Credit Support Default - ISDA Provision
2002 ISDA Master Agreement
Section 5(a)(iii) in full
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A bit of pedantic flannel found its way into the 2002 ISDA — it captures not just the failure of the Credit Support Document itself, but any security interest granted under it, catering to the legal eagle’s most paranoid fears that a contractual right can have some sort of distinct ontological existence independently from the agreement which gives it breath and enforceable currency in the first place. But otherwise the same.
Before you even put your hand up: no, a Credit Support Annex between the two counterparties is not a Credit Support Document, at least under the English law construct: there it is a “Transaction” under the ISDA Master Agreement. It is somewhat different with a 1994 ISDA CSA (NY law), but even there the Users’ Guide cautions against treating a direct swap counterparty as a “Credit Support Provider” — the Credit Support Provider is meant to be a third party: hence references to the party itself defaulting directly under a Credit Support Document.
Therefore, tediously — and we think it was avoiding precisely this tediosity that the Users’ Guide had in mind, but, best laid plans and all that — there is an ontological difference between the mechanics of close out when it comes to a failure under a 1994 New York law CSA when compared to non-payment under a 1995 English Law CSA. A 1995 English Law CSA is a Transaction under the ISDA Master Agreement and is not a Credit Support Document. A failure to meet a margin call under a that annex or any of its modern English-law successors is therefore a Failure to Pay or Deliver under Section 5(a)(i) of the actual ISDA Master Agreement; a failure to post under a 1994 New York law CSA is a Section 5(a)(iii) Credit Support Default.
Does this, in practical point of fact, make any difference at all? It may do, if you have negotiated different grace periods under your CSA than those under your ISDA Master Agreement proper. Before you ask why anyone would ever do that, firstly let us say that far more moronic things than that happen every day in the negotiation of global markets documentation, and secondly that, for example, grace periods for regulatory initial margin may well be standardised — and dealers may not have the capacity or appetite to negotiate them tightly, gien the paper war — so you can quite easily see ISDAs with very brief grace periods, and IM CSDs with longer ones.
For paranoia junkies and conspiracy theorists amongst you, note the long reach this event of default gives to a Cross Default provision. Now, granted, in the ordinary course Cross Default keys off borrowed money or indebtedness, and by common convention that does not count out-of-the-money exposures under derivative contracts, so the ISDA Master Agreement’s own events of default should not exacerbate your cross-default risk under other contracts. Unless you widen Specified Indebtedness to include derivative exposures, as some counterparties do.
Now we see that courtesy of Section 5(a)(iii), a default by my Credit Support Provider (which, remember, need not be my parent: it may be an unaffiliated third-party like a bank writing a letter of credit or financial guarantee) is also default under my ISDA Master Agreement, even where I personally am fully solvent, in good standing, of sound credit and up-to-date with my rent, outgoings, credit card payments and so on.
Fair enough, you might say, for that Credit Support Document was a fundamental part of your calculus when you agreed to trade swaps with me in the first place, and so it was — but, since (through 5(a)(iii) that guarantor’s default counts as my default under our ISDA Master Agreement, through a carelessly widened cross-default in another facility that same guarantor default could be used by my other counterparties to accelerate those other facilities, even though those other facilities are not guaranteed by the same guarantor. So there is this ugly — rather theoretical, I grant you, but nonetheless ugly — snowball risk.