Interpretation - ISDA Provision
2002 ISDA Master Agreement
Section 1 in a Nutshell™
Use at your own risk, campers!
Full text of Section 1
Related agreements and comparisons
Content and comparisons
Section 1 is a gentle introduction indeed to the dappled world of the ISDA Master Agreement: much coming from the “goes without saying, but let’s say it anyway” dept of legal wordwrightery — a large department indeed, in the annals of modern legal practice. It starts getting a bit tasty in Section 1(c) with the Single Agreement, but it’s not until the Section 2(a)(iii) flawed asset provision that you’re properly in the ISDA ninja twilight zone.
In a nutshell: DO NOT ADJUST THIS PROVISION. It does no-one any harm. How could it?
Okay, do not adjust the Single Agreement provision unless you are writing an ISDA Master Agreement for a repackaging vehicle issuing segregated, secured, limited recourse obligations. In that case you — and here I am supposing that “you” are the inhouse legal eagle at the arranging bank, or someone advising her — will have multiple Transactions nominally between the same two entities — your employer and the SPV — but economically being totally distinct, relating as they do to discrete ring-fenced “Series” issued by the SPV and you absolutely do not want these to form a single agreement with each other, or net, or do anything ostensibly desirable like that.
Each Transaction (or set of Transactions, if more than one Transaction attaches to a single Series) stands quite alone, should not be accelerated, cross-defaulted, DUSTed, closed out or heaven forbid netted, just because some other Transaction, relating to another series, has gone arriba. Treat them as if each Series had its own distinct ISDA Master Agreement, completely isolated, air-gapped and insulated against misadventure occurring in other ISDA Master Agreements the SPV has entered with you relating to other Series.
Section 1(c): the Single Agreement
Most of Section 1 may be theatrical throat-clearing, but section 1(c) is important — by some lights, the main reason one even has an ISDA Master Agreement: it vouchsafes your close-out netting analysis, purporting to inextricably bind together all Transactions under the ISDA Master Agreement as part of a single, concerted, nettable whole. Should (God forbid) your counterparty have imploded, an unthinking administrator might feel the three-year jet fuel swap you traded in July 2012 had nothing really to do with your six-month interest rate swap from February last year and when it comes to considering who owes who what, the two should be treated as separate, unitary transactions. It might think this quite enthusiastically if one of those transactions happens out-of-the-money to you, and the other one in-the-money. This, at any rate, has been the dominant fear of the Basel Committee on Bank Supervision since it hit upon the idea of capital relief for master netting agreements in 1986.
“Why, that’s dashed bad luck, old man! You have to pay me that out-of-the-money exposure and while this dead parrot owes you on the other trade, the end of the creditors’ queue is that one you can see over there in the far distance, should you have a telescope on you.”
You might be inclined to say, “but wait: we should be able to set these off surely! This is all the same stuff, right! Swaps! They all go together! They’re not unitary transactions at all!”
Well, Section 1(c) — the one that says “it is all a single agreement, and we would never have done any of this if we had thought for a moment it might not be, and to prove it we are saying this out loud at the very inception of our derivatives relationship” is your friend in making that argument. There are similar provisions in other agreements, but none is so classic or elegant as the ISDA Master Agreement’s.
For details freaks
Assignment and its effect on netting and set-off
Could a right to assign by way of security upset close-out netting such that one should forbid parties making assignments by way of security of their rights under the ISDA Master Agreement, for fear of undermining your carefully organised netting opinions?
- An assignment by way of security is a preferred claim in the assignor’s insolvency over the realised value of certain rights the assignor holds against its counterparty. It is not a direct transfer of those rights to an assignee: the counterparty is still obliged to the assignor, not the assignee, and any claim the assignee would have against the counterparty would only be by way of subrogation of the assignor’s claim, should the assignor have imploded in the meantime or something.
- “Nemo dat quod non habet”: the unaffected counterparty’s rights cannot be improved (or worsened) by assignment and, it being a single agreement, on termination of the agreement the assignee’s claim is to the Termination Amount determined under the ISDA Master Agreement, which involves terminating all Transactions and determining the aggregate mark-to-market and applying close-out netting. No one can give what they do not have.
At the point of close-out, the assignee’s right is to any Termination Amount payable to the Counterparty. Therefore any assignment of rights is logically subject to the netting, as opposed to potentially destructive of it.
But: This is only true insofar as your netting agreement does not actively do something crazy, like disapplying netting of receivables which have been subject to an assignment and dividing these amounts off as “excluded termination amounts not subject to netting”. I know what you are thinking. “But why on God’s green earth would anyone do that?” This is a question you might pose to the FIA’s crack drafting squad™, who confabulated the FIA’s Professional Client Agreement, which does exactly that.
Equivalents in other agreements
- Single Agreement - GMRA Provision
- Single Agreement - GMSLA Provision
- Single Agreement - GTMA Provision
- Except as regards “Bankruptcy” of the SPV, but if you have structured your vehicle correctly, it won’t be able to go bankrupt. And in any case the same bankruptcy event would be an independent Event of Default occurring under each discrete Master Agreement.
- Yes I know: Section 2(a)(iii). We’ll get to that. And in some jurisdictions mandatory insolvency set-off would also spike an administrator’s guns. But for now, let’s say.
- “A chap cannot give away what he doesn’t own in the first place.”
- Except under New York law — isn’t that right, rehypothecation freaks?