Correction of Share Prices and Index Levels - Equity Derivatives Provision

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2002 ISDA Equity Derivatives Definitions
A Jolly Contrarian owner’s manual™

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Section 11.4 in a Nutshell

Use at your own risk, campers!
11.4. Correction of Share Prices and Index Levels. If any Exchange price or Index level is corrected by the Exchange or Index Sponsor within a Settlement Cycle of publication, either party may notify the other and the Calculation Agent will determine any resulting payment or adjustment to the Transaction.

Full text of Section 11.4

Section 11.4. Correction of Share Prices and Index Levels. In the event that any price or level published on the Exchange or by the Index Sponsor and which is utilized for any calculation or determination made under a Transaction is subsequently corrected and the correction is published by the Exchange or the Index Sponsor within one Settlement Cycle after the original publication, either party may notify the other party of that correction and the Calculation Agent will determine the amount that is payable or deliverable as a result of that correction, and, to the extent necessary, will adjust the terms of such Transaction to account for such correction.

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This clause deals with what happens of the Index Sponsor or calculation gent or an Exchange screws something up and then quickly takes action to fix it. See also Adjustments to Indices for what to do where the index methodology is changed, the Index is cancelled or disrupted.



Given that a Settlement Cycle means (in the JC’s summary):

1.37. “Settlement Cycle” means the usual period of Clearance System Business Days or Exchange Business Days) following a trade on which settlement usually occurs according to the Exchange’s rules. If there are multiple Exchanges, it will be the longest such period.

You will see these only apply to adjustments that happen quickly following publication of the relevant closing price, by way of snafu.

There is no method for calculating what the adjustment should be, which is commendably laissez faire from ISDA’s crack drafting squad™ but really no more than common sense: trying to solve for an unspecified error in the complex adaptive system that is an equity market is a fool’s errand. The Calculation Agent should usually be the swap dealer, and we would expect any such dealer wanting to keep its clients at all, let alone happy, is going to consult with them and do whatever most appears to be The Decent Thing as long as it does not involve the dealer itself taking a bath.

(There will be some earnest souls in compliance who think the safest thing will be for the dealer to take a bath, but try to resist this siren call, and spare a thought for that other ill-considered bunch of investors: the dealer’s shareholders.)

There is usually a common-sense solution that means the dealer does not take a bath and the investors are treated fairly (remember to treat investors rateably, by the way). All you need is someone on the trading desk to think of it.

Adjustments of this kind are quite rare and tend to happen immediately or not at all

There are some fairly obvious snafus — MSCI’s pricing of its Emerging Markets Index on the day of sanctions were imposed on Russian equities in 2002 — which were apparently wrong, but were not immediately corrected, and in all likelihood (writing a month later) will not be corrected at all.

If they are, it is too late, dear friends: your Index Swap Transaction will be stuck with the original calculation. Comfort yourself thus: even if it were not, your swap dealer would almost certainly have had some means of passing the loss it will inevitably take as a result of the adjustment.

To see why spontaneous, historical adjustments to index levels are unlikely, consider the real world in which indices operate:

  • Path dependency: The index performance is path-dependent: not just that one value, six weeks ago, but every value since will need to be restated.
  • Trading frequency: Bear in mind investors go in and out of these investments quickly, so the administrative or legal burden of figuring out who was affected by an index adjustment, and by how much — all functions of path-dependent time series — are hard, if not impossible to calculate.
  • Synthetic: Indexes are inherently synthetic instruments, meaning the index provider has limited knowledge of who has exposure to the index, and how they may be affected. Unlike, say, an ETF which is long a phyiscal set of securities, investors can take positions on indices without telling the index provider.
  • You can’t please everyone and two wrongs don’t make a right: For every short investor who is furious that the Index forgot to value Russian stocks at nil, there will be a long investor who is delighted. Reversing that mistake some time after you made it is going to generate only the exact opposite emotions among investors — at a net gain of zero on the global happiness index — and will create immense headaches for those manufacturing, issuing and delta-hedging products based on the index — at a net loss to global happiness.

So — it is spilt milk. Cry over it if you must, but don’t try to put it back in the carton.


See also