Events of Default - GMSLA Provision
2010 Global Master Securities Lending Agreement
Clause 10 in a Nutshell™
Full text of Clause 10
Related agreements and comparisons
Content and comparisons
- 10.1 List of Events of Default
- 10.2 Notification of Events of Default
- 10.3 Complete statement of remedies
- 10.4 No consequential loss
Difference between 2010 GMSLA and 2018 Pledge GMSLA
In the 2018 Pledge GMSLA we wave good by to the 2010 GMSLA’s Automatic Early Termination provision — which was only really there to slake the consciences of those worried that netting might not work. In a pledged security arrangement, it is much more old-fashioned and traditional; you’re not really relying on the cute, clever-dickish type of close-out netting that is so warily eyed by ruddy-cheeked German insolvency administrators, no no need for an AET-35 unit.
No Event of Default without notice
The dog that didn’t bark in the nighttime
More interesting than the Events of Default that are there are the ones that are not: There is no:
- Cross Default
- Default under Specified Transaction equivalent
- Credit Support Default equivalent
- Merger without Assumption equivalent
- Illegality equivalent
- Tax Event equivalent
- Credit Event Upon Merger equivalent
- Tax Event Upon Merger equivalent
Why not?: Unlike an ISDA Master Agreement, generally, securities financing transactions are generally short-dated (if repos) or callable on notice (if stock loans) and (unlike an ISDA, where margin is a function of an independent credit support arrangement which may or may not be there) daily margin is a structure feature of the transaction. If your counterparty suffers any kind of credit deterioration, your margin (or its failure to pay it) should cover you, and if it doesn’t, you can immediately — or at least quickly — get out of your exposure. If they unwind okay—great. If they don’t, you have them bang to rights on a Failure to Pay. Simples.
Your more perfidious counterparties might want to start crow-barring these events in — at least, ones like Illegality — especially if you, like many brokers, are in the habit of doing trades on term. An Illegality event ought not poop the nest, but a credit deterioration-related default events like DUST or Cross Default may, seeing as the very point of the term trade is to prove to your accountants you have stable financing of your margin loan operations.
Failures to deliver are not Events of Default
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.
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.
10.1(a): Failure to pay or deliver
- Cash Collateral failures: Any failure to pay or repay cash Collateral when required — the theory being that you can’t blame an upstream counterparty for your failure to deliver cash;
- Non-cash Collateral delivery failures: Any failure to deliver non-cash Collateral (either at inception of by way of further Collateral). Here the Borrower has discretion on what Collateral it delivers, so again doesn't have the excuse that it has suffered an upstream failure. Where it is a Collateral return, the Lender has less discretion, so is more prone to upstream settlement failures. Note that non-delivery of Securities at the commencement of a Loan is not a failure to pay, also for “potential upstream failure” reasons: it just means the Loan doesn’t happen.
- Mini closeout failures: Any failure to pay following exercise of a mini closeout under Paragraph 9. That is, not a failure to redeliver Equivalent Collateral or Securities themselves, but a failure to settle any mini close-out or buy-in following the mini closeout.
But this is not an accident, for the same reason a failure to redeliver Equivalent Securities isn’t an Event of Default. Indeed, it is a plainly deliberate omission. The drafters were careful to capture the payment or repayment of cash, and deliveries and further deliveries of Collateral, but not the return of Equivalent Collateral.
A counterparty may have on-lent, or on-collateralised, with non-cash Collateral it has been posted. It may have exactly the same difficulties in getting hold of it to redeliver as a borrower may in getting hold of Equivalent Securities. So the remedy is to withhold the return of securities, buy in and mini close-out under 9.2 which gives the aggrieved party equivalent rights, but not the right to close out the whole agreement (until there’s a failure of the mini-close out settlement amount itself).
10.1(b): Unremedied failure to manufacture Income
Note the tedious back and forth of notices here.
- First, the Income has to be due under the Collateral or Loaned Securities.
- Then the person obliged under Paragraph 6 to manufacture the Income back has to fail to do so, on that due date.
- Then the aggrieved party has to tell the delinquent one — note: it is not yet technically a “Defaulting Party” as there is a grace period — that it has failed to make that payment, and ask it to make the payment within three Business Days.
- Then the delinquent party has to fail to remediate the manifactured Income payment by close on the third Business Day after that notice. Then the aggreived party can notify the delinquent party — whereupon it becomes a “Defaulting Party” — that it is, finally, an Event of Default.
10.1(c) Minicloseout failure
See commentary above under 10.1(a).
For which you will need the definition of Act of Insolvency, which is not quite the same as the definition of Bankruptcy in the ISDA Master Agreement. I suspect this was just a matter of professional pride for ISLA’s crack drafting squad™, and its ninja forebears when they crafted the equivalent provision in the 1995 OSLA, on which this provision is based
10.1(e): Breach of warranty
Why exclude the 14(e) warranty about not having the primary purpose of voting on the Securities? Search me.
- See 9.1(b) and 9.2(b).
- For a jauntily metaphysical examination of the nature of hard cold folding green stuff — why it is, by nature, profoundly different to any other financial instrument, see our article on cash.
- From those assets that meet the eligibility criteria in the Schedule; moral of story: don’t allow yourself to be too tightly constrained on eligibility criteria.