Miscellaneous - ISDA Provision
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2002 ISDA Master Agreement
A Jolly Contrarian owner’s manual™ Go premium
Crosscheck: 9 in a Nutshell™
Original text
See ISDA Comparison for a comparison between the 1992 ISDA and the 2002 ISDA.
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Comparisons
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.
Basics
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[1] 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. ”[2]
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.[3] 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.
Section 9(e)(ii) Confirmations
“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.
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See also
References
- ↑ Sail configuration can be tricky especially if you are absent-minded, however, as Theseus’ father-in-law might have told you, had he been around to do so.
- ↑ South West Terminal Ltd. v Achter Land, 2023 SKKB 116
- ↑ In the counterparts article, as a matter of fact.