Events of Default - Pledge GMSLA Provision
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2018 Global Master Securities Lending Agreement (Pledge version)
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Comparisons
Redlines
2010 ⇒ 2018: Redline of the 2010 GMSLA vs. the 2018 Pledge GMSLA: comparison (and in reverse)
Discussion
The major differences between the 2010 GMSLA and 2018 Pledge GMSLA Events of Default are:
- Collateral obligations: Under the 2010 GMSLA it is bilateral and refers to Cash Collateral and the Delivery, but not return, of non-cash Collateral, whereas the 2018 Pledge GMSLA makes any failure to meet Collateral obligations an Event of Default.
- Manufactured income: Under the 2010 GMSLA it is bilateral; under the 2018 Pledge GMSLA it applies against the Borrower only.
- Failure to Pay or Deliver: Under the 2010 GMSLA it is bilateral; under the 2018 Pledge GMSLA it applies against the Borrower only.
- Insolvency: There is an Automatic Early Termination trigger under the 2010 GMSLA but not the 2018 Pledge GMSLA.
- The remainder of the Events of Default are the same as between the two versions, but the 2018 Pledge GMSLA surprises us at the last moment with a new subparagraph 10.1(j) containing a brand new “breach of security agreement” Event of Default.
Which is nice.
Basics
The consequences and ramifications of Events of default under the 2010 GMSLA and the 2018 Pledge GMSLA are different so this section varies quite a bit between the editions.
The reason for divergence
Why the differences in sections (a) through (d)? These reflect the different theoretical underpinnings. Unlike in the 2010 GMSLA the provider of Collateral in a 2018 Pledge GMSLA does not give up either title to it, or control over it: it sits quietly in a darkened corner of the triparty system, in a pledge account, immobilised, held for the security of a passive principal lender, but not going anywhere.
Unlike most pledge arrangements for financial assets in the derivatives trading world, which are a bit of a pantomime and ultimately a sham,[1] a 2018 Pledge GMSLA pledge really is a pledge. The pledged Collateral assets don’t get re-optimised, they can’t be rehypothecated, sold, used, or eaten by the 2018 Pledge GMSLA (at least not unless, and until, the Borrower goes titten hoch). So the Borrower owns them, and has a degree of control over them throughout. If they are not returned, this is likely to be a failure of the custodian, or the triparty system, and not the Lender (who is likely to be a passive participant in an agent lending programme, and not involved in the operational process at all.
The same therefore goes for manufactured income off posted collateral, and a failure to redeliver pledged Collateral.
To be read with the commentary paragraph 11 (Consequences of an Event of Default) (and for the 2018 Pledge GMSLA verily the accompanying Security Agreement). The way close-out happens under a 2018 Pledge GMSLA is markedly different from the close-out netting regime of the 2010 GMSLA.
Control over assets and the desirability of a grace period before action
Now there’s a subtle point to look out for here about control over assets. If, as is likely under a 2018 Pledge GMSLA, you have pledged your assets to an escrow agent or third party custodian, the key (for your financial reporting friends and relations) will be that you retain ownership of those assets and, more to the point, they stay outside the bankruptcy estate of your Lender. That’s the whole reason you have the 2018 Pledge GMSLA and not an ordinary title-transfer 2010 GMSLA in the first place — to avoid having to hold capital against the credit risk of your Lenders for the return of excess Collateral.
On the other hand, at the point where you, Borrower, are spiralling into a Lehman-shaped crater in the side of a hill is just the point where jumpy Sir from the Lender’s credit sanctioning team will be hyperventilating, jumping up and down on the spot and shrieking at anyone within earshot how he’d like to “put a cap in yo’ ass” and just go and take those assets away from you and start liquidating them.
There’s — at this particular moment in time, and no other — a little tension in the air. As Borrower you need to satisfy your accountants that the assets really are yours, in case the Lender unexpectedly blows up; the Lender wants quick access to them, and to put aside all ceremony, in case you do.
Should we be unthinkably deep in the tail of improbable market events such that both parties are blowing up simultaneously — the sort of event that Fisher Black would tell you ought to be unobservable in a period several times the life in the universe, but that Nassim Nicholas Taleb likes to remind us does happen once every five years or so — these two contingencies can arrive at once. On the theory, the Borrower’s interest trumps the Lender’s, since the security interest keeps the assets out of range of the Borrower’s other creditors. But that is cold comfort for most credit sanctioners, and besides, they don’t want to hang around waiting when collateral values are pogo-ing around with all the market dislocation.
Thus the dynamics dealing with who can tell the escrow agent to do what at any point in time are — sensitive, shall we say. Nowhere did ISLA’s crack drafting squad™ address this in the document. It can be dealt with by a little grace period, requiring the credit officer to wait, not for long, but for long enough to satisfy a financial reporting officer that there is enough time to settle any debts, call off the dogs and carry sedately on.
Try this:
Each Event of Default listed in Paragraph 10.1(a), (b) and (c) will become Events of Default only if, within 2 hours following the Lender’s written notice to the Borrower of the event in question, Borrower has not cured the relevant default in full. Upon the expiry of that 2-hour period without such cure, the Event of Default will occur immediately without the need for further notice from the Lender.
I haven’t got a two-hour grace period! Is that a problem?
Those on the 2018 Pledge GMSLA standard form won’t have that grace period of course. Are you sunk? Possibly not, but you may have to undertake a lonely intellectual voyage taking in topics like constructive trust, tracing of assets, and tortious liability on the part of a third party’s agent for misappropriation of assets to get comfortable.
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See also
References
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2018 Global Master Securities Lending Agreement (Pledge Version)
Clause 10 in a Nutshell™ Use at your own risk, campers!
Full text of Clause 10
Related agreements and comparisons
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Content and comparisons
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.
To compensate, there’s a new “breach of security agreement” Event of Default at 10.1(j). Which is nice.
Summary
See also
References
- ↑ Sorry, Americans, but it is true.