.
“Specified Transaction” means:

(a) any transaction between the parties to this Agreement (or their respective Credit Support Providers or Specified Entities) which is not governed by this Agreement, but

(i) is a swap, option, forward, foreign exchange, cap, floor, collar, credit protection or spread transaction, repo, buy/sell-back, securities lending, index or forward purchase or sale of a security, commodity or other financial instrument;or

(ii) is a similar transaction forward, swap, future, option or other derivative on any rates, currencies, commodities, financial instruments, benchmarks, indices or other measures of economic risk that is at any time common in the financial markets;

(b) any combination of the above; and

(c) any transaction specified as a Specified Transaction in the Schedule or confirmation.

“Stamp Tax” means any stamp or documentation tax.
“Stamp Tax Jurisdiction” is defined in Section 4(e).
“Tax” means any tax of any kind (including interest or penalties added to it) imposed by a taxing authority on any payment under this Agreement other than a Stamp Tax.
“Tax Event” is defined in Section 5(b).
“Tax Event Upon Merger” is defined in Section 5(b).
“Terminated Transactions” means, for a Early Termination Date resulting from:

(a) an Illegality or a Force Majeure Event, all Affected Transactions specified in the Section 6(b)(iv) notice;

(b) any other Termination Event, all Affected Transactions; and

(c) an Event of Default, all Transactions :

that were in effect immediately before the the Section 6(a) notice designating that Early Termination Date took effect or, if Automatic Early Termination applies, immediately before the Early Termination Date.
“Termination Currency” means the Termination Currency specified in the Schedule if it is freely available, and failing that euro for English law-governed Agreements or US Dollars for New York law-governed Agreements.
“Termination Currency Equivalent” means, for an amount denominated in any other currency, the Termination Currency amount needed to buy that other currency using the FX agent’s spot exchange rate at 11:00 a.m. (in its location) on the day one would customarily fix a rate to purchase that currency for value the relevant termination date.

If there is an Innocent Party, it will select the FX agent in good faith. If not, the parties must agree the FX agent. “Termination Event” means an Illegality, a Force Majeure Event, a Tax Event, a Tax Event Upon Merger an applicable Credit Event Upon Merger or an Additional Termination Event.
“Termination Rate” means each party’s self-certified average cost of funding.
“Threshold Amount” will be specified in the Schedule.
“Transaction” is defined in the Preamble.
“Unpaid Amounts” owing to any party means, with respect to a Early Termination Date, the aggregate, in each case as at such Early Termination Date, and together with any the Non-Defaulting Party’s Expenses, of:

(a) in respect of all Terminated Transactions, all amounts that had become payable but which remain unpaid;

(b) in respect of each Terminated Transaction, the fair market value of each obligation which had become due for delivery but has not been delivered; and

(c) where all Transactions are being terminated on the Early Termination Date, any due but unpaid Early Termination Amounts relating to a prior Termination Event,

together in each case with accrued but unpaid interest.
“Waiting Period” means:―

(a) for an Illegality (other than where performance under a Credit Support Document is required on the relevant day (here no Waiting Period will apply), three Local Business Days after the Illegality happened; and

(b) for a Force Majeure Event (other than where performance under a Credit Support Document is required on the relevant day (here no Waiting Period will apply), eight Local Business Days after the Illegality happened.

Comparison between versions

The basic definitions that propel and power the ISDA Master Agreement. There are a lot more definitions in the definitions section of the 2002 ISDA, but part of that is that it helpfully cross-references terms that are defined in the body of the Agreement, whereas the 1992 ISDA does not.

We have put together a handy colour-coded grid of which definitions go in which edition of the ISDA Master Agreement which is surprisingly useful — so useful, in fact, that we are keeping it for our favourite subscribers over in the you know where.

Discussion

Palaeontology 101: how things change

The basic reason for the differences between the different editions:

1987 to 1992

The 1992 ISDA was introduced principally, to:

• Expand range of products covered: Expand beyond interest rate and currency swaps.
• Netting: Enhance and strengthen close-out netting.
• Market developments: Reflect market developments — the period between 1987 and 1992 was a massive growth in the swaps market, and lessons were learned.
• Physical delivery: Allow for physical delivery of underlying instruments referenced in a swap (the only “underlying” for rates and fx is cash, so the 1987 ISDA only needed to contemplate the payment of cash).
• Settlement Amounts: Introduce greater flexibility for determining Settlement Amounts on termination of Transactions (introducing the Loss, Market Quotation, First Method and Second Method regimes thereafter replaced in the 2002 ISDA by Close-out Amount).
• Two-way payments on termination: Under the 1987 ISDA a Defaulting Party is not entitled to termination payments. This is the so-called “limited two-way payments” provision which was a large part of the reason 1987 ISDAs were not reliable on netting.
• Settlement netting: more flexibility for netting groups of transactions under Section 2 - under the 1987 ISDA you could either net just within a single Transaction or across all Transactions but not, as standard, across a given subset of Transactions.

1992 to 2002

The 2002 ISDA was introduced, primarily, to:

• Loss/MQ begone: Finally take out to the woodshed the whole Loss/Market Quotation farrago (and all that First Method and Second Method nonsense) by introducing the Close-out Amount.
• Reference market makers, Settlement Amounts also begone: That meant no need for Reference Market-makers, Settlement Amounts and so on so they went too.
• Force majeure: finally make an honest man out of , well, God, by adding a Force Majeure Event under Section 5(b)(ii) — hitherto parties had boshed up something custom each time.
• Waiting Time for Illegality: The 2002 ISDA builds out Illegality to include the Waiting Period concept (also used in Force Majeure Event come to think of it).
• Set-off: To finally end the gruesome cottage industry of half-arsed, half-witted set-off provisions that don’t really work, by providing an express, fully-arsed half-witted set-off provision that doesn’t really work (Set-off under Section 6(f)).

A list of the definitions

Here, for handy reference, is a list of all the definitions used in this edition of the ISDA Master Agreement:

14 Definitions

Additional Representation
Additional Termination Event
Affected Party
Affected Transactions
Affiliate
Agreement
Applicable Close-out Rate
Applicable Deferral Rate
Automatic Early Termination
Burdened Party
Change in Tax Law
Close-out Amount
Confirmation
consent
Contractual Currency
Convention Court
Credit Event Upon Merger
Credit Support Document
Credit Support Provider
Cross-Default
Defaulting Party
Designated Event
Determining Party
Early Termination Amount
Early Termination Date
electronic messages
English law
Event of Default
Force Majeure Event
General Business Day
Illegality
Indemnifiable Tax
law
Local Business Day
Local Delivery Day
Master Agreement
Merger Without Assumption
Multiple Transaction Payment Netting
Non-affected Party
Non-default Rate
Non-defaulting Party
Office
Other Amounts
Payee
Payer
Potential Event of Default
Proceedings
Process Agent
rate of exchange
Relevant Jurisdiction
Schedule
Scheduled Settlement Date
Set-off
Specified Entity
Specified Indebtedness
Specified Transaction
Stamp Tax
Stamp Tax Jurisdiction
Tax
Tax Event
Tax Event Upon Merger
Terminated Transactions
Termination Currency
Termination Currency Equivalent
Termination Event
Termination Rate
Threshold Amount
Transaction
Unpaid Amounts
Waiting Period
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