Default Under Specified Transaction - ISDA Provision
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2002 ISDA Master Agreement A Jolly Contrarian owner’s manual™ 5(a)(v) in all its glory
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Overview
DUST has been expanded in five significant ways by the 2002 ISDA:
- Mini-closeout carveout: Defaults require the acceleration of just the Specified Transaction in question (for general defaults) but off all outstanding transactions under the relevant master agreement (for delivery defaults). This change was made with mini-close-out under repos and stock loans in mind — a concept which the stock loan market invented after the 1992 ISDA was published, so you can’t really blame ISDA’s crack drafting squad™ for overlooking it at first — where delivery failures under are common and do not of themselves indicate weakness in the Defaulting Party’s creditworthiness.
- Credit support failures covered: DUST under the 2002 ISDA can be triggered by default under a credit support arrangement relating to a Specified Transaction. These weren’t included for the 1992 ISDA DUST.
- Shortened cure period: The cure period for a failure to make a final or early termination payment ona Specified Transaction has been reduced from three days to one.
- Repudiation evidence: Repudiation was modified in two significant ways:
- The phrase “or challenges the validity of” was added after “disaffirms, disclaims, repudiates or rejects” to reduce ambiguity as to whether a party’s action constitutes a repudiation; and
- to stiffen the criteria for something to count as a repudiation so as to require written evidence from the repudiating party of its extended middle finger. This is really an articulation of common sense, for it would be a brave risk officer indeed who closed out an ISDA Master Agreement based on an oral communication, or the proverbial extended middle finger, for which she could not subsequently produce in fairly compelling evidence. But still.
- Widened definition of Specified Transaction: The “Specified Transaction” concept has been broadened to include additional transaction types such as repos, and to include a catchall clause designed to include any future derivative products that have not been thought of yet.
The mini closeout point, as we discuss in the commentary below, is technically correct but should have led to a simplification of the DUST provision, rather than a convolution of it. I know what you’re thinking, and you’re right: like that was ever going to happen.
Summary
The connoisseur’s negotiation oubliette.
Default Under Specified Transaction — colloquially, “DUST” — is often confused with Cross Default. In fact, they’re meant to be mutually exclusive. That won’t stop folks conflating them, though. Look, we all do it.
DUST is like Cross Default, but where Cross Default references indebtedness owed to third parties, DUST is all about non-“borrowing” style transactions — e.g., swap agreements, stock loans[1] and repos, but only transactions between the two counterparties.[2]
If a Counterparty[3] experiences an Event of Default under a swap agreement (or other “Specified Transaction”[4] with you, this will be an Event of Default under the ISDA Master Agreement.
Voltaire and DUST
In which ISDA’s crack drafting squad™ got bogged down in the weeds once in 1987, doubled down in their in-weed bogged-downness in 2002, and we’ve been dealing with resulting confusion ever since. A case of perfection being the enemy of good enough, as Voltaire would say, in the JC’s humble opinion, especially in these modern times where, thanks to compulsory daily zero-threshold variation margining, DUST is even more of a dead letter than it even was in the good old days. To our knowledge, no ISDA Master Agreement in history has been closed out using, exclusively, Section 5(a)(v).
That said, the 1992 ISDA version is a bit skew-wiff as regards mini-closeout, and you may find assiduous counterparties hungrily licking their lips at the prospect of a hearty negotiation about this bald man’s comb.
We are talking about other derivative-like transactions, between you and the same counterparty, where the counterparty presents a clear and present danger of blowing up, but where that behaviour has not yet manifested under the present ISDA Master Agreement, meaning you have no grounds to blow them up directly. So, you know, fairly implausible scenario, but still. You want to use the event arising under this other Specified Transaction to detonate the present ISDA. The squad breaks your ability to do so down in to four scenarios:
- Counterparty fails to pay amounts falling due before maturity on a Specified Transaction, and you accelerate that transaction, but not necessarily others under the same master agreement. Here the principle is that any obligation to pay a sum of money on time is fundamental, of the essence and speaks indelibly to a merchant’s credit, whether or not one accelerates other related Specified Transactions (though, actually, walk me through the scenarios in which you wouldn’t, or even weren’t obliged to?)
- Counterparty fails to pay amounts falling due at maturity on a Specified Transaction, so you can’t “accelerate” as such on that Specified Transaction, as it has matured, but you are still out of pocket and of a mind to press a big red button — though, again, curiously, only on this Specified Transaction and not the other outstanding transactions under the same master agreement, even though you could;
- Counterparty fails to deliver assets due under a Specified Transaction, and as a result you accelerate the Specified Transaction (1992 ISDA) or all Specified Transactions under the affected master agreement (2002 ISDA — the 2002 version being designed to carve out things like mini close-out under a 2010 GMSLA as these are not credit-related;
- Counterparty presents you an extended middle finger generally with regard to any obligation under any Specified Transaction, whether you accelerate it or not. Here if your counterparty is playing craziest dude in the room, it has committed a repudiatory breach thereby losing what moral high-ground it might otherwise stand on to expect you to follow form and protocol before closing it out.
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- The JC’s famous Nutshell™ summary of this clause
- Why it attaches to Acceleration, not Default
- Default under any Specified Transaction, and the question of overreach
- Final payments
- Snapshot of differences between Cross Default and DUST
- Why payment acceleration is treated differently to delivery acceleration
- What if I “jump the gun”? Could it be an anticipatory breach?
See also
References
- ↑ I know these sound like borrowing transactions, but they’re fully collateralised, and in fact aren’t.
- ↑ And — sigh — their Credit Support Providers and Specified Entities.
- ↑ Or — sigh — its Credit Support Provider or Specified Entity
- ↑ This is typically wide, though it excludes borrowed money — but check the Agreement!