Events of Default - GMSLA Provision

GMSLA Anatomy™ A Jolly Contrarian owner’s manual™ Go premium Overview — Summary — Premium — See also — Wikitext Crosscheck: →2010 GMSLA equivalent →Pledge GMSLA equivalent 10 in a Nutshell™ The JC’s Nutshell™ summary of this term has moved uptown to the subscription-only ninja tier. For the cost of ½ a weekly 🍺 you can get it here. Sign up at Substack. You can even ask questions! Ask about it here. Original text 10. Events of Default 10.1 Each of the following events occurring and continuing in relation to either Party (the Defaulting Party, the other Party being the Non-Defaulting Party) shall be an Event of Default but only (subject to sub paragraph 10.1(d)) where the Non Defaulting Party serves written notice on the Defaulting Party: 10.1(a) Borrower or Lender failing to pay or repay Cash Collateral or to deliver Collateral on commencement of the Loan under paragraph 5.1 or to deliver further Collateral under paragraph 5.4 or 5.5; 10.1(b) Lender or Borrower failing to comply with its obligations under paragraph 6.2 or 6.3 upon the due date and not remedying such failure within three Business Days after the Non Defaulting Party serves written notice requiring it to remedy such failure; 10.1(c) Lender or Borrower failing to pay any sum due under paragraph 9.1(b), 9.2(b) or 9.3 upon the due date; 10.1(d) an Act of Insolvency occurring with respect to Lender or Borrower, provided that, where the Parties have specified in paragraph 5 of the Schedule that Automatic Early Termination shall apply, an Act of Insolvency which is the presentation of a petition for winding up or any analogous proceeding or the appointment of a liquidator or analogous officer of the Defaulting Party shall not require the Non Defaulting Party to serve written notice on the Defaulting Party (Automatic Early Termination); 10.1(e) any warranty made by Lender or Borrower in paragraph 13 or paragraphs 14(a) to 14(d) being incorrect or untrue in any material respect when made or repeated or deemed to have been made or repeated; 10.1(f) Lender or Borrower admitting to the other that it is unable to, or it intends not to, perform any of its obligations under this Agreement and/or in respect of any Loan where such failure to perform would with the service of notice or lapse of time constitute an Event of Default; 10(g) all or any material part of the assets of Lender or Borrower being transferred or ordered to be transferred to a trustee (or a person exercising similar functions) by a regulatory authority pursuant to any legislation; 10(h) Lender (if applicable) or Borrower being declared in default or being suspended or expelled from membership of or participation in, any securities exchange or suspended or prohibited from dealing in securities by any regulatory authority, in each case on the grounds that it has failed to meet any requirements relating to financial resources or credit rating; or 10(i) Lender or Borrower failing to perform any other of its obligations under this Agreement and not remedying such failure within 30 days after the Non Defaulting Party serves written notice requiring it to remedy such failure. 10.2 Each Party shall notify the other (in writing) if an Event of Default or an event which, with the passage of time and/or upon the serving of a written notice as referred to above, would be an Event of Default, occurs in relation to it. 10.3 The provisions of this Agreement constitute a complete statement of the remedies available to each Party in respect of any Event of Default. 10.4 Subject to paragraphs 9 and 11, neither Party may claim any sum by way of consequential loss or damage in the event of failure by the other Party to perform any of its obligations under this Agreement. The Varieties of Stock Lending Experience Subject 2010 GMSLA 2018 Pledge GMSLA 1995 OSLA Applicability/Preamble 1 1 Preamble Interpretation 2 2 1 Definitions 2.1 2.1 1 Loans of Securities 3 3 2 Delivery 4 4 3 Collateral 5 5 6 Distributions and Corporate Actions 6 6 4 (“Rights and Title”) Rates for Loans and Collateral 7 7 4 Delivery of Equivalent Securities 8 8 7 Failure to Deliver 9 9 N/A Events of Default 10 10 12 Consequences of Events of Default 11 11 8 (“Set-off”) Taxation 12 12 9 Lender's Warranties 13 13 10 Borrower's Warranties 14 14 11 Interest on Outstanding Payments 15 15 13 Termination of Agreement 16 16 15 Single Agreement 17 17 N/A Severance 18 18 18 Specific Performance 19 19 19 Notices 20 20 20 Assignment 21 21 21 Non-Waiver 22 21 22 Governing Law and Jurisdiction 23 23 26 Time 24 24 24 Recording 25 25 25 Waiver of Immunity 26 26 N/A Expenses N/A 27 N/A Miscellaneous 27 28 N/A Resources and Navigation Navigation 2010 GMSLA 1 · 2 · 3 · 4 · 5 · 6 · 7 · 8 · 9 · 10 · 11 · 12 · 13 · 14 · 15 · 16 · 17 · 18 · 19 · 20 · 21 · 22 · 23 · 24 · 25 · 26 · 27 · Schedule · Agency Annex · Addendum for Pooled Principal Agency Loans 2018 Pledge GMSLA 1 · 2 · 3 · 4 · 5 · 6 · 7 · 8 · 9 · 10 · 11 · 12 · 13 · 14 · 15 · 16 · 17 · 18 · 19 · 20 · 21 · 22 · 23 · 24 · 25 · 26 · 27 · 28 · Schedule · Agency Annex Stock Loan owner’s manuals: 2010 GMSLA · 2000 GMSLA · Pledge GMSLA · OSLA Index: Click ᐅ to expand: GMSLA Pledge GMSLA

Comparisons

Redlines

2010 ⇒ 2018: Redline of the 2010 GMSLA vs. the 2018 Pledge GMSLA: comparison (and in reverse)

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Discussion

The major differences between the 2010 GMSLA and 2018 Pledge GMSLA Events of Default are:

1. Collateral obligations: Under the 2010 GMSLA it is bilateral and refers to Cash Collateral and the Delivery, but not return, of non-cash Collateral, whereas the 2018 Pledge GMSLA makes any failure to meet Collateral obligations an Event of Default.
2. Manufactured income: Under the 2010 GMSLA it is bilateral; under the 2018 Pledge GMSLA it applies against the Borrower only.
3. Failure to Pay or Deliver: Under the 2010 GMSLA it is bilateral; under the 2018 Pledge GMSLA it applies against the Borrower only.
4. Insolvency: There is an Automatic Early Termination trigger under the 2010 GMSLA but not the 2018 Pledge GMSLA.
5. The remainder of the Events of Default are the same as between the two versions, but the 2018 Pledge GMSLA surprises us at the last moment with a new subparagraph 10.1(j) containing a brand new “breach of security agreement” Event of Default.

Which is nice.

Basics

The consequences and ramifications of Events of default under the 2010 GMSLA and the 2018 Pledge GMSLA are different so this section varies quite a bit between the editions.

The reason for divergence

Why the differences in sections (a) through (d)? These reflect the different theoretical underpinnings. Unlike in the 2010 GMSLA the provider of Collateral in a 2018 Pledge GMSLA does not give up either title to it, or control over it: it sits quietly in a darkened corner of the triparty system, in a pledge account, immobilised, held for the security of a passive principal lender, but not going anywhere.

Unlike most pledge arrangements for financial assets in the derivatives trading world, which are a bit of a pantomime and ultimately a sham, a 2018 Pledge GMSLA pledge really is a pledge. The pledged Collateral assets don’t get re-optimised, they can’t be rehypothecated, sold, used, or eaten by the 2018 Pledge GMSLA (at least not unless, and until, the Borrower goes titten hoch). So the Borrower owns them, and has a degree of control over them throughout. If they are not returned, this is likely to be a failure of the custodian, or the triparty system, and not the Lender (who is likely to be a passive participant in an agent lending programme, and not involved in the operational process at all.

The same therefore goes for manufactured income off posted collateral, and a failure to redeliver pledged Collateral.

Automatic Early Termination

Unusually for a securities financing arrangement, there is an Automatic Early Termination provision. There is a separate article on that because it is a bit of an oddity.

No Event of Default without notice

Note that (unlike the ISDA Master Agreement an event only becomes an Event of Default once the Non Defaulting Party has given the Defaulting Party notice of it.

The dog that didn’t bark in the nighttime

More interesting than the Events of Default that are there are the ones that are not: There is no equivalent of:

• Cross Default
• Default under Specified Transaction
• Credit Support Default
• Merger without Assumption
• Illegality
• Tax Event
• Credit Event Upon Merger
• Tax Event Upon Merger

Why not? Well, unlike an ISDA Master Agreement, generally, securities financing transactions are generally short-dated (if repos) or callable on notice (if stock loans) and (unlike an ISDA, where margin is a function of an independent credit support arrangement which may or may not be there) daily margin is a structure feature of the transaction. If your counterparty suffers any kind of credit deterioration, your margin (or its failure to pay it) should cover you, and if it doesn’t, you can immediately — or at least quickly — get out of your exposure. If they unwind okay—great. If they don’t, you have them bang to rights on a Failure to Pay. Simples.

Your more perfidious counterparties might want to start crow-barring these events in — at least, ones like Illegality — especially if you, like many brokers, are in the habit of doing trades on term. An Illegality event ought not poop the nest, but a credit deterioration-related default events like DUST or Cross Default may, seeing as the very point of the term trade is to prove to your accountants you have stable financing of your margin loan operations.

Failures to deliver are not Events of Default

Failures to deliver Securities under a 2010 GMSLA are not Events of Default because failure to deliver securities to initiate a Loan is not a breach of agreement, and if a Borrower fails to redeliver Equivalent Securities at the end of a Loan, the Lender may buy in Securities to cover the fail, and may execute a mini close-out, but that is not an Event of Default either.

But a failure to deliver Collateral at inception or to redeliver Equivalent Collateral on termination is an Event of Default.

Deliveries frequently fail in the stock lending market for many reasons:

• Operational failures, such as a mismatch of instructions.
• A Lender may lose its expected supply (for example a rehypothecating prime broker intending to rehypothecate client’s securities where the client recalls and sells the securities before the Loan settles)
• A market counterparty may fail against the party expecting to deliver under the Loan
• Market events may cause a lack of liquidity — for example, if the shares go “special”

Making delivery failures an Event of Default would put participants in a perpetual state of default even though there were no credit concerns for the "failing” counterparty. Events of Default are really only meant to address counterparty insolvency risk: The innocent party can immediately terminate all outstanding transactions upon an Event of Default and so end its exposure.

Where the creditworthiness of a counterparty is not in question the innocent party can rely on normal contractual remedies for breach of contract.

Allowing a party to declare an Event of Default allows extraordinary leverage for what is often a technical or minor breach.

Compare that with Collateral delivery failures. The Borrower can choose what it delivers as Collateral. If, having done so, the party still fails to deliver, the recipient has grounds for a credit concern.

What is the protection for delivery failures then?

Deliveries in stock lending are usually free of payment: cash collateral moves after the shares settle. This is for 3 reasons:

• The cash collateral is not usually in the same currency as shares, meaning that a delivery versus payment is not practical anyway.
• Requiring DVP would increase an already high failure rate.
• Because of the high failure rate, the cash would frequently be transferred against failed settlements, presenting an inverted credit risk.

In practice, each day participants determine the securities and collateral that are currently held by each party, calculate their values as at market close, and make a collateral calls for any shortfall. A Borrower expecting to be delivered securities would wait for them to settle before paying away cash against a margin call by the Lender. If they were not delivered, the margin call against the Borrower would be reduced.

All other things being equal:

• If a Lender failed to settle at inception there would be no loan and neither party would have any exposure.
• If a Borrower failed to settle at redemption, the Lender would not return Collateral, and (but for intraday market moves) each party would have the same exposure it had previously.

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