Payments - 1987 ISDA Provision
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1987 ISDA Interest Rate and Currency Exchange Agreement
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Crosscheck: 2 in a Nutshell™ Original text:
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Overview
Readers looking for significant differences between the 1992 ISDA and 2002 ISDA will find their socks resolutely still on by the time they get to the end of section 2. Other than some new Multiple Transaction Payment Netting wording designed to untangle a cat’s cradle of language that, in this commentator opinion, didn’t need to be there in the first place, the only significant change in Section 2 is that the Default Interest provision has been removed and now appears, in a gruesomely reorganised format, in Section 9(h) of the 2002 ISDA.
Section 2(a)
The 1987 ISDA, being concerned only with interest rates and currency exchange, does not contemplate delivery, as such. Delivery implies non-cash assets. Therefore portions of 2(a)(i) and 2(a)(ii) were augmented in the 1992 ISDA to cater for this contingency. The 1992 ISDA also added a condition precedent to the flawed asset clause (Section 2(a)(iii)) that no Early Termination Date had been designated.
Thereafter Section 2(a) is identical in the 1992 ISDA and the 2002 ISDA. However the subsidiary definition of Scheduled Settlement Date — a date in which any Section 2(a)(i) obligations fall due — is a new and frankly uncalled-for innovation in the 2002 ISDA.
We have a special page dedicated to Section 2(a)(iii), by the way. That is a brute, and one of the most litigationey parts of the Agreement.
Section 2(b)
But for the new definition of Scheduled Settlement Date in the 2002 ISDA, the 1992 ISDA text is formally the same.
Section 2(c)
The 2002 ISDA introduces the concept of Multiple Transaction Payment Netting, thereby correcting a curiously backward way of applying settlement netting.
Section 2(d)
Other than an “on or after the date on which” embellishment towards the end of the clause, exactly the same text in the 1992 ISDA and the 2002 ISDA.
Section 2(e)
Section 2(e), dealing with default interest, was removed in the 2002 ISDA, and replaced with a spikier, more fulsome Section 9(h) (Interest and Compensation).
A new and different Section 2(e) for the 2002 ISDA was almost revived after the global financial crisis as a tool for imposing a “use it or lose it” trigger on Section 2(a)(iii), but the moment passed. See Condition End Date for more information.
Summary
Section 2(a) contains the fundamental payment and delivery obligations under the ISDA Master Agreement; the remainder of the section is a random collection of harmless and uncontroversial, or even unnecessary, bits of housekeeping such as how one changes settlement instructions (Section 2(b)), under what circumstances the parties can net down offsetting payments in the ordinary course (Section 2(c) — though, spoiler, it is whenever they both feel like it), and arrangements for where and when one grosses up for withholding tax is (Section 2(d)).
Section 2(a)
Section 2 contains the basic nuts and bolts of your obligations under the Transactions you execute. Pay or deliver what you’ve promised to pay or deliver, when you’ve promised to pay it or deliver it, and all will be well.
“Scheduled Settlement Date”
Though it doesn’t say so, at least in the 2002 ISDA the date on which you are obliged to pay or deliver an amount is the “Scheduled Settlement Date”. The ’02 definition only shows up only in Section 2(b) (relating to the time by which you must have notified any change of account details) and then, later, in the tax-related Termination Events (Tax Event and Tax Event Upon Merger). That said, “Scheduled Settlement Date” isn’t defined at all in the 1992 ISDA.
Section 2(a)(iii): the flawed asset provision
And then there’s the mighty flawed asset provision of Section 2(a)(iii). This won’t trouble ISDA negotiators on the way into a swap trading relationship — few enough people understand it sufficiently well to argue about it — but if, as it surely will, the great day of judgment should visit upon the financial markets again some time in the future, expect plenty of tasty argument, between highly-paid King’s Counsel who have spent exactly none of their careers considering derivative contracts, about what it means.
We have some thoughts on that topic, should you be interested, at Section 2(a)(iii).
Section 2(b)
ISDA’s crack drafting squad™ phoning it in, we are obliged to say, and not minded to make any better a job of it when given the opportunity to in 2002. On the other hand, in this time of constant change, it is reassuring to know some things just stay the same.
Section 2(c)
Section 2(c) is about “settlement” or “payment” netting — that is, the operational settlement of offsetting payments due on any day under the normal operation of the Agreement — and not the more drastic close-out netting, which is the Early Termination of all Transactions under Section 6.
If you want to know more about close-out netting, see Single Agreement and Early Termination Amount.
We wonder what the point of this section is, since settlement netting is a factual operational process for performing existing legal obligations, rather than any kind of variation of the parties’ rights and obligations. If you owe me ten pounds and I owe you ten pounds, and we agree to both keep our tenners, what cause of action arises? What loss is there? We have settled our existing obligations differently.
To be sure, if I pay you your tenner and you don’t pay me mine, that’s a different story — but then there is no settlement netting at all. The only time one would wish to enforce settlement netting it must, ipso facto, have happened, so what do you think you’re going to court to enforce?
Section 2(d)
Section 2(d) does the following:
- Net obligation: if a counterparty suffers withholding it generally doesn’t have to gross up – it just remits tax to the revenue and pays net.
- Refund obligation where tax subsequently levied: if a counterparty pays gross and subsequently is levied the tax, the recipient must refund an equivalent amount to the tax.
- Indemnifiable Tax: the one exception is “Indemnifiable Tax” - this is tax arises as a result of the payer’s own status vis-à-vis the withholding jurisdiction. In that case the payer has to gross up, courtesy of a magnificent quintuple negative.
Stamp Tax reimbursement obligations are covered at 4(e), not here.
News from the pedantry front
Happy news, readers: we have a report from the front lines in the battle between substance and form. The JC asked no lesser a tax ninja than Dan Neidle — quietly, the JC is a bit of a fan — the following question:
In the statement, “X may make a deduction or withholding from any payment for or on account of any tax” is there any difference between “deducting” and “withholding”?
They seem to be exact synonyms.
Likewise, “for” vs. “on account of”?
We are pleased to report Mr N opined[1] replied:
I don’t think there’s a difference. Arguably it’s done for clarity, because people normally say “withholding tax” but technically there’s no such thing — it’s a deduction of income tax.
Which is good enough for me. So all of that “shall be entitled to make a deduction or withholding from any payment which it makes pursuant to this agreement for or on account of any Tax” can be scattered to the four winds. Henceforth the JC is going with:
X may deduct Tax from any payment it makes under this Agreement.
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- JC’s “nutshell” summary of the clause
- Background reading and long-form essays
- “Flawed Assets” generally
- What is meant by “payments” and “deliveries”, related conceptual matters, especially as regards “delivery”
- Modern electronic clearance as a practical control
- Wry speculation about what should happen if a counterparty changes its address to somewhere stupid, just to annoy everyone.
- Multiple Transaction Payment Netting — what’s that all about
- Transaction and collateral flows
- The curious timing lapse between transaction payments and collateral marks, and the not particularly good reason why they don’t net settle.
See also
- Flawed asset
- Section 2(a)(iii)
- Commercial imperative
- Netting
- Transaction
- Confirmation
- Office
- Multiple Transaction Payment Netting