Market Disruption Event - Equity Derivatives Provision
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2002 ISDA Equity Derivatives Definitions Section 6.3(a) in a Nutshell™ Use at your own risk, campers!
Full text of Section 6.3(a)
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Content and comparisons
Article 6. Valuation
Section 6.1. Valuation Time
Section 6.2. Valuation Date
Section 6.3. General Terms Relating to Market Disruption Events
- 6.3(a) Market Disruption Event
- 6.3(b) Trading Disruption
- 6.3(c) Exchange Disruption
- 6.3(d) Early Closure
Section 6.4. Disrupted Day
Section 6.5. Scheduled Valuation Date
Section 6.6. Consequences of Disrupted Days
Section 6.7. Averaging
- 6.7(a). Averaging Date
- 6.7(b). Settlement Price and Final Price
- 6.7(c). Averaging Date Disruption
- 6.7(d). Adjustments of the Exchange-traded Contract
- 6.7(e). Adjustments to Indices (Averaging)
Section 6.8. Futures Price Valuation
- 6.8(a) Valuation Date (Futures Price Valuation)
- 6.8(b) Additional definitions (Futures Price Valuation)
- 6.8(c) Settlement Price and Final Price (Futures Price Valuation)
- 6.8(d) Adjustments of the Exchange-traded Contract (Futures Price Valuation)
- 6.8(e) Non-Commencement or Discontinuance of the Exchange-traded Contract
- 6.8(f) Corrections of the Official Settlement Price
Market Disruption Events fall in the Valuation chapter of the 2002 ISDA Equity Derivatives Definitions, not the Extraodinary Events. So that should tell you these are disruptions that get in the Calculation Agent’s hair and make valuing the trade harder — annoying, sure, but not so gnarly that the Hedging Party can’t comfortably hedge its exposure, so there’s no need to reprice the Transaction, or call on time on it altogether. To be sure, that time might come — especially if the Market Disruption is prolonged — but as long as you are in the Valuation chapter, the presumption is that it hasn’t come just yet.
If it does, make directly for the Extraordinary Events section (Section 12), and especially the Triple Cocktail.
Summary
The rubber meets the road in the definition of Disrupted Day, whereupon you can find out what happens to your Transaction should you suffer a Market Disruption Event. These apply to Share Transactions, Basket Transactions and Index Transactions: it is least intuitive and most complicated in the case of Index transactions because, having the most underlying components, these are the ones most likely to be only partially disrupted.
An Index is really just an glorified, overgrown dynamic Share Basket, whose constituents from time to time are determined by a third party “index calculation agent” according to pre-formulated index rules.
That being the case, one can’t directly hedge by buying the “Index”: there is no Index, in the abstract, to buy (though of course you can buy index-tracking ETFs and Index futures — though these only really push the fundamental observation down one level). At some point, to hedge the risk of a glorified, overgrown dynamic {{eqderivprov|Share} Basket, someone, somewhere, has to go and buy the Shares in that basket, at the prices that the index determines, and that means having access to the markets on which those index constituents trade, at the point in time at which the index rules say one should take the price of those Shares.
Another oddity is that you are not necessarily trying to hit the best available price for the Share at the time of sale; you are trying to hit the actual price determined by the Index Calculation Agent, however good or bad that price is. That price is usually the “official closing price” of the Exchange.
You cannot, of course, ever guarantee you will be able to trade at exactly the official closing price, but it helps in trying to get near it if the Exchange on which that price is determined is open at the time when that closing price is derived, is liquid, tradable, and isn’t subject to some unforeseen disruption. These are “Market Disruption Events”.
General discussion
Indices
In the case of an Index, the disruption needs to affect 20% of more of the securities comprising the Index for the Index to be treated as disrupted. In that case valuation is moved for the whole index, not just the disrupted part.
Baskets
In the case of Baskets where some underliers are disrupted and some aren’t, only the affected underliers are subject to disruption provisions and the undisrupted aspects settle/value as scheduled.
Exchange and Related Exchange
- Determining which are the “Exchanges” and “Related Exchanges” is ordinarily straightforward as they are specified in the confirmation.
- However, where “All Exchanges” is specified as the “Related Exchange”, then the Market Disruption Event may be triggered if there is a disruption on any exchange where trading has a material effect (as determined by Calculation Agent) on the overall market for futures or options relating to the underlier.
For details freaks
Where share Final Price is determined by reference to the Volume Weighted Average Price during a trading session you may see this following amendment:
- (a) Section 6.3(a) is amended by deleting “at any time during the one hour period that ends at the relevant Valuation Time, Latest Exercise Time, Knock-in Valuation Time or Knock-out Valuation Time, as the case may be” and replacing it with “at any time during the regular trading session on the Exchange, without regard to after hours or any other trading outside of the regular trading session hours”.
- (b) Section 6.3(d) is amended by deleting the remainder of the provision following the term “Scheduled Closing Time” in the fourth line thereof;
- (c) If the final Valuation Date is a Disrupted Day, the Calculation Agent may determine that such day is a Disrupted Day only in part, in which case the Calculation Agent must designate the Valuation Date determined pursuant to Section 6.6(a) for the remaining portion and the Calculation Agent must adjust the Number of Shares for which the Disrupted Day is the Valuation Date and must determine the Final Price based on such adjustments which will be based on such factors as the Calculation Agent considers relevant.
The current US tax interpretation is that benchmarking an equity swap on a US Share to the close is viewed a cross (and one is guilty until proven innocent). Therefore, do not use the official closing price for US Shares at maturity as it would then invalidate them as true derivatives and recharacterise them as repos. Instead, confirm VWAP over the day as an observable benchmark price for termination.
This does not, however, prevent one early-terminating an Equity Swap Transaction on a US Share using methods other than VWAP. Now, if you are a synthetic prime brokerage sort of camper, you might wonder why all this fuss as equity swaps are treated, for most purposes, as undated and are always terminated at the client’s motion as an optional early termination.
Template
See also
- Disrupted Day, being a day on which a Market Disruption Event has occurred.
- Consequences of Disrupted Days;
- Trading Disruption under 6.3(b);
- Exchange;
- Related Exchange;
- Exchange Disruption under 6.3(c);
- Early Closure under 6.3(d).