Consequences of an Event of Default - Pledge GMSLA Provision

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2018 Global Master Securities Lending Agreement (Pledge Version)
A Jolly Contrarian owner’s manual

Clause 11 in a Nutshell
Use at your own risk, campers!

11 Consequences of an Event of Default
11.1 If an Event of Default happens to either Party:
11.2 Acceleration: Borrower’s obligations will be accelerated as at the time of the Event of Default (the Termination Date) as follows:

11.2(a) The Non-Defaulting Party will determine the Default Market Value of the Borrower’s delivery and payment obligations under paragraph 11.4 as at the Termination Date.
11.2(b) Using those values, [the Non-Defaulting Party will determine and notify][1]what each Party owes as at the Termination Date, converting amounts into the Base Currency at the Spot Rate where necessary, and will set those sums off against each other. The Party owing the greater amount must pay the difference on the Business Day after notification.

11.3 The Default Market Value of any Equivalent Securities will be determined under paragraphs 11.4 to 11.6 below, where:

Appropriate Market is the most appropriate market for any securities determined by the Non-Defaulting Party;
Default Valuation Time means the Close of Business in the Appropriate Market on the fifth dealing day after the Event of Default;
Net Value of any securities means the Non-Defaulting Party’s reasonable opinion of their fair Market Value less (where Lender is the Defaulting Party) or plus (where Borrower is the Defaulting Party), all reasonable costs of any transaction needed under paragraph 11.4 or 11.5 (Transaction Costs).

11.4 Transactions and quotes: If, between the Termination Date and the Default Valuation Time:

11.4(a) Actual sale or purchase: as Non-Defaulting Party, the Borrower has sold or the Lender has purchased, fungible Equivalent Securities it may treat as the Default Market Value the net proceeds of any sale (after deducting Transaction Costs) or the total cost of any purchase (including Transaction Costs). Were the securities sold or purchased are not in identical in amount to the Equivalent Securities, Non-Defaulting Party may in good faith pro rate those values to determine the necessary Default Market Value.
11.4(b) Market quotes: the Non-Defaulting Party has received bids (where it is Borrower) or offers (where it is Lender) for fungible Equivalent Securities from at least two regular participants in the Appropriate Market in what it determines to be a commercially reasonable size, it may treat as the Default Market Value the arithmetic mean of the quoted prices as reasonably adjusted to account for for accrued but unpaid interest and Transaction Costs.

11.5 Where there’s no commercially reasonable value: If, having tried in good faith, the Non-Defaulting Party has not been able to sell nor purchase Securities under paragraph 11.4(a) or obtain quotations under paragraph 11.4(b), or it considers the quotations it did obtain are not commercially reasonable, it may determine the Net Value of the Equivalent Securities and treat that as their Default Market Value.
11.6 If the Non-Defaulting Party has not determined the Default Market Value under 11.4, it will equal the Net Value of the securities in question at the Default Valuation Time. However, if the Non-Defaulting Party determines it is not practicable to calculate a commercially reasonable Net Value at that time, the Default Market Value will be the Net Value it determines as soon as reasonably practicable after the Default Valuation Time.
11.7 Costs and expenses following an Event of Default: The Defaulting Party must pay the Non-Defaulting Party’s reasonable professional expenses in connection with the Event of Default plus interest at the rate agreed by the Parties or, failing that, the overnight LIBOR rate as at 11.00 a.m., London time. Interest will accrue and compound daily.
11.8 Set-off: The Non-Defaulting Party may set off any amount due under paragraph 11.2(b) against any amount payable the other way under any other agreement between the Parties. The Non Defaulting Party may estimate any unascertained obligation but must account for any difference once finally ascertained. This paragraph does not create a security interest, or prejudice any other rights either party may have.
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Clause 11 in full

11 Consequences of an Event of Default
11.1 If an Event of Default occurs in relation to either Party then paragraphs 11.2 to 11.8 below shall apply.
11.2 Borrower’s Delivery and payment obligations (and any other obligations Borrower has under the Agreement including, without limitation, any obligation to pay amounts which have accrued under paragraph 7) shall be accelerated so as to require performance thereof at the time such Event of Default occurs (the date of which shall be the Termination Date) so that performance of such obligations shall be effected only in accordance with the following provisions.

11.2(a) The Default Market Value of the Equivalent Securities to be delivered by Borrower and any amount (including interest accrued) to be paid by Borrower shall be established by the Non-Defaulting Party in accordance with paragraph 11.4 and deemed as at the Termination Date.
11.2(b) On the basis of the sums so established, an account shall be taken (as at the Termination Date) of what is due from each Party to the other under this Agreement (on the basis that Lender's claim against Borrower in respect of Delivery of Equivalent Securities is equal to the Default Market Value thereof) and the sums due from one Party shall be set off against the sums due from the other and only the balance of the account shall be payable (by the Party having the claim valued at the lower amount pursuant to the foregoing) and such balance shall be payable on the next following Business Day after such account has been taken and such sums have been set off in accordance with this paragraph. For the purposes of this calculation, any sum not denominated in the Base Currency shall be converted into the Base Currency at the spot rate prevailing at such dates and times determined by the Non-Defaulting Party acting reasonably.

11.3 For the purposes of this Agreement, the Default Market Value of any Equivalent Securities shall be determined in accordance with paragraphs 11.4 to 11.6 below, and for this purpose:

11.3(a) the Appropriate Market means, in relation to Securities of any description, the market which is the most appropriate market for Securities of that description, as determined by the Non-Defaulting Party;
11.3(b) the Default Valuation Time means, in relation to an Event of Default, the Close of Business in the Appropriate Market on the fifth dealing day after the day on which that Event of Default occurs;
11.3(c) Net Value means at any time, in relation to any Equivalent Securities, the amount which, in the reasonable opinion of the Non-Defaulting Party, represents their fair Market Value, having regard to such pricing sources and methods (which may include, without limitation, internal and external pricing sources, and available prices for Securities with similar maturities, terms and credit characteristics as the relevant Equivalent Securities) as the Non- Defaulting Party considers appropriate less, where Lender is the Defaulting Party, or plus, where Borrower is the Defaulting Party, all Transaction Costs incurred or reasonably anticipated in connection with the purchase or sale of such Securities; and
11.3(d) Transaction Costs in relation to any transaction contemplated in paragraph 11.4 or 11.5 means the reasonable costs, commissions (including internal commissions), fees and expenses (including any mark-up or mark-down or premium paid for guaranteed Delivery) incurred or reasonably anticipated in connection with, where Borrower is the Defaulting Party, the purchase of Equivalent Securities or, where Lender is the Defaulting Party, the sale of Equivalent Securities, calculated on the assumption that the aggregate thereof is the least that could reasonably be expected to be paid in order to carry out the transaction.

11.4 If between the Termination Date and the Default Valuation Time:

11.4(a) Borrower as Non-Defaulting Party has sold, or Lender as Non-Defaulting Party has purchased, Securities which form part of the same issue and are of an identical type and description as the relevant Equivalent Securities, (and regardless as to whether or not such sales or purchases have settled) such Non- Defaulting Party may elect to treat as the Default Market Value:
11.4(a)(i) in the case of such a sale by Borrower as Non-Defaulting Party, the net proceeds of such sale after deducting all Transaction Costs; provided that, where the Securities sold are not identical in amount to the Equivalent Securities, Borrower as Non-Defaulting Party may, acting in good faith, either
(A) elect to treat such net proceeds of sale divided by the amount of Securities sold and multiplied by the amount of the Equivalent Securities as the Default Market Value or
(B) elect to treat such net proceeds of sale of the Equivalent Securities actually sold as the Default Market Value of that proportion of the Equivalent Securities,
and, in the case of (B), the Default Market Value of the balance of the Equivalent Securities shall be determined separately in accordance with the provisions of this paragraph 11.4; or
11.4(a)(ii) in the case of such a purchase by Lender as Non-Defaulting Party, the aggregate cost of such purchase, including all Transaction Costs; provided that, where the Securities purchased are not identical in amount to the Equivalent Securities, Lender as Non-Defaulting Party may, acting in good faith, either
(A) elect to treat such aggregate cost divided by the amount of Securities purchased and multiplied by the amount of the Equivalent Securities as the Default Market Value or
(B) elect to treat the aggregate cost of purchasing the Equivalent Securities actually purchased as the Default Market Value of that proportion of the Equivalent Securities,
and, in the case of (B), the Default Market Value of the balance of the Equivalent Securities shall be determined separately in accordance with the provisions of this paragraph 11.4;
11.4(b) the Non-Defaulting Party has received, where the Non-Defaulting Party is Borrower, bid quotations or, where the Non-Defaulting Party is Lender, offer quotations in respect of Securities which form part of the same issue and are of an identical type and description as the relevant Equivalent Securities from two or more market makers or regular dealers in the Appropriate Market in a commercially reasonable size (as determined by the Non-Defaulting Party) the Non-Defaulting Party may elect to treat as the Default Market Value of the relevant Equivalent Securities:
11.4(b)(i) the price quoted (or where more than one price is so quoted, the arithmetic mean of the prices so quoted) by each of them for, where the Non-Defaulting Party is Borrower, the purchase by the relevant market marker or dealer of such Securities or, where the Non-Defaulting Party is Lender, the sale by the relevant market maker or dealer of such Securities, provided that such price or prices quoted may be adjusted in a commercially reasonable manner by the Non-Defaulting Party to reflect accrued but unpaid coupons not reflected in the price or prices quoted in respect of such Securities;
11.4(b)(ii) after deducting, in the case where the Non-Defaulting Party is Borrower, or adding, in the case where the Non-Defaulting Party is Lender, the Transaction Costs which would be incurred or reasonably anticipated in connection with such transaction.

11.5 If, acting in good faith, either

(A) the Non-Defaulting Party has endeavoured but been unable to sell or purchase Securities in accordance with paragraph 11.4(a) above or to obtain quotations in accordance with paragraph 11.4(b) above (or both) or
(B) the Non- Defaulting Party has determined that it would not be commercially reasonable to sell or purchase Securities at the prices bid or offered or to obtain such quotations, or that it would not be commercially reasonable to use any quotations which it has obtained under paragraph 11.4(b) above

the Non-Defaulting Party may determine the Net Value of the relevant Equivalent Securities (which shall be specified) and the Non-Defaulting Party may elect to treat such Net Value as the Default Market Value of such Equivalent Securities.
11.6 To the extent that the Non-Defaulting Party has not determined the Default Market Value in accordance with paragraph 11.4, the Default Market Value of the relevant Equivalent Securities shall be an amount equal to their Net Value at the Default Valuation Time; provided that, if at the Default Valuation Time the Non-Defaulting Party reasonably determines that, owing to circumstances affecting the market in the Equivalent Securities in question, it is not reasonably practicable for the Non-Defaulting Party to determine a Net Value of such Equivalent Securities which is commercially reasonable (by reason of lack of tradable prices or otherwise), the Default Market Value of such Equivalent Securities shall be an amount equal to their Net Value as determined by the Non-Defaulting Party as soon as reasonably practicable after the Default Valuation Time.
11.7 Other costs, expenses and interest payable in consequence of an Event of Default: The Defaulting Party shall be liable to the Non-Defaulting Party for the amount of all reasonable legal and other professional expenses incurred by the Non-Defaulting Party in connection with or as a consequence of an Event of Default, together with interest thereon at such rate as is agreed by the Parties and specified in paragraph 10 of the Schedule or, failing such agreement, the overnight LIBOR as at 11.00 a.m., London time, on the date on which it is to be determined or, in the case of an expense attributable to a particular transaction and, where the Parties have previously agreed a rate of interest for the transaction, that rate of interest if it is greater than LIBOR. Interest will accrue daily on a compound basis.
11.8 Set-off: Any amount payable to one Party (the Payee) by the other Party (the Payer) under paragraph 11.2(b) may, at the option of the Non-Defaulting Party, be reduced by its set-off against any amount payable (whether at such time or in the future or upon the occurrence of a contingency) by the Payee to the Payer (irrespective of the currency, place of payment or booking office of the obligation) under any other agreement between the Payee and the Payer or instrument or undertaking issued or executed by one Party to, or in favour of, the other Party. If an obligation is unascertained, the Non-Defaulting Party may in good faith estimate that obligation and set off in respect of the estimate, subject to accounting to the other Party when the obligation is ascertained. Nothing in this paragraph shall be effective to create a charge or other security interest. This paragraph shall be without prejudice and in addition to any right of set-off, combination of accounts, lien or other right to which any Party is at any time otherwise entitled (whether by operation of law, contract or otherwise).
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Related agreements and comparisons

Related agreements: Click here for the same clause in the 2010 GMSLA
Comparison: Click to compare the 2010 GMSLA and 2018 Pledge GMSLA versions of this clause.

Resources and navigation

2010 GMSLA: Full wikitext · Nutshell wikitext | GMLSA legal code
Pledge GMSLA: Hard copy (ISLA) · Full wikitext · Nutshell wikitext |
1995 OSLA: Full wikitext · Nutshell wikitext | GMSLA Netting
Let me Google that for you: Guide to equity finance | ISLA’s guide to securities lending for regulators and policy makers
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Content and comparisons

There is little difference between the 2010 GMSLA and the 2018 Pledge GMSLA versions of Consequences of an Event of Default, as you can see more easily in this comparison of the nutshell versions. (There’s a comparison of the full provisions in the usual place in the panel). One thing you will notice is how utterly dismal is the drafting of the original provision. It was no small task to create nutshell versions — you can thank me later — but they boil down to not very much.

The differences that there are are significant, since the philosophical unpinning of what is going on is profoundly different, even if the commercial outcome is the same. Think VHS and Betamax. In a nutshell, under the 2018 Pledge GMSLA:

  • Only the Borrower’s redelivery payments are accelerated, since by the theory of the game, the Lender never gets possession of the collateral and is not therefore in a position to redeliver it.
  • There’s less fog and confusion because ICMA’s crack drafting squad™ in their wisdom removed Letters of Credit as a form of eligible Collateral from the 2018 Pledge GMSLA
  • The reckoning of what is due under Paragraph 11.2(b) — setting off all sums owed by one party against all sums owed by the other — is less fraught, and will always be a net payable back to the Lender (because the Borrower never transferred title to the pledged Collateral in the first place)
  • There is no concept in the2018 Pledge GMSLA of “Deliverable Securities” or “Receivable Securities”, seeing as there will not always be a receiver and a deliverer, so they don’t come into the frame for the reckoning of the Default Market Value in the same way.

ISLA thought leadership

ISLA published a curious piece of thought leadership in September 2018 which painted a worst-case scenario timeline for closing out a 2018 Pledge GMSLA which made it look quite a bit worse than the corresponding critical path under a normal — hardly calculated to set at ease the jittery nerves of a very modern agent lenderer. The perceived difference was this:

2010 GMSLA 2018 Pledge GMSLA
Upon notice of default, Non-Defaulting Party can start immediately liquidate and has 5 days to trade and set pricing to allow for liquidity. You have to return any excess. Upon notice of default Non-Defaulting Party can theoretically start liquidating but has value the pledged Collateral to be transferred. This may take a bit longer in an illiquid market. But seems to the JC there’s no reason you can’t execute trades in the collateral without physically holding it, seeing as it settles later. Any excess goes back to the pledgor.

In either case for the Default Market Value, the main thing you’re valuing is the Loaned Securities not (primarily) the Collateral: as long as you aren’t under-collateralised, and you take steps to get a reasonable price, you can sell all the Collateral — remember, that’s how security works — the Defaulting Party is in the soup and can’t be too particular about what happens to its collateral as long as, once the debt is satisfied, it gets the remainder back. If you are under collateralised, it doesn’t make any odds whether you hold by pledge or title-transfer —either way, you are short.
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Summary

So, how does default and close-out differ between title transfer and pledge versions of the GMSLA, then? Not as much as you might think. The mechanism for determining who owes what is broadly the same but, since the Borrower hasn’t parted company with the Collateral it has pledged — yet — and byt the theory of the game the pledged Collateral is sitting quietly in a segregated account with a triparty custodian, ready to be returned or seized and liquidated, as the circumstances require, all of the Securities valuation mechanisms focus on the Loaned Securities leg of the transaction, since the Borrower won’t, if it has a scooby doo what it is doing, be holding the Loaned Securities at any time during the Loan. It will have sold them short.

It only really comes in to play if the Borrower has defaulted

If the Lender has defaulted, you generally wouldn’t call an Event of Default under a 2018 Pledge GMSLA. There is no need: the Borrower just returns the Loaned Securities, security is released from its pledged Collateral and we all carry on our sedated ways. I mean sedate ways. Sure, if you’re a masochist you could invoke the default process of Paragraph 11, but why would you? The Loan is terminable at will; if you do want out, just terminate it and give Equivalent Securities back, and the security is released from your pledged Collateral. Far easier.

If the Borrower has defaulted, de l’autre main, there is the matter of getting Equivalent Securities back which (a) by our theory, the Borrower hasn’t got, and would therefore have to go out to the market and get, and (b) the Borrower couldn’t, without the permission of its insolvency administrator, give back to you even if it did have one. Therefore the netting and close out provisions are quite handy.

How the closeout works

Anyway, the process on any Event of Default — but let’s presume for the sake of simplicity it is one committed by the Borrower — is this:

  • All Loans are all accelerated, and the Borrower is liable to return Equivalent Securities as at the time of default. It won’t be able to of course, for the reasons given above.
  • So the Lender works out the Default Market Value of the Equivalent Securities. It does this selling Equivalent Securities, getting and averaging quotes for the sale[2] of Equivalent Securities, or, if it can’t, or the quotes seem out of whack, it can come up with its own opinion of their value, factor in any notional Transaction Costs, and use that. Expect an aggrieved Lender to confabulate some difficulty in getting good quotes and to go for using its own opinion more often than you’d necessarily expect. The Borrower’s bust, so what does he care, right?
  • The Lender can also confabulate I mean reasonably calculate its legal costs of closing out, and add those to the Default Market Value
  • Lastly, it can set off against amounts it owes to the Borrower but, unlike under the title transfer 2010 GMSLA, there aren’t likely to be many, seeing as the Collateral leg is not a title transfer collateral arrangement and is still technically owned by the Borrower. But not for long.

Unlike under the 2010 GMSLA the netting mechanic doesn’t do much. There isn’t much to net. The Lender has a large claim against the Borrower, for the Default Market Value, and it satisfies this by enforcing its security under a separate Security Deed. To reiterate what should be obvious, under a pledged collateral arrangement the credit mitigation is by way of security, not netting.

So what about the Collateral then?

Your 2018 Pledge GMSLA leaves you will a closed-out big fat portfolio of receivables owing from the Borrower to the Lender, and a big fat pool of Collateral sitting with the triparty agent, in the Borrower’s name but pledged in favour of the Lender. So the heavy lifting in terms of taking the Collateral is done by the Security Deed. While, intellectually, this cleaves the normal arrangements under a title transfer 2010 GMSLA into two parts, they now work the same way. While it might take a while to work out the Default Market Value, the Lender can exercise on the Collateral immediately there is an Event of Default (though note the Borrower should want some kind of grace period built into failure to pay events reacquiring a period of notice before Collateral can be exercised. It is easier to build that into the definition of non-payment-style Events of Default in Paragraph 10.[3]
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See also

Template:M sa Pledge GMSLA 11
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References

  1. Well, we assume it will be the NDP: the 2018 Pledge GMSLA rather brilliantly puts it into an unattributed passive, as if God is going to to it, or it will magically happen by itself. Go, ISLA’s crack drafting squad™.
  2. Or purchase, but as discussed only an idiot Borrower would use the close-out provisions to terminate a Loan where a Lender defaulted.
  3. Hint hint — we’ve got some suggested language there!