Template:Isda 6(e)(i) summ isda92prov

Upon a Termination Event under the ISDA Master Agreement it is good to have your payment and calculation methods well-defined. The section {{{{{1}}}|Payments on Early Termination}} (ISDA Master Agreement Section {{{{{1}}}|6(e)}} and Schedule 1(f)) covers this.

{{{{{1}}}|First Method}}

Fun fact: That terrible FT book about derivatives, and other like-minded sources, label the First Method a “limited two-way payments” clause, by which lights Long John Silver was a “limited two-legged pirate”. Less disingenuously also known as a “walkaway clause”, the First Method, which ensured that on close-out a Defaulting Party got paid nothing, regardless of how far in-the-money its Transactions were, was rarely used, even in the heady early 1990s, when derivatives seemed fun, new and mostly harmless.

Under the First Method, a payment is only ever made if the Settlement Amount is payable by the Defaulting Party to the Non-defaulting Party. This is, needless to say, a big fat free option against a Defaulting Party. The First Method is thus a back door to withhold payments that otherwise would due under the ISDA Master Agreement, it is hard to see why anyone in their right mind would give away this kind of optionality at the commencement of a derivative trading relationship, and, predictably, no one did.

Very, very rarely seen.

{{{{{1}}}|Second Method}}

The {{{{{1}}}|Second Method}} is a method of determining the {{{{{1}}}|Early Termination Amount}} due upon close out of an 1992 ISDA. Unlike the {{{{{1}}}|First Method}}, it requires a payment to be made equal to the net value of the {{{{{1}}}|Terminated Transactions}} to whom it is due, regardless whether it is the {{{{{1}}}|Defaulting Party}} or the {{{{{1}}}|Non-defaulting party}}. I.e., the Defaulting Party might get paid. Nice, huh?

Transaction Valuation

The 1992 ISDA provides alternative ways of arriving at a value for your portfolio of {{{{{1}}}|Terminated Transactions}}. This probably seemed like a good idea to ISDA’s crack drafting squad™ at the time — hey look: acid wash denim seemed a good idea at the time, to someone — but it leads to complexity, confusion, fear and loathing.

• {{{{{1}}}|Market Quotation}} requires at least three arm’s length quotations to value the {{{{{1}}}|Transactions}} to be terminated. Since the {{{{{1}}}|Reference Market-makers}} won’t know anything about the state of your {{{{{1}}}|Transaction}}s — and you are hardly likely to tell them — they can hardly be expected to factor your specific {{{{{1}}}|Unpaid Amounts}} into their quotations, so their quotations, if they even give you one, will be to replace the remainder of the Transaction in the abstract, assuming all past payments have been made, and there are no {{{{{1}}}|Unpaid Amounts}}. Therefore, later on in your close-out calculation process, you will have to factor in those {{{{{1}}}|Unpaid Amounts}} yourself.
• {{{{{1}}}|Loss}} allows the {{{{{1}}}|Non-defaulting Party}} to figure out (in "good faith") its losses and costs (minus its gains) replacing {{{{{1}}}|Terminated Transactions}}. While the NDP can to this by reference to dealer quotations, it doesn’t have to. Seeing as, unlike a {{{{{1}}}|Reference Market-maker}}, the {{{{{1}}}|NDP}} itself absolutely does know what the {{{{{1}}}|Unpaid Amounts}} are, ISDA’s crack drafting squad™ thought it easier for the {{{{{1}}}|Loss}} calculation method to factor the {{{{{1}}}|Unpaid Amounts}} in right away, rather than doing that as a separate second step, as per {{{{{1}}}|Market Quotation}}. But this really just confuses things, when it could have all been simple.