Increased Cost of Stock Borrow - Equity Derivatives Provision
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2002 ISDA Equity Derivatives Definitions A Jolly Contrarian owner’s manual™
12.9(a)(viii) and 12.9(b)(v) in all its glory
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Overview
Section 12.9(a): The actual Additional Disruption Events
Summary
A gentler provision than Loss of Stock Borrow — wherein the non-hedging party has to either find a stock borrow for the Hedging Party to execute, or be closed out of its position like that, under an Increased Cost of Stock Borrow, if the Hedging Party notifies an Increased Cost of Stock Borrow, specifying a proposed Price Adjustment, the non-Hedging Party has three options:
- Accept the Price Adjustment, the Transaction is amended and carries on as repriced;
- Make a one-off payment of the determined Price Adjustment; or
- Allow the dealer[1] to terminate the Transaction on the second Scheduled Trading Day.
Only if the Non-Hedging Party has failed to give any such election by the end of the second Scheduled Trading Day can the Hedging Party terminate the Transaction. The Non-Hedging Party can lend the Hedging Party the relevant Shares in the intervening period to mitigate its loss. Template:M summ Equity Derivatives 12.9(b)(vi) Comparing Loss of Stock Borrow and Increased Cost of Stock Borrow: There is a logical hand-off and interaction between Loss of Stock Borrow with Increased Cost of Stock Borrow:
- Under a Loss of Stock Borrow the Non-Hedging Party has a bit less flexibility in what it does: it must pony up (or procure) a stock borrow within 2 Scheduled Trading Days itself, or Hedging Party can terminate outright. Under Increased Cost of Stock Borrow, the worst that can happen is the trade is repriced to take in the higher rate. So ICOSB is the “gentler” provision from the Non-Hedging Party’s perspective.
- If the cost of a stock borrow exceeds the Maximum Stock Loan Rate it is deemed to be (as good as) impossible to borrow stock, so it is treated as a Loss of Stock Borrow, not merely an Increased Cost of Stock Borrow.
- If a counterparty wants to apply Increased Cost of Stock Borrow whatever the cost of an available bid — and given that it can pass the cost on, a synthetic prime broker might be happy to do this — the answer is to disapply Maximum Stock Loan Rate altogether. This means that any possible stock borrow rate, however astronomical, comes under Increased Cost of Stock Borrow, and Loss of Stock Borrow (which is slightly more onerous a termination right) only applies where there are no offers in the market at all.
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- The JC’s famous Nutshell™ summary of this clause
Template:M premium Equity Derivatives 12.9(a)(viii) and 12.9(b)(v)
See also
References
- ↑ The dealer will always be the Hedging Party, though you may on occasion have trouble persuading buy-side counsel of this patently obvious fact.