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GMSLA Anatomy™
In a Nutshell™ Clause 10:
10. Events of Default
10.1 The following events happening to a Party (the Defaulting Party) will be an Event of Default but (barring Automatic Early Termination) only once the Non Defaulting Party has notified the Defaulting Party:
- 10.1(a) Failure to Deliver: The failure, when required under Paragraph 5, of:
- (i) either party to pay or repay Cash Collateral; or
- (ii) the Borrower to deliver any other Collateral to the Lender;
- 10.1(b) Unremedied failure to manufacture Income: Lender or Borrower fails to manufacture Income on Loaned Securities or Collateral when due and has not remedied that failure within three Business Days of notice from the Non Defaulting Party requiring remediation;
- 10.1(c) Mini-Closeout failure: Either party failing to pay any sum when due following a mini-closeout (that is, under paragraphs 9.1(b) or 9.2(b) or 9.3;
- 10.1(d) Act of Insolvency: An Act of Insolvency occurring to Lender or Borrower. If Automatic Early Termination applies, if anyone presents a winding up petition or appoints a liquidator, it will be an Automatic Early Termination and the Non Defaulting Party need not serve written notice.
- 10.1(e) Breach of warranty: any Lender’s Warranty, or any of the Borrower’s Warranties except the ast one (14(e), about voting on Borrowed Securities) is materially incorrect when made or “deemed”;
- 10.1(f) Repudiation: Either party admitting that it cannot or will not perform any of its obligations hereunder where, upon completion of formalities, that non-performance would be an Event of Default;
- 10.1(g) Seizure of assets: a material part of its assets are ordered to be transferred to a trustee by a regulatory authority under any legislation.
- 10.1(h) Regulatory default: It is declared in default by the appropriate authority or is suspended or expelled from any securities exchange or other self-regulatory organisation, or is suspended from securities dealing by any government agency, for not meeting any requirements relating to financial resources or credit rating;
- 10(i) Other unremedied breach of agreement: Either party defaults on any of its other obligations under this Agreement and does not remedy them within 30 days of the Non Defaulting Party’s written notice requiring remedy.
10.2 Each Party must formally notify the other it if suffers any Event of Default or potential Event of Default.
10.3 There are no remedies for any Event of Default other than those set out in this Agreement.
10.4 Subject to the Failure to Deliver and Consequences of an Event of Default clauses, neither Party may claim consequential losses if the other Party breaches this Agreement.
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2010 GMSLA full text of Clause 10:
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.
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10. Events of Default
- 10.1 List of Events of Default
- 10.1(a): Failure to pay Collateral
- 10.1(b): Unremedied failure to manufacture payments
- 10.1(c): Failure to pay or deliver
- 10.1(d): Insolvency
- 10.1(e): Breach of warranty
- 10.1(f): Repudiation
- 10.1(g): Seizure of assets
- 10.1(h): Suspension from exchange
- 10.1(i): Unremedied failure to perform
- 10.2 Notification of Events of Default
- 10.3 Complete statement of remedies
- 10.4 No consequential loss
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 sells 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.