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This is a page about the general concept of | {{a|banking|[[File:Crossing Threshold Hope.jpg|450px|thumb|center|an equally forlorn attempt to influence matters beyond one's control]]}}This is a page about the general, generally stupid, concept of {{t|cross default}}. | ||
===As a standard term in [[master trading agreement|master trading agreements]]=== | |||
===As a standard term in master trading | |||
For specific provisions see: | For specific provisions see: | ||
*{{isdaprov|Cross Default}} ({{tag|ISDA}}) | *{{isdaprov|Cross Default}} ({{tag|ISDA}}) | ||
*{{ | *{{fbfprof|Cross Default}} ([[FBF]]) | ||
*'''[[Cross Default - GMSLA Provision|Stock lending and repo have no cross default]]''': Neither the {{gmsla}} nor the {{gmra}} have, as standard, either a [[cross default]] or a [[default under specified transaction]] provision. ''[[Cross Default - GMSLA Provision|Unless some bright spark thinks it is a good idea to negotiate one in]].'' | |||
*'''Stock lending and repo have no cross default''': Neither the {{gmsla}} nor the {{gmra}} have, as standard, either a [[cross default]] or a [[default under specified transaction]] provision. | |||
===Compare and contrast=== | ===Compare and contrast=== | ||
*'''[[Default under specified transaction]]''': | *'''[[Default under specified transaction]]''': {{t|DUST}} is ''like'' [[cross default]], but just between you and me, on [[derivative]] transactions and without a {{isdaprov|Threshold Amount}}; | ||
*'''[[Cross acceleration]]''': like [[cross default]], only for a kinder, gentler world where people wait for indebtedness to be actually [[accelerated]] before closing out their exposures. | *'''[[Cross acceleration]]''': like [[cross default]], only for a kinder, gentler world where people wait for [[indebtedness]] to be actually [[accelerated]] before closing out their exposures. | ||
==History== | ==History== | ||
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===Then the [[lawyer|lawyers]] and [[credit officer|credit officers]] start fiddling with things=== | ===Then the [[lawyer|lawyers]] and [[credit officer|credit officers]] start fiddling with things=== | ||
Cross default is a bad enough idea in a [[derivatives]] [[master agreement]] in the first place, before [[risk managers]] start having a go at it. Misguided things they can do include the following: | Cross default is a bad enough idea in a [[derivatives]] [[master agreement]] in the first place, before [[risk managers]] start having a go at it. Misguided things they can do include the following: | ||
*Widening it to include default under agreements which aren’t in the nature of indebtedness | *Widening it to include default under agreements which aren’t in the nature of [[indebtedness]]: for example, [[derivatives]], or even “any payment obligation”. | ||
*Adding in [[grace period]]s or other preconditions, excuses, permission to skip PE class and so on, before a party | :*This is problematic because of the accretive nature of the threshold: A single technical or operational failure may mean one is technically in default on payments which, if aggregated, could quickly exceed even a large threshold (especially in a heavily traded derivative master agreement). | ||
*Arguing the toss about [[threshold amount]]s (should it be shareholders funds or cash? or both? lower or higher of? Honestly it is so tedious). | *Not, in the case of banks, excluding [[deposit|retail deposits]], where operational failure or even governmental action (like a moratorium or currency controls) could lead to technical default on a large amount of indebtedness. (Bank deposits are a form of indebtedness, and will almost certainly be a significant source of indebtedness for any trading bank). | ||
*Adding in [[grace period]]s or other preconditions, excuses, permission to skip PE class and so on, before a party may invoke a [[cross default]]; | |||
*Arguing the toss about [[threshold amount]]s (should it be shareholders funds or cash? or both? lower or higher of? Is my threshold higher than yours? Is it too big? Is it too small? Does my {{isdaprov|Threshold Amount}} look big in this? Honestly it is so tedious). | |||
==Introduction== | ==Introduction== | ||
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* [[default under specified transaction]] which references default under financial contracts which do '''not''' represent indebtedness, but only as between the two counterparties to the present contract. | * [[default under specified transaction]] which references default under financial contracts which do '''not''' represent indebtedness, but only as between the two counterparties to the present contract. | ||
Cross default is potentially a very damaging clause, as this picture to the right amply illustrates. Or would do, if there were a picture to the right. To the extent it | Cross default is potentially a very damaging clause, as this picture to the right amply illustrates. Or would do, if there were a picture to the right. To the extent it doesn’t: | ||
===Cross | ===Cross default=== | ||
A cross default right effectively imports into the [[ISDA]] all the default termination rights under any {{isdaprov|Specified Indebtedness}} owed by a party: | |||
*It | *It dramatically (and indeterminately) widens the definition of {{isdaprov|Event of Default}}. | ||
* | *It entitles a [[Counterparty]] to [[cross accelerate|accelerate]] the {{tag|ISDA}} whether or not the {{isdaprov|Specified Indebtedness}} itself has been accelerated. | ||
*Depending on the market value of the | *Depending on the market value of the {{isdaprov|transaction}}s under the ISDA it may cause an immediate capital outflow (though is less likely to in these days of compulsory variation margin). | ||
===Specified Indebtedness=== | ==={{isdaprov|Specified Indebtedness}}=== | ||
Specified Indebtedness means, generally, any [[borrowed money|borrowings]] that, in aggregate, exceed a designated {{isdaprov|Threshold Amount}}. Because of the aggregation right, even comparatively trivial agreements can trigger the provision where they are relatively homogenous and affected by the same local circumstances (for example, retail | {{isdaprov|Specified Indebtedness}} means, generally, any [[borrowed money|borrowings]] that, in aggregate, exceed a designated {{isdaprov|Threshold Amount}}. Because of the aggregation right, even comparatively trivial agreements can trigger the provision where they are relatively homogenous and affected by the same local circumstances (for example, [[retail deposit]]s). A low {{isdaprov|Threshold Amount}}, therefore, presents three challenges: | ||
*It allows a more varied (and difficult to monitor) range of potential termination rights, because a greater number of agreements will qualify as Specified Indebtedness. | *It allows a more varied (and difficult to monitor) range of potential termination rights, because a greater number of agreements will qualify as {{isdaprov|Specified Indebtedness}}. | ||
*It “lowers the bar” so failures to comply with comparatively trivial financial commitments could be aggregated to trigger the Cross Default. | *It “lowers the bar” so failures to comply with comparatively trivial financial commitments could be aggregated to trigger the {{isdaprov|Cross Default}}. | ||
*By not excluding bank | *By not excluding [[bank deposit]]s, it raises the possibility of being triggered by localised events unrelated to a bank counterparty’s creditworthiness (for example, political action in a single jurisdiction which affects the bank's ability to pay on its local deposits) | ||
*Note that [[repo]] is not considered | *Note that [[repo]] is not considered {{isdaprov|Specified Indebtedness}}: see [[borrowed money]]. But don’t let your inner anal retentive amending the definition in your {{isdaprov|Schedule}} so that it is (even though [[repo]] is more properly dealt with by {{isdaprov|DUST}}). | ||
{{derivatives as specified indebtedness|isdaprov}} | |||
===Credit Mitigation=== | ===Credit Mitigation=== | ||
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===Contagion risk=== | ===Contagion risk=== | ||
It is important to maintain minimum standards which are reflective of genuine credit concerns against the bank so as to limit a | It is important to maintain minimum standards which are reflective of genuine credit concerns against the bank so as to limit a “[[snowball effect|snowball]]” effect: were we to allow a £50mm {{isdaprov|Threshold Amount}}, we would potentially be open to a large number of derivative counterparties simultaneously (and opportunistically) closing out [[out-of-the-money]] derivatives positions, which in itself could have massive liquidity and capital implications. |