Equity Notional Reset - Equity Derivatives Provision

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Commentary

The Equity Notional Reset is a feature for automatically restriking the Equity Notional Amount on a periodic basis to the preveiling value of the Equity Notional Amount. It has the effect of converting posted collateral - which for financial institutions may suffer a punitive capital treatment - into absolutely paid amounts.

The swap will reset automatically on each Cash Settlement Payment Date, (i.e., usually a Settlement Cycle after each Valuation Date).


Example

Let's say:

  • a swap is struck with an initial Equity Notional Amount of £10m
  • the swap is now out of the money to Party A by £1mm.
  • Party A has therefore posted £1mm in collateral to Party B.

An Equity Notional Reset would operate as follows:

  • The Equity Notional Amount would be reset at £9mm (the calculation being original Equity Notional Amount + Equity Amount, which in this case would be £10mm + £-1mm = £9mm)
  • In consideration for this reduction in the Equity Notional Amount, Party A would become liable to pay an exchange amount of £1mm.
  • at the same time Party B's exposure to Party B would be reduced to nil, meaning Party B would be oblished to return £1mm of equivalent credit support.
  • The return of credit support would be netted off against the exchange amount due, meaning no cashflow would take place.

Result: instead of the swap being out of the money by £1mm and collaterased by that amount, the restruck swap has a MTM of 0 and neither party holds any collateral. "

User Guide

Adapted from the User Guide:

Equity Notional Reset has been amended from the 1996 Definitions by Section 5.10 of the 2002 Definitions to reflect the change in terminology from "Equity Payment Date" to "Cash Settlement Payment Date".

If "Equity Notional Reset" is specified then for the first Cash Settlement Payment Date, the Equity Notional Amount is the amount specified in the Confirmation and, for subsequent Cash Settlement Payment Dates, it is the sum of the Equity Notional Amount in respect of the prior Cash Settlement Payment Date and the Equity Amount in respect of the prior Cash Settlement Payment Date.

Lastly, if a "Notional Amount" has been specified in the Confirmation, such amount will be adjusted as set forth in Sections 5.10(a) and (b) as though it were an Equity Notional Amount.

If parties wish to extend the Floating Amount Payer Calculation Period in the situation where a Payment Date does not correspond with a Cash Settlement Payment Date, they should consider including the following additional language to the end of the definition of Payment Date:

"provided that, if on such date the corresponding Cash Settlement Payment Date has not yet occurred, such Payment Date shall be postponed to the date on which the Cash Settlement Payment Date occurs and the Floating Amount Payer shall pay the Floating Amount due in relation to the relevant Calculation Period on that postponed Payment Date."

As an alternative to extending the Floating Amount Payer Calculation Period in this situation, the parties may wish to defer payment of the Floating Amount to the Cash Settlement Payment Date, and accrue interest during that period. lf the parties wish to take that approach, they may wish to consider adding the following language:

", provided that, if on such date (the "Original Payment Date") the corresponding Cash Settlement Payment Date has not yet occurred, (i) the Calculation Period will be deemed to end on (but exclude) the Original Payment Date, (ii) interest will accrue on the Floating Amount from (and including) the Original Payment Date to (but exch1ding) the Cash Settlement Payment Date at [ ] calculated on the basis of daily compounding and the actual number of days elapsed and (iii) the Floating Amount Payer shall pay the relevant Floating Amount, together with any accrued interest, on the Cash Settlement Payment Date".

Related Provisions

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